For most of us there simply isn’t enough money to do or have everything we want. Modern life puts heavy-duty pressure on us to overspend. Besides the big things like housing and transportation, there are everyday expenses like a data plan for your phone, a networking event for your career and, of course, the small things you barely think about, like subscriptions for online movies, music, news. Ten dollars here, fifteen dollars there. Eventually you have to say no to some things so you can say yes to others.
You’ve seen how the Hard Limit and Happy Spending give you the tools you need to gain control of your finances, a way to stop the Spending Vortex and live happily within your means, enjoyably, without worry for the future. But the key to using these tools is knowing when to say no to spending and when to say yes.
When to Say No
The Hard Limit lets you know what you can and cannot afford, alerting you to when you should say no, while Happy Spending ensures that you’re spending money mindfully on purchases that will leave you feeling satisfied. Basically you’re asking yourself two things before you spend money:
1. Can I afford this? (Is it safe to spend money?)
2. Does it make me happy? (Is it Happy Spending?)
These questions aren’t mutually exclusive. Both must be considered at all times before you spend money. You have to be able to afford it (it’s safe) and to be certain that your Emotional Return on Investment will be worth it (it’s Happy Spending). If you cannot meet both of these criteria, you must say no to spending. This is the beautiful marriage of practicality and fun in your financial life.
There are three types of spending that you need to watch out for when deciding to say yes or no:
• Spending Money: your daily spending on clothes, coffee, gas, groceries, fun—within your Hard Limit.
• Lifestyle Upgrades: buying a house, rent increases, having kids, getting a car, home renovations paid on debt.
• Big Purchases: expenses that won’t permanently affect your finances like Lifestyle Upgrades but are definitely outside the capacity of your daily spending.
Spending Money
Spending Money shouldn’t be complicated now that you are living within your Hard Limit and have isolated your money for daily expenses in a separate chequing account (joint or individual). You know what you can and cannot afford on a daily basis. A quick look at the balance in your Spending account will let you know when you can and cannot afford something. If the answer to “Is this Happy Spending?” is yes, then the decision is easy. Go for it. Spend away!
“I spend $10 a day on lunches out,” my client Randy told me. “And I’m 100 percent cool with it. For me, buying groceries is often a waste. I’m never home to cook and I’m throwing out mouldy broccoli all the time. Pretending I’ll take my lunch every day is totally unrealistic for the way I live my life—it just won’t happen. Going out for lunch is also social time with my co-workers. We vent about the day, bond, and try new places. It’s fun.”
Before she spends, Randy answers the two questions. Is it safe? Yes, lunches out are affordable within her Hard Limit. Is it happy? Hell, yes—lunch out gets a 4 out of 5 happiness rating. So she keeps going out for lunch without a second thought. No guilt. No fear.
On the other hand, we have Brad. “I’m so frustrated with myself,” he confessed. “I can’t believe I spend $10 a day on takeout lunch at the office. That’s $50 a week! If I could just get it together and cook more I’d probably be way healthier, and I’d have so much more savings.”
Now Brad answers the same questions. Is it safe? Yes, lunches are within his Hard Limit. Is it happy? No—it gets only a 1 out of 5 rating. Lunches out clearly don’t bring Brad the same satisfaction that Randy enjoys. Cutting back on takeout was a no-brainer for Brad, while keeping the lunches out was a no-brainer for Randy.
Lifestyle Upgrades
For Lifestyle Upgrades, you also know that you need to say no or proceed with extreme caution if a new purchase will permanently increase your Fixed Expenses to more than 55 percent of your monthly after-tax income. If it will, the spending is not safe. You can’t truly afford it.
Life is messy and complex. A lot of our purchasing decisions fall somewhere between the categories of daily Spending Money and permanent Lifestyle Upgrades. These can be things like splurging on a designer couch or saying yes to a crib that costs more than the budget allows but matches the nursery. These are Big Purchases, which can’t be decided simply by looking at your Spending account, because the amount required is likely larger than the balance that may be in there until the next pay period. However, such purchases also aren’t Lifestyle Upgrades that will affect your Fixed Expenses permanently.
