Smart Frugality
In an earlier post, we touched upon why frugality can be a major lever in one's quest for perpetual satisfaction/happiness. But a lot of people new to this concept think it's so complex to achieve frugality. In practice, frugality is a lot easier than most people make it out to be. Smart frugality is this idea, derived from the Pareto principle, that 20% of the work can easily result in 80% of the gains.
If you don't really care about the philosophical aspect of frugality, and only care about the dollars and numbers, simply being mindful of the following 6 areas of your life (in decreasing order of impact) can easily get you 80% of the way to a fairly frugal life. You won't quite become a guru of frugality, but it's a very good start for the uninitiated.
Smart frugality isn't so much about using a reusable cloth towel to wipe a spill instead of a paper towel, although that would be pretty nice. It isn't about turning off all the lights when you leave home, although that would be pretty environmentally friendly as well. It's about putting your effort into what matters the most. It's also about setting things up to work on auto-pilot so you don't have to think about it every day or every week.
- Housing
Your housing expenses have the largest impact on your savings rate. This is because most people spend the largest slice of their take-home money on rent. Housing therefore offers you the largest leverage to reducing your housing expenses. This is one of those decisions where you make the right call once and enjoy the benefits for at least a few years. Especially in a city like San Francisco where I live, living just a few blocks away from the core of the city can easily make a big step-function dent in your rent. Same with getting roommates. You then get to enjoy the benefits of the new lower rent for at least a year to until you move out.
People generally ask what percentage of their net after-tax income they should be spending on housing. There's no right answer here and it depends a lot on the city you live in and whether you're renting or bought. The lower the percentage, the bigger your savings rate. A lot of people I know spend around 33% in San Francisco which is normal here. If you're at 40%, that's probably too high. I'm personally at 22% which I'm very happy with, 16% if you assume I get all principal payments back in the future. I'd be able to go down even more pretty easily, but would have to endure a longer commute.
Potential savings: $700-$1200 every single month.
- Taxes
The less you pay in taxes each year, the higher your savings rate. This means taking maximal advantage of all your available deductions. Mortgage interest and property taxes are the biggest ones if you own a place. However, regardless of whether you rent or bought, maxing out your 401(k) account every single year is absolutely essential. Not only does the 401(k) force you to save + invest a minimum amount each year, it also chops off all federal and state taxes on that $18k at the marginal (highest) rate. These savings can add up pretty quickly over the years.
After you've maxed out your 401(k), time to put in another $5.5k into your Traditional IRA (if you qualify), and then another $3.4k into your HSA (if you have one). Finally, if you have known health care expenses, put additional money into your tax-free FSA, and keep your HSA untouched for retirement. Finally, be sure to pay your commute expenses (train/bus/parking) via tax-free deductions. If you bike to work, most decent-sized companies give you $20/mo for free to use towards almost any bike-related expense.
Thinking about getting married? Probably a bad idea financially, at least here in the United States, if both members are high income earners without kids (I call these people DINKS: double income, no kids). However, if your partner earns significantly less than you or close to nothing, you can "transfer" some of your income to your low-income-earning partner thereby reducing your combined tax burden. If you're already living with someone like that and don't mind sealing the deal, getting married might be a good strategy money-wise. Likewise, if you're already married to someone and both of you are high income earners, a paper divorce might not be the worst of ideas from a purely tax perspective. From a social perspective, your mileage might vary, but nobody has to know about your legal married status, do they?
The Traditional IRA deduction limit also favors unmarried individuals over a married couple with double income. In 2017 for instance, you get phased out of IRA deductions at $72k individually ($144k combined), but as a married couple, you get phased out sooner at $119k combined, a whole $25k earlier.
This is not official tax or legal advise so run your own numbers or consult someone professional before making actual decisions.
Potential savings: $450-$650 every single month.
- Car
If you don't need a car for work or to get to work, you should probably sell it. Cars are fairly expensive from a total-cost-of-ownership perspective. There's plenty of cheaper on-demand rental options these days for the weekend like Zipcar, Getaround, and Uber. If you have easy commute options to work, stop driving to work! You'll save a ton on insurance, gas, wear & tear, and expensive parking. Lastly, if you must own a car, only buy a used car, ideally with cash. If you must lease or get an auto-loan, try to negotiate an interest rate as close to 0% as possible.
Potential savings: $300-$650 every single month.
