This is the first of ten posts describing the key pillars of building a strong financial foundation. Read the introduction here. Check back each Monday for the next post in the series. When you break down what can be done with money at the root level there are not many categories. You can make money, save money and spend money. Spending money is the easiest to do and most dangerous of the three categories, so I will focus on it for the first pillar of building a strong financial foundation.
What should someone spend their money on? A roof over their head would be a start. Food for their family is a necessity. But beyond the basic needs of food and shelter what should people be spending their money on? It is easy to think about possessions or experiences that people do spend their money on: Fancy cars, large houses and exotic trips. It is much harder to differentiate between the “do” and the “should”.
My philosophy on money is that you should only spend money on things that add value to your life. Let’s say you are hungry and are trying to decide if you want to make food at home or go out to a restaurant. Do you only focus on the instant gratification of a ten or twenty dollar meal from a local chain or do you think beyond today’s hunger towards long term financial goals? Doesn’t eating an expensive meal out add value to your life? If so, that’s great! More power to you. If it doesn’t though, make something fresh and hopefully healthier at home and save the money.
This carries into many other areas of life also. Does driving an expensive new car add value to your life or would you be just as satisfied with a used car? Do you really need to buy the latest gadget right when it comes out or do you already have a possession that serves all the same purposes? Do you need to take a vacation all the way across the world or can you get just as much adventure and relaxation within driving distance? I am not saying that you should avoid spending money on parts of your life that matter to you, I am saying that you should be conscious of if you value what you spend your money on.
Now what shouldn’t you spend your money on? It is not a good idea to spend money on possessions that quickly or completely depreciate in value. An example of this would a brand new car. The minute you drive the car off the lot is loses a substantial amount of value. Unless the item you buy that decreases in financial value increases the value of your life in some other way, you should avoid the purchase and find a better alternative.
By not spending money you are able to save or invest your money in the future. What does this mean exactly? If you decide against purchasing an upgrade to your television that is just a few years old, you can put that money towards savings for a car, retirement, a college fund for your children or even set it aside until your current television dies and really does need to be replaced. Put the money in a savings account or other investments that can earn interest and you will be able to keep contributing towards a savings goal. It is amazing how much money can be saved to pay off debt or plan for large purchases just by delaying the instant gratification of spending. Put the 30 day rule in place I described during my financial journey. Make a separate savings account at your bank for “Delayed Gratification”. Put the aside the cash you don’t spend in an envelope for a rainy day. By not spending money now, you have more to spend later.
Another key point on spending is that credit should only be used for emergencies. Buying a pair of shoes on sale is not an emergency. Neither is having internet on your phone. Spending money you don’t have is not a game that should be played. When you are carrying a credit card balance from month to month, not only are you losing money by paying interest on your debts you are lowering your credit score. Having debt also gives you less independence from your current job situation. Debt (which is the pillar I’ll discuss next Monday) can be used for good, but having bad debt can slowly destroy someone’s financial life.
One simple way to look at how someone should spend their money comes from the book All Your Worth by Elizabeth Warren and Amelia Warren Tyagi. In the book they describe a 50/30/20 rule to use with your money. You spend 50% of your money on must-needs: food, shelter, insurance, transportation, etc. You then allocate 30% to spend on wants: entertainment, going out to restaurants, cable television, etc. Lastly, you save 20%: savings for a down payment on a house, retirement accounts, debt repayments. This is a simple way to start categorizing how much money you spend on each part of your life and can help organize your spending in a way that is easily understood.
Eventually, all the money you have will either be spent or given away. While in the end it is your choice as to how you handle your money don’t forget that every little bit that you save helps you towards your long term life goals. Check back next Monday when I’ll discuss debt.
Are you proud of how you have spent your money or do you have a bunch of regrets? Leave a comment below.
Financial Foundations Series