Debt, Savings, and Budgeting for Everyday People

You recently started thinking of how to put money aside, what to do to get returns, and what to do about retirement or how to finance big life projects such as buying a house, starting a business, traveling the world, or whatever else. Maybe you struggle with your budget. You don’t know where to start. Start here!

Budgeting: income-spending… and more

The overriding principle of savings, budgeting, and investments is this:

Your “breathing room” is proportional to the distance between your income and your spending, whether you earn 20k per year or 200k or 2 million! The bigger the distance between your income and your spending, the more “air” you have, the less stress you feel, and the more choices you have for now and for later.

You can feel free of financial pressure with very low income and I know for a fact that many people earning decent annual incomes are unable to save money and live with considerable financial pressure.

Many of the income and savings challenges are related to lifestyle choices, beliefs, and psychology. Yes, I know there are health costs, “bad surprises” (you should budget these!), student debt, kids, and so much more… SO? Think hard about all these “excuses”… do they make reality go away?

Some want “the standard North American Setup”: nice house, nice car, garage, kids, pools, dogs, etc. Others are happy living in total simplicity. I have friends who live “rock climbing dirtbag lives” and are perfectly happy: they spend a LOT of their free time climbing outside around the world, they decided to have no kids, and they live a healthy and full life with a low income. One of my friends lives in his van (no, it’s not Alex Honnold).

Since I am a firm believer in freedom, individual choice and responsibility, I firmly believe that whatever your lifestyle choice, it’s FINE, as long as you can live with it and finance it yourself, whether that means to become super wealthy and live in a loft downtown NYC and travel first class or live the “dirtbag life” all the way, such as so many have done and are still doing… and all shades of grey in the middle (not 50!).

Some people live beyond their means on a relatively systematic basis. If you 1) are not studying and 2) are unable to increase your total savings each year, then you are living beyond your means. You need to 1) increase your income now or soon or 2) decrease your spending.

The ones who build up debt are living beyond their means. Period. That is generally not a good thing, unless the debt is due to “productive investments”, meaning spending now that will end up giving you higher income down the road: education (be careful of your choice of program and general career strategy!), starting a business (if it works out!), etc. In the long run, if your ratio of total-debt-to-disposable-income is increasing year after year (and it’s not due to student debt or entrepreneurial risk taking), then you must make major changes to your income side or your spending side, which typically means major lifestyle changes.

The ones feeling less pressure are living within their means and sometimes making tough choices to do so: their income comfortably covers their expenses. Some earn a very low income, some a high income. I have friends earning very modest incomes and traveling the world on rock climbing trips and feeling very little budget pressure. They often have no cars, live with roommates, and live “modestly” day by day. They save money every month with their low income and they travel the world. It’s their lifestyle choice.

One clear phenomenon of the past 20 years is the disproportional rise in the price of 1) housing and rent, 2) education and 3) costs related to health issues relative to wages. This has put greater pressure on the budget related to “other stuff” and caused some to dive into debt to finance the lacking income… this is NOT a solution.

Accusing the world and income inequality and everything else than yourself will NOT change a thing about your down-to-earth monthly and annual budget reality. If your budget is too tight for you to live with at least a bit of monthly “slack” (savings) and without building up debt, then you need to make a “brutal reality check” of your spending… everything. Everything. With brutal reality, not smothered in rosy glasses or “ideal spending”… I mean what is actually happening, not what you think is happening. Look at ALL expenses: the regular monthly bills, groceries, restaurants and bars, the ad-hoc-but-frequent stuff like parking tickets, the typical “annual” expenses (car repairs, clothes, house repairs, gardening, etc). Vacations, leasure, etc. EVERYTHING.

Once that is done, you can make hard choices, which can go as far as moving far away, moving into a commune / roommate setup, moving back in with your parents, getting rid of your car, taking public transport, brutally cutting on restaurants and social outings, getting a second or third job, etc. Once the brutal reality has really sunk in, it is time for major choices and changes. These should be oriented on increasing your well-being by decreasing budget pressure stress and improving your overall budget situation over the following years.

Income and spending

Your sources of income could be mostly from your job, but maybe you get extra income from other sources, such as a small business, trading, government subsidies, etc. All these are to be accounted for in a realistic fashion, as well as your spending habits.

Your expenditures are typically very varied, but here are just a few to keep in mind:

Mortgage or rent payments, car loan, student loan, healthcare, cell phone, cable and Internet, heating and electricity, gym monthly payments, Netflix/Spotify/etc, transport costs such as gasoline or public transit + occasional or regular taxi/Uber, insurance of all types, occasional parking and speeding tickets, standard weekly groceries + pharmacy stuff, restaurants, alcohol/cigarettes/whatever-others, weekend road trips with hotels or camping + food and restaurants, annual vacation/trips, house decoration, flowers/plants/etc, standard repairs on car/house/etc, kitchen and other equipment, furniture/washer-dryer/etc changes or upgrades, driving license, clothes, school and activities for kids, parking fees, software/books, hairdresser and personal care stuff like therapists, SPA days, pet expenses for dogs and cats, etc. There’s more. You get the point. Plenty of possibilities to spend! Endless! Limited upside for your income if you only have a job and no business projects or trading going on. So budget carefully! This should all be written down in Excel or at least Word or other document and should be monitored closely so that your actual income and your actual spending are represented realistically in your budget!

