This is the first post of a series I’m calling “FI Fundamentals” where I introduce important practices involved to achieve financial independence. I will be publishing each one (six total) throughout the coming days.
This is the first FI Fundamental for a reason. Most FI’ers will say that the easiest way for newcomers to FI to increase their savings rate is to reduce spending, not increase income. Why? Because this has a double effect:
- Your spending is lower, which means you are saving more money, and
- The amount you need to live on is reduced, so the money you have saved for retirement goes further.
We want the difference between income and spending to be as large as reasonably possible. The difference between the two is savings and goes directly toward increasing your net worth, which is what allows you to reach financial independence. The larger your savings, the faster you can achieve financial independence, and that’s good (in case you weren’t sure).
Financial independence isn’t about making yourself miserable through frugality with the hope of somehow becoming magically happy in early retirement*. It is about rejecting consumerism and shifting your spending to the truly important aspects in your life. It is a lifestyle change that should not only improve your finances, but your overall happiness.
A useful way to think about spending is to consider the time you spent to earn that money in the first place. For example, Spendy Sally earns $50,000 per year after tax, which is a salary rate of around $24 per hour. If Sally eats out every meal at a cost of $30 per day, she’s spending $900+ every month. It wouldn’t take much creativity to reduce her monthly food bill below $200 by cooking meals herself, so that $700 difference equates to her working for over 29 hours each month. Just for eating out. This is discussed much more in the book Your Money or Your Life, and I recommend that everyone read it.
Know where your money is going
Welcome to the 21st century! These days you don’t have to write down every transaction and hoard receipts in order to remember where you spent money last month, or even last year. There’s an app for that! Well, lots of apps, actually, but Mint and Personal Capital are the most commonly used. I prefer Mint for tracking spending and Personal Capital for tracking investment performance, but both services can do both.
Simply connect your bank and credit card accounts and Mint or Personal Capital takes care of the rest. Each time you make a purchase, the tracking service will automatically sort it into one of its many common categories. You can also manually choose how you want transactions categorized.
Once you have a baseline for typical spending you can begin to analyze the best ways to make improvements.
Eliminate unnecessary spending
At this point you should begin asking yourself whether the purchases you have made provide you with enough happiness to justify the amount you spent. You don’t have a choice on some things, like (legally required) auto insurance, but you do have a choice on other things, like whether you actual even need to have a car in the first place.
I like to think of my spending similarly to investing – the money that I spend is the investment, and my happiness is the return. If I’m not getting a good return on my investment, I will seek other investment opportunities.
You might decide that there are some things you can’t live without, which is fine. But, 9 times out of 10 (no source), you can find a suitable, less expensive substitute.
Search for substitutes
There is always a less expensive option, but that is easy to forget when we fall into a routine.
In the age of the Internet, do you really need a cable television subscription? Depending on your preferences, you could use streaming services like Netflix, Hulu, Amazon Prime, and Sling TV instead.
Your $80/month unlimited data cell phone plan through Verizon is convenient and reliable, but have you stopped to wonder if there are less expensive options that deliver the same reliable service? There are plenty of cellular providers that charge under $30/month for 1 or 2 GB. There are even free options (for those who use less data, calls, and texts).
Instead of paying for a gym membership, consider buying weights to exercise at home.
Instead of driving to work, consider biking to save money on gas and wear and tear on your car.
Get the idea?
Put your money where your mouth is
A major aspect of FI is identifying what actually makes you happy and only spending money on that. This has two effects:
- You prioritize the important things in your life.
- You save more of your money, which accelerates your progress to FI.
We spend money on what we value. The trouble is that sometimes we fail to differentiate between what we actually value, and what society expects us to value.
- Track your spending using a service such as Mint or Personal Capital (or write everything down with ye olde pen and paper).
- Once you have established a baseline for your spending, analyze each purchase and ask yourself: “Did this purchase bring me enough happiness to justify the time I spent to earn the money to afford it?”
- For the things that you decide bring value to your life, ask yourself: “Could I be spending less?”
- Eliminate unnecessary spending by canceling services and finding alternatives.
*Remember: the purpose of minimizing spending is to optimize consumption and exercise self-control. I think everyone should submit themselves to a moderate amount of voluntary hardship, but only to the point that it feels like it is improving your life. If you find that something you are doing is not bringing you happiness, don’t do it – even if every personal finance guru says you should. Decide what you want, and then figure out how you want to get there.