One of the most common and dangerous fallacies I see in the personal finance world is the notion that a personal or household budget is the starting point for financial independence.
Conceptually, keeping a budget makes perfect sense, right? You literally budget your spending, ensuring that it does not exceed your income. What could possibly go wrong?
In reality, budgeting prioritizes (and actually encourages) spending and consumption over saving. This is because spending is the focus of any budget. As a result, budgeting, by its very nature, sets you up for failure.
A typical budget starts with a laundry list of all of your anticipated expenses and their dollar estimates. As a conscientious financial planner, you will also leave some breathing room for unexpected outlays. Finally, you will determine a reasonable percentage of income to sock away into your savings and retirement accounts.
The problem with this approach is that when your expenses for a given month fall below the expected amount, your “budget” has effectively granted you permission to spend the difference (usually frivolously) rather than to save it. For most of us, the psychological temptation and incentive to spend up to the maximum budgeted amount is too great to resist and too easy to rationalize.
This is not to suggest that you shouldn’t track your income and expenses. You certainly should. There are a litany of easy-to-use and inexpensive personal accounting software products out there for that purpose. Use one.
What I am suggesting is that saving (not spending) should be the default. In other words, you should begin by determining the absolute maximum that you can reasonably save given your socio-economic status, family circumstances, geographic location, etc. Decide on all discretionary expenses you can reasonably forego and consumption you can reasonably sacrifice in order to maximize your savings.
I don’t advocate being cheap or stingy when you’re out on an occasional dinner with friends, shopping for a gift for your mother-in-law’s birthday, treating your parents to brunch, etc. However, view every personal spending opportunity critically and with skepticism. You will be amazed at how much of your spending is discretionary and personal and unnecessary.
I have always tracked all of my income and expenses carefully. However, I have never kept a budget, and I partly attribute my wealth and early retirement to that fact. I have certainly indulged in occasional nice things and luxuries, especially as I got closer to my “number.”
However, I have never carried a credit card balance, I have always minimized discretionary expenses (especially monthly and recurring ones), and I have always sought out “value” when spending money, whether it’s on a car, a movie, or a luxury vacation.
(Side note: “Value” doesn’t necessarily mean spending the least amount of money on something, but rather buying something that is of high quality and that will last, that will give you long-term joy or convenience, and that will give you the most bang for your buck.)
The most important thing to remember is that saving should always be your default move. Meaning, if you receive a year-end bonus, save it. If your inherit money from Uncle Joe, save it. That is how you get rich and retire early. Once you get there, you can indeed spend more money and enjoy the fruits of your labor, so long as you remember to never touch the principal.