Common and sensible advice, is to save and invest 20% of your net income. This seems, ironically, both too small to make a significant difference, whilst also seeming a massive lifestyle sacrifice. So most put it off and lose out.
Front loading savings by investing small amounts from the very start of your career will provide disproportionate results due to the effect of compound interest. A small degree of delayed gratification is the ‘Secret” to building financial freedom, and eventual independence.
Some readers are late to the party, perhaps having spent several years spending all that you earn (or more). Although probably earning more, fear of leaving it too late can hold you back. 20%-30% of your net income is a significant amount, and with sustained saving and investing will turn your financial situation around surprisingly quickly.
No matter your stage of life, or how much you earn, progress always feels painfully slow at the start. Whether you are using your savings to pay down a mortgage, build an emergency fund or dollar cost average into an investment, I doubt anyone gets through this without it feeling hopeless at some point.
However, over time, it gradually gets easier – interest starts to compound (whether from interest you don’t pay or interest you earn) and it feels less and less like hard work over time.
Around two years of commitment is needed, in my experience, to feel like you are getting somewhere.
FOMO: The Fear of Missing Out
The fear of missing out (FOMO) is a powerful motivator, often used to sell products, experiences and dodgy investments.
When your friends and colleagues spend insane amounts of money on holidays and luxury vehicles (and they will, long before they are financially ready) you will doubt yourself.
A little bit of the green-eyed monster (envy) will probably make you wonder whether saving and investing is worth it.
It can be really difficult to sustain enthusiasm for such a long-term goal. This FOMO can lead to impulsive spending that can undo a lot of your hard work to date.
Balancing Short and Long term Goals
Nobody’s tomorrow is guaranteed. We see shockingly premature deaths and terminal illness during our work all the time. This does tend to give you a skewed perspective. Of course, the vast majority of healthy people don’t need to see a doctor.
Particularly sad cases, especially if their lives before illness mirror our own, tend to have a powerful effect on our thinking. It is definitely not worth living in deprivation for a future that is not guaranteed.
In reality, life expectancy in Australia is 82.5 years and readers of this blog are in a wealthier demographic than the average.
It is very likely you will live a long life. It makes no sense living only for today.
There has to be a balance between FOMO and YOLO (You Only Live Once), so neither your current or future self is short changed.
Exactly where the balance is right is very individual.
Why Budget Fun Money
With a long-term goal requiring some delayed gratification, it is vital to have some encouragement strategies along the way. Some of the strategies I use include:
- Reading regularly about financial independence through email subscriptions, facebook/twitter and Money Magazine. I think the subscriptions are important – I aminvoluntarily reminded of good financial management even when I’m not “In the mood” and over time has helped me refocus·
- Setting short-term goals and celebrating them. Start with regular goals (Save my first $1000…) and wean yourself to longer one
- Budgeting for “Fun money”
- Writing this blog – Keeps me busy and less impatient with the inevitably slow progress. Researching topics in so much detail sometimes gives me a whole new idea or way to look at a topic.
- Making a financial plan and reviewing it (and progress) twice yearly
“Fun money” should be completely guilt free. I know how much is allocated to the “fun account” each pay, but don’t track the actual spending within that account.
Of the household money management techniques I have read about, separating discretionary from essential spending is the key to success.
Having a smaller account from which discretionary spending, or fun money is spent and saved allows budgeting on a much smaller, and less complicated scale.
All essential spending comes out of a different account, and so doesn’t need intense scrutiny more than once or twice a year, when essential spending categories are examined to see whether spending can be reduced (e.g. shopping around for cheaper insurance premiums).
Having this smaller account makes spending decisions more transparent.
Instead of money just disappearing, if too much is spent from the fun money account, it runs out. You are then confronted with the consequences of excessive spending, by denying yourself your favourite takeaway coffee, beer with mates until pay day.
As long as you stick with the system, this is a powerful way to limit discretionary spending to reasonable amounts.
You will find yourself consciously making decisions on which discretionary spending item you value more, and only spending on expenses that are worthwhile for you. Seems so simple!
Yet this is the cornerstone of effective money management, and spending less than you earn – a skill that most people haven’t learnt, or choose not to practice.
FOMO even motivates me to save a portion of my fun money, for impromptu fun opportunities. I’m hoping for a weekend in New York one day.
Fun Money for Couples
Allocated spending money for fun comes in even more useful when you have merged finances with a life partner.
It is rare that both members of a couple are on exactly the same page financially – usually one is a relative saver, the other a spender – with huge variations in extremes.
But this provides plenty of potential for conflict, argument and resentment. What are the results if one partner is obsessed with saving a home deposit, and the other blows $500 on a play station or Dyson Air Wrap? Sound familiar?
These conflicts are almost universal in couples at some time in their relationship.
It is important to have some completely separate cash that each partner can spend without criticism or judgement.
How Much Fun Money should I Budget?
Enough fun money should be budgeted so that you don’t feel deprived, but not so much you can afford everything.
The fun money strategy has to force you to make value decisions.
Paula Pant is a prominent financial blogger who has coined the phrase “You can afford anything…But not everything”. I think some on high incomes don’t realise this applies to them too!
Ideally, you would start with a financial plan, and work back to see how much fun money you can afford.
Many will be better off starting with limiting their fun money to a reasonable level first, and realising that doesn’t mean deprivation, just more conscious spending on what you actually value.
Not increasing this “Fun money” when payrises occur will result in a relatively painless increase in savings rate over a few years.
The Aussie Doc Freedom household based our fun money on Barefoot investors advise – 20% of net income on “Blow it” money. Half of our “blow” money goes towards joint discretionary spend such as holidays, Christmas gifts, and home improvements.
The other 10% of our net income is split evenly between the two adults, providing a pretty generous allowance to spend on whatever we like.
Balance priorities for now and later. Allow yourself a fun budget, and stick to it, to build the habit of prioritising the way you spend you money. Spend less than you earn, build up to 20-30% of your net income save. Stick to it for 2 years and just see how far you have come!