So far, I’ve blogged a couple of posts about saving, and how you can completely automate it. However, in a seemingly about-face in my philosophy of prudent saving, my previous post was about spending extravagantly on the things you love. My friend Paul told me that it might be a tad confusing for everyone, so I decided to take the opportunity to clear the air, and sneak in a little tip on how you can spend on what you love, yet not sacrifice your long run savings.
I used to joke that I should create a charity called the “Buy Lionel a Porsche Fund” and I’d pester people to donate to ‘a worthwhile cause’ (hey, it’s worthwhile to me). Even though it’s pretty unlikely you could get people to donate to your charity, there’s nothing to stop you from donating to it. Here’s the crux of it – when your money comes in every month, it should be divided into three parts:
1. Your long-run savings (which would also include funds for investment, or your downpayment on your house, etc)
2. All those mandatory expenses (your rent, your mortgage, utility bills, phone bills, insurance, etc) that are annoying, but necessary to ensure you’re not a hobo.
3. Your Guilt-Free Spending Fund, which you can use to spend on whatever the hell you want.
The reason why I could afford to drop a thousand dollars on a dance trip to Europe without a single shred of guilt was because I took care of parts 1 and 2 first. Here’s how to do it:
First, decide on how much you want to save (more on this later – because this involves planning for your investments and your retirement. But for now, just pick a reasonable arbitrary amount and stick with it.) Next, take stock of all your mandatory monthly expenses. If you’re a single young executive, this exercise shouldn’t take you more than 10 minutes – just pull all your bills from last month and examine them for anything that’s recurring: your phone bill, insurance premiums, subscriptions, food, whatever. Most of them should be more or less the same amount every month. Then, add 15% to that for any unexpected expenses. (I call this my ‘Stupid Mistakes’ fund – more on this in another post)
Once your savings and expenses have been subtracted from your income, whatever’s left over automatically goes into your Guilt-Free Spending Fund. Now this is where you can draw your money from and spend the heck out of it on things that you love, whether it’s a trip to the Maldives, or watches, or shopping, or kinky sex toys (hey, whatever floats your boat). This is why I can afford to spend money on dance classes and not worry about retirement. Sure, maybe it’ll take you a couple of months to save up for that expensive trip, but once you’ve reached your target, you should have no qualms about spending it… because you’re worth it. (cue L’Oreal model flicking her hair and smiling)
Like my previous posts on saving, you can create a system to build your Guilt-Free Spending Fund, without ever having to worry about whether you’re spending too much or not. If you’ve followed the advice from my previous post, you probably have 2 accounts: a current (or checking) account that your salary gets deposited into, and a savings account. If your bank lets you partition your current account, then create a sub-account for this purpose. In Singapore, where I live, I don’t really know of any banks that let you do that, so I did the next best thing – I signed up for a POSB MySavings account. I chose this because POSB lets you transfer money to and from this account seamlessly and for free. Your interest rate in the MySavings account gets hit when you withdraw money from it, but since the money is not going to be there for very long (it’s meant to be spent, remember?), it’s not going to make much of a difference.
It then becomes very obvious when your accounts are segregated. Your current account is for paying off all your expenses, your savings account is for your long-term savings and investments, and your third account is for your guilt-free expenses.
You can then automate the building of your Guilt-Free Spending fund by setting up automatic transfers with your bank. Arrange for your bank to automatically transfer this amount into your third account on a monthly basis: Amount to transfer = your income – [(your expenses) x 1.15], where the extra 15% is for unexpected expenses. That’s it. You now have an account where you know you could spend the entire amount in it tomorrow, and you know you won’t starve or compromise on your future. It’s a liberating feeling.
I love this account. It’s the one account I actually love seeing a low bank balance on, because it shows that I’ve been living an awesome life by spending when I deserve it. Of course, if you’re saving up for a specific goal, say an expensive trip or Christmas gifts and parties, then you can’t blow the entire account tomorrow. But the same principle holds – that money is for you to spend, and it’s your reward for working hard and saving. Enjoy it.