As a numerate cynic brought up in a family that treated frugality as its religion, I believe I understand the topic of managing money quite well. Recently inspired by the Money Mustaches, I have compiled ten tips for leading a successfully frugal life.
Many of the tips are hard to implement, but tip one is the hardest. It is to invest in familiarity of basic finance theory. As many as half of the population are baffled and repelled by all mathematics, and spend their lives avoiding the topic wherever possible. Sadly, in managing personal finances, it is not possible. I believe a basic school maths curriculum should focus on the key relevant competences of arithmetic, budgeting, probability and estimating, but, until it does, we all have to try to compensate.
There are two halves. The easier half is budgeting, because all that involves is adding and subtracting, and even poor schools teach that. At its simplest, a budget starts with a balance in a repository such as bank account, and predicts cash in and out over a defined period to lead to an estimated balance at the end. Then actual expenses are compared with the budget, leading to a new opening balance and, hopefully, a better attempt to predict the following period, because of the knowledge gained. Especially with excel available, this skill should not be beyond the wit of most.
The tougher half links cash to wealth. The knowledge is not essential, but darned helpful in many ways. A profit and loss statement adjusts the cash flow for a period by including some virtual incomes and charges, reflecting items that do not lead to cash flows in this period but which average cash flows across periods. The only difference between cash flow and profit is this sort of item. The third statement is the balance sheet, that tracks accumulated wealth, which is the sum of all the previous profit and loss statements. The balance sheet tries to estimate assets and liabilities, by guessing what every item would be worth were it sold (or cashed in) today.
My second lesson is that wealth begets wealth and debt begets debt. The Money Mustaches show that if you can accumulate some wealth, then you can retire early and still live well for years, because of the income that the wealth generates. Socialists like me bemoan the way money tends to flow to the rich, but in simple terms that is only natural and fair, because the rich did something in the first place to earn the wealth that generates more wealth. So we are wrong, but also right, in that good public policy tries to dampen the effect by taxing assets and high incomes.
The main takeaway from this lesson for most people is to be very careful about getting into debt, because it can swallow you up. It is OK taking a mortgage or buying big items like cars on credit, but only if you can confidently predict future income to pay off the resulting liabilities. Just building up debt and trying to roll it up into more debt usually does not work forever. People in their 40’s should be paying down mortgages not refinancing them. Maybe I take this advice too far in my own life; I was taught to fear debt and addiction terribly. Nothing makes me shudder more than watching people gamble uncontrollably, since it combines those two fears.
Like many of the lessons, this one applies to businesses and even countries as well as to individuals. The US can get away with ramping up the deficit for many years, because it has a reserve currency and good credit. But over time the cost of servicing the debt creates a debt spiral, and then the creditors start calling at the door.
Lesson three is to budget, and to follow up with tracking and decisions. It is like dieting. We can all set a calorie target and set off on a good road. But we tend to break our own rules and then to drift before being jolted into setting another target. What is missing is the follow up, tracking what actually happened, and then making tough choices based on this reality rather than some naïve dreams of our capabilities. Budgeting is the same. Setting the first monthly budget is the easy bit. But it will only work if we then track the differences between our guesses and what then transpires, and then actively use this knowledge to improve both the next budget and our future frugal behaviour.
Lesson four is related, and it is about special and unforeseen expenses. Special includes vacations, big treats, gifts and times like Christmas. Unforeseen include family calls, medical bills, car maintenance and so on. For both types, if you budget and track over lots of months, you’ll start to see how much to allow, even though for any particular month you won’t know exactly what costs will emerge. But don’t just hope, or naively assume that just because costs feel like one-offs, they won’t recur. It is a sobering thought that most American families are just one or two unforeseen expenses away from real hardship.
Lesson five is about how to manage finances in a relationship. In truth, I have no idea how to do this. Every couple that makes this work well seems to have a different approach. You can either merge everything and have joint accounts, or try to keep everything separate with each contributing agreed shares to common expenses. Both of these have horrible flaws and can lead to terrible arguments. But I think the key lesson is to communicate and to be transparent. So force the discussion early on, agree to something and then talk about how it is going. There is no faster or more common way for relationships to turn sour, except perhaps sleeping with someone else.
Lesson six is a reminder that frugality and generosity are not exclusive; indeed we should aim for both. You don’t have to be cheap to be frugal, but you do have to budget for what you are likely to spend, whether on a passion or on compassion. For charity, I like the idea of having a budget set aside. Then you can choose whether to give to every homeless person on the subway or hard-up family members or every cause in the mail or to chosen charities or even all of these. But it all comes from the charity pot, so you know where you stand and can make choices.
Lesson seven suggests a financial clean up every couple of years. Businesses find they need a cost-cutting effort every so often, because there are always good projects to spend on. It is the same for all of us. It makes sense to perform a big review sometimes, usually looking for chances to save, or to sell some assets. Our homes are usually full of clutter, and our finances are often much the same.
The last three lessons are more tactical. Number eight is to know frugality enemies. 90% of the financial industry comes in this category. I used to think financial firms and advisors were trying to help me, but now I know better. They want me to get into debt so they can make money servicing that debt, or they want me to spend on services that benefit them. Do not trust them; avoid them wherever possible, except where you can use their tricks to your benefit, such as churning credit cards. Most advertisers are also your enemy – the only thing they want you to do is spend, and if you really needed what they had, they would not need to advertise. The harder they push it, the less you want it.
Number nine is a tactic to build on number eight, and it concerns special offers. My lesson is to ignore all special offers until you have decided to buy something. Never think of what you have saved; only what you have spent. But as soon as you have decided to buy something, then it is time to shop around for offers.
My last advice is a bit old-fashioned, and it is to use cash. There is something about forking out bits of paper that give a feeling of spending and control. It is too easy to flash a card and to somehow treat the expenditure as unreal or deferred. It would be hard to achieve nowadays, but the ultimate in budgeting would be to use cash for everything. I can’t do that, but I do note the frequency that I visit ATM’s and I find myself pulling back when it becomes too common. The last thing the finance industry wants to you use is cash, and they are your enemy, so it is probably a good idea to use it.
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