When a purchase is too big to fall within your Spending Money but is also not a Lifestyle Upgrade, you need to ensure that you are both safe and happy before you spend the money. Hopefully you’ve been using your Short-Term Savings to save up for Big Purchases. If it’s a home repair, you’ve got it covered. If it’s a trip, you’ve been saving for that too. That’s the beauty of the plan so far—Short-Term Savings are designed to keep Big Purchases off your credit cards for good.
But what happens when you want to make a Big Purchase and it’s something you haven’t planned for in your Short-Term Savings? Typically such purchases will end up sitting on a credit card. So the question then becomes “Are you ever safe to spend on a credit card when you can’t pay it off right away?” Before you swipe that card, use the Three-Question Check-In:
Check 1 |
Will this purchase permanently increase my Fixed Expenses to more than 55 percent of my after-tax income? Yes? Then don’t spend. This is likely a Lifestyle Upgrade that you cannot afford. It’s not safe. |
Will I need to eat into or reduce ongoing Meaningful Savings to accomplish this purchase? Yes? Then don’t spend. Eating into your Meaningful Savings is not financially responsible. It’s not safe. |
|
Check 3 |
Will this decrease my Spending Money by more than 5 percent for longer than six months? Yes? Then don’t spend. It’s not safe. |
So if you answer yes to any of the above, do not pass Go. Do not collect $200, and drop that idea like it’s hot. You can’t afford whatever you’re looking at. It’s not safe, regardless of how happy it makes you. Sorry.
Now you may be wondering why I set six months as the limit to how long you can safely carry a credit card balance for a Big Purchase. Isn’t credit card debt the Big Evil? Yes, but I am realistic. If you can realistically pop a purchase onto your credit card and then reduce your other spending in order to pay off that debt within six months, I’m fine with it. As long as you don’t put any more Big Purchases on the card until the initial purchase is paid off, there’s a realistic and manageable plan of attack.
If it will take you longer than six months, it’s out of your price range. You’ll need to save up for at least part of it first. I know any credit-card-abstinence-preaching personal-finance junkies reading this will hate that I’ve just told you to go ahead and carry a balance. But I’m not going to sit here and demand that you never, ever again spend outside your Hard Limit. You’re human, and so am I. I get it—I’ve been a bridesmaid; I’ve bought a bed frame; I’ve had to call an exterminator. You simply cannot plan for absolutely every Big Purchase you’ll ever need. I’ve worked with enough individuals and families to know this to be true, and I don’t want you to feel ashamed. But I do want you to know where that hard no is so you can use credit responsibly and safely.
How to Say Yes
Sometimes life demands that you spend outside your Hard Limit. So you need to have a plan of attack that’s realistic. You must be mindful about unexpected Big Purchases, because that is how Debt Creep starts. Too many purchases outside your Hard Limit means that you can’t realistically pay them all off and that you will be overspending and under-saving permanently. Your debt will rise or your emergency account will empty and you won’t be moving forward.
Here’s how my client Ray said yes to spending, even though it was a Big Purchase that he floated on his credit card.
Ray, a musician, wanted to purchase a new guitar. “It’s $820, and it’s amazing,” he said.
The cost was clearly outside the realm of his monthly Hard Limit ($1,220). If he were to purchase the guitar with money from his Spending account, he’d have almost nothing left for the rest of the month. The guitar wasn’t Spending Money; it was a Big Purchase, and one that he hadn’t budgeted for. It would have to go on a credit card or he would have to eat into his vacation account.
“I really want this guitar,” he said. “Can I afford it and still go on my vacation?”
I looked at the numbers. If Ray purchased the guitar and put the whole thing on a credit card charging 19 percent interest, his minimum payment on the credit card would be $17 per month. It was time for the Three-Question Check-In.
