Budgets That Work Distinguish Between Seven Types of Spending: Type #1 — Basics-of-Living Spending
A good percentage of your spending is directed to the basics of living, spending categories that you can’t do much about. You’ve got to pay the rent. You can’t do without electricity. You need health insurance. It’s important to distinguish this type of spending from types over which you have some control. If half of your budget covers the basics of living, you might have only $30,000 of spending rather than $60,000 of spending from which to identify any spending cuts.
Be careful not to include the entire amount of spending directed to a category that is primarily but not entirely a Basics-of-Living spending category as Basics-of-Living spending. Some portion of your rent should be characterized as Basics-of-Living spending because you need shelter from the elements. But if you paid extra to live one block from work and to have an extra bedroom and a breathtaking view, some of the money you are paying for rent belongs in a classification other than the Basics-of-Living classification.
Always be on the lookout for strategies that permit you to lower your spending on Basics-of-Living categories. When I was earning a big income at a corporate consulting job, my category for “Income Taxes” was huge. Today, my income is not big enough for me to need to pay income tax. I saved a bundle by eliminating that Basics-of-Living category for several years (until the earnings from my writing business is large enough to require me to pay income tax again).
I also eliminated the biggest cost of housing by paying off my mortgage. As a result, I can cover my Basics-of-Living costs much easier today that I could have at an earlier time.
Budgets That Work Distinguish Between Seven Types of Spending: Type #2 — Circumstance-Conditioned Spending
Circumstance-Conditioned Spending is spending that could be viewed as good or bad, depending on the circumstances of the individual considering it. For example, spending on a high-priced car might be viewed as a bad idea if done early in life, where it most damages efforts to reach early financial freedom. But it could be viewed as positive if done at a stage of life where financial freedom has been reached and where the life-affirming attributes of the automobile can be better appreciated by the owner.
There is no such thing as “good” spending or “bad” spending. All spending is to some extent Circumstance-Conditioned Spending. This classification is for spending items that are particularly circumstance-conditioned.
Another example is spending on an expensive vacation prior to having children. An argument can be made that this is Luxury Spending. But if the thought is that there will not be another opportunity for a vacation involving travel for a good number of years, this spending could properly be viewed as Circumstance-Conditioned Spending.
Does it matter in which of the two categories you place this spending item? It does if you are seeking to make well-considered decisions as to how to obtain the best value proposition from the limited pool of dollars that passes through your hands. You might quite justifiably permit yourself some Circumstance-Conditioned Spending at a time when you are seeking to eliminate Luxury Spending.
Budgets That Work Distinguish Between Seven Types of Spending: Type #3 — Inspiration Spending
One of the primary purposes of a budget is to rationalize your spending decisions. I believe that one of the problems that many of us have sticking to a budget is that we resist this rationalization project because, taken too far, it becomes artificial and even absurd. Life is not an entirely rational affair. Perhaps you’ve noticed. Go too far with the rationalization project, and you risk taking the juice out of the orange.
Say that you are going through your spending categories one by one seeking to find places to make spending cuts. You’re having a hard time identifying enough cuts to reach your goal. Then you come across a category called “Charity.” Hey, that’s easy. Cut that one and you won’t notice any pain whatsoever, right? It’s easy money.
It’s not easy money. Stop giving money to charity and it is going to change how you feel about yourself and your place in the world. There are times when it makes sense to cut spending on charity. There are times when it does not. You can’t debate this one solely by looking at considerations that can fairly be characterized as “rational.” There are reasons why you spend money on charity, but those reasons are of a different nature than the reasons behind most of your other spending categories.
There’s one that comes up on Retire Early boards all the time. Kids. Aspiring early retirees are trying to do everything they can to get to financial freedom as early in life as possible. Not having kids would help out a whole big bunch, right? .
In a direct financial sense, it would help out a lot. I see a big flaw in thinking about things that way, however.
It’s not my place to advise you whether it’s a good idea for you to have kids or not. It is my place to tell you that this is not a decision that can be rationalized in the way that many other spending decisions can be rationalized.
Spending on charity and on raising children can in many circumstances provide a long-term financial payoff. Those who give, get. It’s a paradox, but it’s true for all that. My desire to do right by my boys inspires me to work harder than I would work if I didn’t possess that desire. Hard work often produces a big payoff. And of course there are all sorts of non-financial payoffs that come from giving to charity and having kids that anyone concerned about living a rich life (that’s the point of effective money management, of course) needs to consider too.
You do need to include Inspiration Spending categories in your budget. You do need to devote thought to them; mindless spending on charity and on raising children is as unfortunate as mindless spending on anything else. But you need to take different sorts of considerations into account when deciding how much to spend on Inspiration-Spending categories.