The triple price of debt

Debt has a direct impact, which you know very well: you feel that nagging pressure… it comes each month with minimal payments due on credit cards… and the credit margin, the past unpaid cell phone and heating bills, and all the rest. Mortgage debt is different, because it really is savings down the road, because once that house or condo is paid in full, you can sell it and live off that capital.

The issue with non-mortgage debt is that it creates a vicious cycle of debt: that little extra uses up your potential breathing room, which prevents you from feeling more in control, which creates stress and anxiety, which creates more spending, which creates the “what’s the use of trying?” issue…

Then you have interest payments! These generally outweigh typical asset market returns, which means you are not only stuck with interest payments that are preventing you from saving, but you are also NOT getting extra wealth creation from your savings… Non-mortgage debt is a drain on your overall wealth and health.

The price of debt is thus triple:

1. The direct cost of interest, which is typically high.
2. The indirect cost related to the inability of saving and getting returns.
3. The stress, which feeds compulsive spending, which keeps you in debt.

Planning retirement

Humans are absolutely AWFUL long term planners, as are all animals. Most animals “plan” at a maximum of a few months ahead due to Winter and mating seasons. Planning into the far-away 30 year future is very close to impossible for most humans because there is not enough sense of urgency. That’s why putting regular payments aside and essentially “forgetting about it” is a good idea. If you think it’s impossible to save, remember that countries as different as China, Switzerland, Sweden, Germany, and Chile all have relatively high household savings.

When thinking of retirement, remember that you can have “all options” open, meaning think outside the box… maybe moving to low-cost countries while getting your personal pension income, employment pension income (if you have some), and public pension income payments combined allow you to live way better than in high-cost countries such as the USA, Canada, and most industrialized countries. Also note that you can sell your house once you reach retirement, and that could help quite a bit, especially if you cut your costs of living brutally. Most Latin American countries and many Asian countries have very low costs of living, so keep an open mind.

When building wealth, it can go fast via a business project or book or whatever else that ends up being lucrative. Some people are financially tight a long time until they “find a way”… but counting on this is risky! The best way to feel relaxed about your current and future financial situation is to 1) keep an open mind about your lifestyle now and later and 2) count on “compounding”…

The benefits of returns, compounding, and “other sources” of income

You can put all your savings in a standard deposit account at 0% return, but the problem is your money won’t “grow” and that is costly in the long run. When you put 1000$ aside and earn 5% on your savings, that 1000$ becomes 1050$ next year, then 1102$, then 1157$, and so on. Why? because the total amount is impacted by the annual return on a growing base. So the “base” on which the 5% applies grows every year. This may not seem like much, but it is, as the following table shows…

5k per year will end up as the following amounts…

So the amount you end up with depends on 2 things, which are obvious:

1. Your annual savings.
2. The annual returns on your savings.

Note that if you own a house or condo, your total savings in the long run will be these amounts PLUS the market value of your house, once it is 100% paid. Also note that it is better to save monthly or even weekly rather than annually, because you get returns sooner on your savings, so it is better so save 400$ per month rather than 5000$/ year in one 5k “annual chunk.”

Also try to diversify your sources of income, outside simple employment. These small extras make a big impact in the long run.

Parking your savings

Where to put your savings? This depends on your risk tolerance and desire for returns. If you are “borderline gambler”, you may put a big chunk of your savings in risky assets that CAN give very high returns if things turn out as hoped: anything that has “bubble dynamics” such as currently Crypto assets.

If you are like most people and have lower risk tolerance, you may consult with a competent and honest wealth manager / financial planner who will help you see the options, which are many, but often boil down to “financial products” linked directly or indirectly related to:

1. Real estate.
2. Government bonds.
3. Corporate bonds.
4. Stocks (in various sectors).
5. Exchange Trades Funds (ETFs), which I am a fan of.
6. Risky assets such as startups, cryptos, etc.
7. Foreign market assets (be sure to hedge your currency risk).

The most risk averse will avoid all risk. This has a high cost, because returns on risk are significantly higher, so you should accept to tolerate some risk and diversify your financial investments.

So to wrap-up, you have these elements to keep in mind:

1. Make changes so that your income is above your spending.
2. Get rid of non-mortgage debt.
3. Be flexible and open about current and future lifestyle setup.
4. Consider all your income options, now and in the future: other jobs or small “sidelines”, employment pension, government pension, and personal portfolio future income, including risk of fluctuations.
5. Study options for getting returns from your savings.
6. At least take some risk with part of your savings to expose yourself to higher potential returns.

Like and share to show appreciation!

Pascal Bedard

pbedard@yourpersonaleconomist.com