Monthly after-tax income |
$3,200 |
|
FIXED EXPENSES: Money You Cannot Spend |
||
Rent |
$1,150 |
|
Phone |
$55 |
|
Subscriptions |
$20 |
|
Bank fees |
$5 |
|
Total |
$1,230 |
(38% of after-tax income) |
MEANINGFUL SAVINGS: Money You Cannot Spend |
||
Down-payment fund |
$450 |
|
Total |
$450 |
(14% of after-tax income) |
SHORT-TERM SAVINGS: Money You Cannot Spend |
||
Vacation |
$200 |
|
Emergencies |
$100 |
|
Total |
$300 |
(10% of after-tax income) |
SPENDING MONEY: Hard Limit |
$1,220 |
(38% of after-tax income) |
Monthly after-tax income |
$3,200 |
|
FIXED EXPENSES: Money You Cannot Spend |
||
Rent |
$1,150 |
|
Phone |
$55 |
|
Subscriptions |
$20 |
|
Bank fees |
$5 |
|
Credit card minimum payment |
$17 |
|
Total |
$1,247 |
(39% of after-tax income) |
MEANINGFUL SAVINGS: Money You Cannot Spend |
||
Down-payment fund |
$450 |
|
Credit card above-minimum payment |
$130 |
|
Total |
$580 |
(18% of after-tax income) |
SHORT-TERM SAVINGS: Money You Cannot Spend |
||
Vacation |
$200 |
|
Emergencies |
$100 |
|
Total |
$300 |
(9% of after-tax income) |
SPENDING MONEY: Hard Limit |
$1,073 |
(34% of after-tax income) |
Was it safe? Yes, he passed the Three-Question Check-In. Was it happy? Yes—a 5 out of 5 happiness rating. Could Ray say yes to spending on the $820 guitar? Yes.
Ray was pumped. Great! He was stoked and I was satisfied that he had a realistic plan for repayment in place that wouldn’t leave him paying down debt for an unsustainably long time. Over the six months, Ray would pay approximately $45 in interest as he paid down the debt. While I don’t like anyone paying interest ever, he and I both agreed that $45 was worth the pain for the gain. Since it would be realistically paid off within six months, the expense was manageable. A great marriage of financial responsibility and happiness!
If, however, the guitar had cost $2,080, the answer would have been different. Let’s see how that would have played out. Putting $2,080 on his credit card would drive up Ray’s minimum payment to $35. Time for the Three-Question Check-In:
Check 1 |
Will this purchase permanently increase my Fixed Expenses to more than 55 percent of my after–tax income? No. Even though his credit card minimum payment would increase his Fixed Expenses by $35, to 40 percent of after-tax income, this wasn’t over 55 percent and was not permanent. Safe. |
Check 2 |
Will I need to eat into or reduce ongoing Meaningful Savings to accomplish this purchase? No. Ray wouldn’t need to decrease the monthly $450 contribution to his down-payment fund, which was nonnegotiable. Safe. |
Will this decrease my Spending Money by more than 5 percent for longer than six months? Yes. In order to pay back the $2,080 within six months, we calculated that Ray would need to contribute $332 per month in addition to the $35 minimum payment. This would decrease his Spending Money from 38 to 27 percent of after-tax income—a significant 11 percent drop. Or, if he reduced his Spending Money to a safe amount, as for the $800 guitar, and put a total of $147 on the card each month, it would take him 17 months to pay off. |
The problem was that life has a way of throwing curveballs. It was unlikely that Ray would not have other unforeseen Big Purchases over the course of the next 17 months. With only $853 left for Spending Money, it’s likely he would then have to overspend, outside his Hard Limit. Either way, it would be unsafe.
If this were the case, I would tell Ray to make a trade-off between taking a vacation and purchasing the $2,080 guitar. He could take the money earmarked for vacations and put it towards the guitar so that he could pay it down realistically within six months. That means he would need to put down $1,260 cash towards the guitar and carry only the $820 on his credit card. This choice, while not ideal, would keep him financially safe, and he would still get a say in how his money was being spent.