- Eating out
Do you tally up your monthly restaurant expenses? If not, you really should because even people who think they're frugal are surprised when they see their restaurant totals over a month or year. The only way to be absolutely sure is to use free online tools like Mint or Personal Capital to aggregate your restaurant spend. I personally only spend $70/month on restaurants these days because I feel like I've eaten out enough in the last 10 years to last me a lifetime. I'm actually trying to get that number down even more. In comparison, a lot of my friends spend anywhere between $300-$1500 per month.
How do you reduce your restaurant spend? Easy! Just buy more groceries and cook at home. On the weekends, engage in potlucks and picnics with your friends rather than going out to eat at fancy restaurants. Even if you buy groceries from the fanciest grocery store in town like Whole Foods or Woodlands, it doesn't come close to eating out.
Potential savings: $300-$1000 every single month.
- Travel
Travel is a tough one to optimize because these expenses don't happen regularly and are ad-hoc. But many high-earning people easily spend as much as $10-15k per year on travel. The good news is that there's so many cheaper ways to travel. Flying during low season is the easiest strategy. Not flying during weekends, especially long weekends, is another good strategy. Paying for your flight + hotel + rental car using accrued mileage or credit card points is another broad strategy. If you're visiting the wilderness, camping is significantly cheaper than staying in a hotel. If camping isn't your style, then you can look into staying in a motel instead of a hotel if you only really need the room to sleep.
Potential savings: $300-$1000 per month on average.
- One-time purchases
One-time purchases like Amazon products, furniture, clothes, gadgets, toys, etc. can really get you big-time if you're not careful. They don't appear to amount to much because they're so infrequent and you move on so quickly after you've swiped the card. But you have to be quite careful of them otherwise almost none of the previous 5 strategies are worth anything.
One easy heuristic to reign in your one-time purchases is to use public perception as a yardstick. If people in your similar income bracket perceive you to be rich after looking at one or more of your recent purchases, or if they exclaim a "Wow!" after looking at your brand-new piece of clothing, appliance, furniture, or latest tech gadget, your one-time purchase is likely not a very frugal one. Monitoring public perception is perhaps the easiest way to get a quick reality check on whether you're a careless spender or not. Instead, if people think you're "cheap", then you're definitely on the right track, well on your way to becoming a superstar saver. If you lose friends because of this, don't worry, you'll make better, more frugal, and probably smarter friends later on in life.
If you have doubts about an expense, like a new couch, just say no. Don't ask questions. Chances are if you're wondering about buying something, you probably don't need it in the first place.
Potential savings: $300-600 per month on average.
To re-cap, why does any of this matter? Because frugality is one of the most powerful weapons for saving and accumulating money. The more money you can save (and invest) each year, the quicker you can not be tied to your job. Being hyper-dependent on a job is the single biggest source of stress, anxiety, and unhappiness for most people. So being able to go into work without having to worry about money is absolutely the best thing you can do for your happiness long-term. If you get laid off one day, it won't matter because you've got so much money saved up and invested that you can just live off the growth, interest, and dividends alone. If your boss is super annoying, no biggie: just call it quits and take a few months off to find a new job. I've already quit three jobs in the past without another job lined up. I quit not necessarily because of my bosses, but because I wasn't enjoying the work I was doing or the city I was working in. But it was great not having the pressure to immediately jump to a new job, and I could only do that because of my savings buffer.
To the people who enjoy their jobs today and think frugality isn't important: you're making a big mistake. First, there is no guarantee you will enjoy your job forever. Even if there was, there is no guarantee your job will even exist 10 years from now. At the current rate of technological innovation and automation, most of everything we do today will likely be outdated or automated away by software and hardware sooner or later. Having enough money saved up (i.e. at least 25x your annual expenses) is the only decent insurance against your job disappearing into thin air. It'll be too late to start saving then, so you better start now! Also, the sooner you start, the less you have to save each month thanks to the magical power of compounding. At the end of the day, economic freedom can be one of the most powerful drivers of personal happiness and self-esteem, perhaps even more so than political freedom.
If smart frugality is too easy for you, or if you've already conquered the top-6 Pareto suggestions, you may want to look into more advanced ways to be frugal. That being said, frugality isn't the be-all-end-all of happiness and there are other important things you should invest in your life too as outlined in the 4 F's post.
Good luck!
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