Again, please note that a category that is primarily an Inspiration-Spending category is not necessarily entirely an Inspiration-Spending category. Some of the money you direct to raising your kids probably qualifies as Luxury Spending or falls into one of the other categories.
Budgets That Work Distinguish Between Seven Types of Spending: Type #4 — Research and Development
They tell you that it’s dumb to borrow. They also tell you that it’s dumb not to go to school. You can’t go to school without borrowing. The advice they are giving you doesn’t add up.
Spending on the right kinds of schooling is spending on the Research and Development Department of You, Inc. There’s money going out, to be sure. But the purpose of this kind of spending is to bring money in at a later time-period. This is smart spending. This is spending that aids your financial freedom quest rather than hinders it.
Proceed with caution, however. Once you learn that Research-and-Development Spending is “okay,” you are going to feel a temptation to categorize all sorts of things as Research-and-Development Spending. Is spending for a wine appreciation class Research-and-Development Spending? Is spending for braces Research-and-Development Spending? Is spending for clothes that will give you a more professional look Research-and-Development Spending? Is spending on a vacation you need to recover from a stressful work project Research-and-Development Spending?
These are not silly questions. But if you classify every spending desire that has some Research-and-Development angle to it as Research-and-Development Spending and permit yourself freedom to engage generously in Research-and-Development Spending, you are going to have problems winning financial freedom early in life. You really do want to give freer rein to desires for genuine Research-and-Development Spending. You need to be tough with yourself when you feel a temptation to place a questionable spending item in that category, however.
Budgets That Work Distinguish Between Seven Types of Spending: Type #5 — Comfort Spending
Most people understand the difference between Basics-of-Life Spending and Luxury Spending, and most people understand that it is in the area of Luxury Spending where spending cuts are most needed. The problem that many have in writing effective budgets is that they do not make sufficiently careful distinctions in considering the many spending items that fall somewhere between the two extremes. The reality is that most of us could get by on very little spending if we were willing to get along only on Basics-of-Life Spending, but we are just not interested in exploring the possibility. It’s a mistake, though, just to throw up our hands and not try to cut out some of the luxuries and thereby win financial freedom years sooner.
A helpful step is to appreciate the distinctions between different levels of luxury. Your dream car would cost you $50,000. You could buy something that would provide you reliable transportation to work for $5,000. Is everything you spend on a car above $5,000 Luxury Spending then? In a strict sense, yes. However, I think it makes more sense to consider a car-purchase expense of greater than $5,000 and less than $20,000 as Comfort Spending and only a car-purchase expense of greater than $20,000 as Luxury Spending.
Budgeting should not be primarily an effort in self-control, in my view. It should be primarily an effort in self-education. You are seeking to learn what spending dollars provide a great bang for the buck and what spending dollars offer a less than satisfactory long-term value proposition. Spending on the comforts of modern-day middle-class life often provide a strong value proposition, while spending that provides for something beyond that are often truly wasteful.
Different people need to draw the line at different places. For some, financial freedom is so pressing a goal that it does not make sense to direct too many dollars to Comfort Spending. For most. a good bit of Comfort Spending makes sense and it is in the area of Luxury Spending where cutting efforts should be focused.
Budgets That Work Distinguish Between Seven Types of Spending: Type #6 — Strong-Personal-Desire Spending
There are some people who absolutely love cars. Those people should be spending more on cars than most others. There are some people who absolutely love eating out. Those people should be spending more on eating out than most others. There are some people who absolutely love going to baseball games. Those people should be spending more on baseball games than most others.
If you really love something, but you most certainly don’t need it, is it a luxury? It is. But, if it’s a luxury for which you feel an intense desire, it should be treated differently than other luxuries. Strong-Personal-Desire Spending provides a better value proposition than does spending on run-of-the-mill luxuries.
Budgets That Work Distinguish Between Seven Types of Spending: Type #7 — Luxury Spending
What’s left? The true luxuries. Nix them!
I’m joking. Even pure Luxury Spending provides value, just not enough in many circumstances to compete with the value proposition offered by saving.
Luxury Spending makes sense in some cases. But it is on Luxury Spending that you should focus your efforts if you are seeking to make changes permitting you to retire early or pursue some other financial freedom goal. You should review all spending categories, of course. There are probably cuts that you can make in all of them. Luxury Spending cuts comes first.
You may not feel immediately excited about the idea of cutting even Luxury Spending. It’s unlikely, though, that you will come to regret it. One of the benefits of thinking through the distinctions between different types of spending is that it identifies for you the pure luxuries, the spending items that you can eliminate without much worry that spending was providing more life enhancement than could be provided by saving. Luxury Spending is the low-hanging fruit of your budgeting effort.