If you buy something that requires you to reduce your Spending Money for longer than six months or by too much (more than a 5 percent reduction), you are just asking for trouble. Not leaving yourself with enough Spending Money to realistically survive daily life for too long is a surefire way to reach the F*ck-It Moment and fail. You likely won’t ever pay off the credit card purchase, and eventually you will swipe the card, then swipe it again and yet again, while your financial goals slowly slip away.
Monthly After-Tax Income |
$3,200 |
|
FIXED EXPENSES: Money You Cannot Spend |
||
Rent |
$1,150 |
|
Phone |
$55 |
|
Subscriptions |
$20 |
|
Bank fees |
$5 |
|
Credit card minimum payment |
$35 |
|
Total |
$1,265 |
(40% of after-tax income) |
MEANINGFUL SAVINGS: Money You Cannot Spend |
||
Down-payment fund |
$450 |
|
Credit card above-minimum payment |
$332 |
|
Total |
$782 |
(24% of after-tax income) |
SHORT-TERM SAVINGS: Money You Cannot Spend |
||
Vacation |
$200 |
|
Emergency |
$100 |
|
Total |
$300 |
(9% of after-tax income) |
SPENDING MONEY: Hard Limit |
$853 |
(27% of after-tax income) |
When you are making financial decisions outside your Hard Limit, be sure you can safely afford them. Be sure they are safe purchases. While it may be irritating in the moment to say no, this will make you happy in the long run.
Long-Term vs. Short-Term Happy Spending: One Wedding, Two Guests
Avoiding Unhappy Spending is an important part of Worry-Free Money. Unfortunately, you can’t just buy everything you want, so you need to ensure that you are enjoying the money you do have to spend. This makes you less likely to fall off the financial wagon and give up on the long-term plan. Before you spend, you need to be both safe and happy. But when it comes to Big Purchases, how will you recognize Long-Term Happy or Unhappy when you see it?
Ben is getting married. Guess where? The Caribbean. Here are the facts:
• The wedding will take place at a five-star all-inclusive resort. The minimum stay is one week, and you’re guaranteed good food and even better drink.
• The wedding is 12 months away.
• The cost each guest will have to pay is $2,500 + airfare (so $3,000 to $3,500 per person).
• Ben is awesome and his partner, Gil, is also awesome. They are well loved.
Meet two of the invited guests, Dayna and John. They’re not related but they both know Ben. Let’s see how each of them viewed this wedding.
Dayna |
John |
|
Relationship to Ben |
good friend |
cousin |
Current Short-Term Savings balance |
$28 |
$2,000 |
New savings over next 12 months |
$1,200 |
$3,840 |
Dayna really, really wanted to go. She has known Ben since high school and would also love a getaway from the crappy Canadian winter. She had been poring over the resort’s website, envisioning her room and checking out the onsite restaurants.
I asked Dayna to pre-screen this Big Purchase and rate the wedding on a scale of 1 to 5 for Happy Spending. “Four out of five at least,” she said. “All my friends are going. I wanna go!”
Was this wedding short-term Happy Spending? Yes, yes, yes! Great. We had part of the equation, but we needed more. We needed to know if this Big Purchase was safe. Could Dayna afford to go to the wedding? We looked at the numbers.
Including incidentals like a gift, a new outfit and potentially a new bathing suit, Dayna estimated the wedding would cost her $3,500 once all was said and done. The event was in 12 months, so she would need to bump up her Short-Term Savings to $290 ($3,500/12) in order to make it work, an increase of $240 per month ($290 – $50). Would increasing her Short-Term Savings by $240 per month be safe?
Dayna’s Financial Picture
Monthly Income and Expenses |
||
After-tax income |
$4,160 |
|
Fixed Expenses |
$2,280 |
(55% of after-tax income) |
Meaningful Savings |
$630 |
(15% of after-tax income) |
Short-Term Savings |
$50 |
(1% of after-tax income) |
SPENDING MONEY: Hard Limit |
$1,200 |
(29% of after-tax income) |
Assets: $5,000 emergency account (enough for three months of Fixed Expenses and basic spending, less Employment Insurance, if she left her job); $65,000 in retirement accounts, with an ongoing $500 monthly contribution (10% of gross income)
Liabilities: $2,200 line of credit at 6 percent interest (being paid off at $130 per month over the next 18 months)
Monthly after-tax income |
$4,160 |
||
Fixed Expenses |
$2,280 |
(55% of after-tax income) |
hold |
Meaningful Savings |
$630 |
(15% of after-tax income) |
hold |
Short-Term Savings |
$290 |
(7% of after-tax income) |
$240 increase |
SPENDING MONEY: Hard Limit |
$960 |
(23% of after-tax income) |
$240 decrease |
The Three-Question Check-In
Could Dayna afford this wedding? No. It was not safe.
Dayna agreed that reducing her Spending Money from $1,200 to $960 for a whole year would make things too tight. If the reduction in spending were needed for only six months, I might have said, “Go for it.” Human beings are tough; we can do anything for six months if properly motivated. But a whole year? That’s likely unsustainable. I’ve seen it too many times. A lot can happen over a year, and you can’t know what other financial challenges (or windfalls) may lie ahead.
What we did know in the moment was that Dayna couldn’t afford it. Naturally this wasn’t what she wanted to hear, so we started trying some adjustments.
Dayna felt that she could comfortably save $100 per month to her Short-Term Savings (an extra $50) while still leaving enough Spending Money to survive the next year. While I agreed that a $50 reduction in her Spending Money was sustainable, her vacation fund would add up to only $1,228 ($1,200 new savings + $28 that was in there already) by the time the wedding came around, and she needed $3,500.
This meant that $2,272 ($3,500 – $1,228) would go straight onto a credit card, with the likely plan of adding it to the line of credit later. And therein lay the problem. Without this extra expense, in 12 months her existing line-of-credit debt would be almost gone. But now she’d be adding another $2,272, putting her right back into a cycle of debt. It wasn’t safe.
While the payments Dayna would have to make to her line of credit might not screw up her retirement, they would keep her in a constant state of debt for another two years after the wedding! Her only other option was siphoning funds from her emergency account, which she knew was financially irresponsible and would cause her more anxiety. “I don’t want to eat into my emergency account,” she said. “Things are slow at work, and that makes me really nervous.”
This is where the concept of long-term happiness comes into play. I asked Dayna a really important question: “Is this expense Happy Spending?”
“Yes, obviously. I really want to go.”
“Okay, but how about a year from now, when you’ve got an extra $2,272 from this trip left on your line of credit? How will you feel a year from now?”
She paused. “I don’t know. Not good, actually.”
“Why?”
“Because I’ve been working so hard to save up for my other goals. I don’t want to be in debt anymore.”
“What do you think Future You would think about this purchase?” I asked.
“Future Me would probably say ‘Don’t do it’ and call it Unhappy Spending, because I’ll be resentful and frustrated about it down the road, rather than proud and excited.”
As difficult as it was to admit, Dayna could not afford this wedding. It wasn’t true Happy Spending. When it comes to spending, happiness and financial responsibility in the long run matter as much as happiness and financial responsibility now.
Was the wedding safe? No. Was the wedding happy? Yes, in the short term, but not in long run. This is when to say no.
Now let’s have a look at cousin John.
John’s Financial Picture
Monthly Income and Expenses |
||
After-tax income |
$3,200 |
|
Fixed Expenses |
$1,600 |
(50% of after-tax income) |
Meaningful Savings |
$320 |
(10% of after-tax income) |
Short-Term Savings |
$320 |
(10% of after-tax income) |
SPENDING MONEY: Hard Limit |
$960 |
(30% of after-tax income) |
Assets: $8,000 emergency account (which is where it needs to be, since John owns a home); $2,000 in Short-Term Savings; $175,000 in retirement accounts (growing at 5 percent, with $320 monthly contributions in order to reach $600,000 in 30 years)
Liabilities: $0 (debt-free)
John had $2,000 in his Short-Term Savings account. In 12 months’ time, if he continued to save $320 per month, he’d have $5,840 in that account. He could afford to spend $3,500 on the wedding.
The Three-Question Check-In
Check 1 |
Would this purchase increase John’s Fixed Expenses to more than 55 percent of his after-tax income? No. There would be no changes to his Fixed Expenses. |
Would he need to eat into or reduce ongoing Meaningful Savings to accomplish this purchase? No. John was adamant about continuing his savings plan for retirement, and so was I. |
|
Check 3 |
Would this decrease his Spending Money by more than 5 percent for longer than six months? Nope. He could easily take $3,500 from his Short-Term Savings fund without reducing his spending. |
Could John afford this wedding? Absolutely. It was safe.
But ensuring that John was living within his means was only part of the equation. Safe and happy—both at the same time. We needed to ascertain whether or not this wedding would also be Happy Spending.
I asked John to identify how he felt about spending $3,500 on the wedding.
“Not great. I mean, I love my cousin, but I got sick the last time I went to a destination wedding. It’s not really my thing either. Plus I have no one to go with, and I’ve been saving up for a boat for like a year.” It was a used boat that was going to cost $4,000.
Now we had got to the heart of the matter. I asked John to rate both of these goals for Happy Spending on a scale of 1 to 5.
Boat? “That’s 5 out of 5. It’s my passion. I think about fixing up this boat literally 24/7. It’s what I’ve been saving for.” Wedding? “Only 3 out of 5. I don’t really want to go, but I don’t want to be a jerk either.” This was a case of social-obligation spending, a major cause of Unhappy Spending for John.
John had been saving for the boat for more than a year. Wanting to enjoy some of his money in a way that made him happy did not make him selfish. I repeat: it did not make him selfish. If John could afford both, he would go to the wedding and get his boat that year, as planned. But he couldn’t. It was either the wedding or the boat. Not both.
If John allowed the pressure of guilt to make him say yes to the wedding, the approval of others would likely give him an initial feeling of satisfaction, and who doesn’t like a trip somewhere warm? But that satisfaction would wear off quickly when he got home and settled into another year of saving for that boat.
“How would Future You rate the wedding a year from now if you didn’t have enough for the boat?” I asked.
“Probably a 1 or 2. I would be really resentful that I had to wait even longer to reach a goal I’ve been working towards for so long.”
Was the wedding safe spending? Yes. Was the wedding Happy Spending? Mildly in the short term, but not in the long run. This was also when to say no to spending. There would be no long-term happiness for John in that wedding.
John’s highest Emotional Return on Investment was from the boat, in both the short run and the long run. Continuing to save his money for the boat was the best way to ensure that he didn’t end up resenting his financial situation and feeling broke. In order to live within your means without hating your life, your purchases have to be both safe and happy. Not just one or the other.
Taking a moment to answer the Three-Question Check-In can help give you perspective. It’s a black-and-white way to find out if something is safe spending. Is it within your means? If it’s not, that alerts you to when you should say no to spending, regardless of how happy the purchase might make you.
Second, you must ensure that you’ve taken both short-term and long-term happiness into the equation. The question “Does it make you happy?” must focus on both short-term and anticipated longterm happiness in the future. If you are/will be happy in both the short and long run, then it is true Happy Spending.
Should You Spend Money? The Safe/Happy Check-In
Will this purchase leave you safe?
Check 1 |
Will this purchase increase your Fixed Expenses to more than 55 percent of your after-tax income? If yes, don’t spend. |
Check 2 |
Will you need to eat into or reduce ongoing Meaningful Savings to accomplish this purchase? If yes, don’t spend. |
Check 3 |
Will this decrease your Spending Money by more than 5 percent for longer than six months? If yes, don’t spend. |
Will this purchase make you happy?
Check 1 |
Does it make you happy right now? If it’s a 4 or 5 on the EROI scale, that means yes. |
Check 2 |
How will you feel about this purchase a year from now? If it’s still a 4 or 5 on the EROI scale, that means yes. |
Safe and happy. You must be both at the same time in order to live within your means without hating your life and to stop worrying about money once and for all.