designate every other month as fun months or monk months.
People say you shouldn’t spend more than 30% of your money on housing. But is that before or after taxes? Depends on who you ask. Where did the 30% come from?
The truth is, it’s just some bullshit a politician came up with in 1969 when the Brooke Amendment was passed, which capped the rent on some low income housing at 25% of the residents’ income. Congress raised it to 30% in 1981, and every since then, everyone’s been playing around in that area to make decisions. Fannie Mae and Freddie Mac split the difference and only buy loans with a 28% debt-payment-to-income ratio, so that’s what a lot of banks want to work with also.
I want to give you a framework of how to think about your housing costs. A lot of millennials have student loan debt, I think the average is around $25k now. And a lot of millennials have high housing costs, especially in big cities (NY, bay area, LA, DC, etc.). A ton of people around the country have a very serious housing burden. This means that many of the people you know right now are paying too much for housing, so you shouldn’t try to match their lifestyle.
Obviously, the less you spend on housing, the more money you have for other things. But it’s more complicated than that, so I wanted to talk about the big picture and some of the details.
I’ll just skip to the dessert: it’s very important that you minimize your housing losses. And it’s also important that your overall housing payment (including the equity portion) is easy for you to make every month.
– Living in a fancy house encourages you to waste money on a fancy car.
– Living in a fancy house encourages you to compare yourself to your debt ridden neighbors and spend too much.
Worst Case Scenario
– Living in a fancy house means that your emergency savings won’t last as long.
Long Term Cost
– Expensive rent represents a tremendous opportunity cost, and you will end up with millions less at retirement if you miss on maxing out tax advantaged retirement accounts. That’s the last third of your financial life up in smoke.
– Paying a lot on housing means you have less money to use when good opportunities come up, less money to put into tax advantaged 529s to send your kids to college (>30% discount on college).
OK Louis, but I don’t want to live in a crap shack. If I die tomorrow, it’s all a waste.
Yeah, but you probably won’t die tomorrow. And you probably won’t be dead in 5-10 years. You also won’t have to live in the crap shack forever. Just until you have enough savings to justify an upgrade by knowing that your retirement is going to be OK and the paid off house is going to be less than 25% of your net worth. The sooner the better.
The Deal w/ Mortgages
If you can’t afford it on a 15 year fixed loan, you can’t afford it. It’s important to do a 15 year for several reasons:
1) You pay a ton less interest, so it’s way cheaper for you overall
2) You’ll pay off the house before your term life insurance runs out, so if you die in middle age, your spouse will be financially secure.
3) Why fixed? Because interest rates are ridiculously low right now, at about the level of inflation. You want to lock in your shelter costs at something you are absolutely sure you can pay. This is part of the plan to help you never touch your other investments… which is a big part of maximizing your overall investment return.
John and Mary have $5000 savings, $50k of student loan debt. Let’s add a car loan. And let’s add $10k of miscellaneous other debt. They live in Chicago. They make $60k and $40k each. What should they do and where do they live?
Let’s look at their budget. Together, they take home $6000/month after taxes.
Maybe their budget looks like this:
cell phones 200
cc debt 200
education debt 575
car loan 420
car maintenance 50
Okay. So rent is their biggest expense. IT isn’t more than 25% of take home pay, but it’s still the biggest single cost by fare, followed by the education loan and the car loan. Sell the newer car and get an old piece of crap. That will also decrease your insurance costs, since replacement is easier. That process will probably wipe out $4000 of your $5000 in savings, but that’s okay b/c it frees up $420 more in savings a month. Now you have $588.
Kill all optional food expenses. Restaurants and coffee are immediately gone. Start making coffee at home — it’ll taste better anyway. Now you have $928 savings.
But! At this point you probably shouldn’t keep going. You’re going to need to replace that restaurant and coffee pleasure with something else that costs very little money or preferably free. Otherwise, you’re going to go crazy and tell Louis that he’s making your life horrible. Girls in Vietnam dress up to go to Starbucks. It’s a special occasion. Photoshop a picture of Marilyn Monroe at Starbucks. Her brand has a net worth of $27M. Are you worth $27M? No? Okay, you’re not fancy enough to go to Starbucks. That’s for rich people.
Throughout this process, you’ll need to change your expectations about how you should live. You’ll need to surround yourself with things that remind you of the actual lifestyle you can afford if you want to achieve your big, long term important goals.
Alright, looking more. In my opinion, pets are like kids, so if $100 is just how much chow your dog eats and you’re not buying the ridiculous brand, don’t bother trying to save money there. Netflix is cheap. Travel I think is really important. It creates memories that remind you how fancy you are, and let’s face it, spending our youth hermitted up inside sucks. So only cut that to $100. You’re at $1028 now, probably more b/c of reduced car insurance.
Kill the cable, keep the internet, and kill the phones. You can get regular cell phone service and texting for $10/month. You can have smartphones, but they’ll only use wifi. I did this in Vietnam, and it isn’t as bad as you think once your learn the tricks (offline maps, music, etc.).
Okay, finally downgrade to a 1 bedroom $1000 apartment. That should put you at $1758 savings per month. It’ll also put you in an area where relatively, your $100k household income probably seems better off than the people around you. So you won’t be lusting after everybody else’s car/computer/tv/dress/whatever.
You should have a small party with $2 chuck to celebrate how much easier your smaller apartment is to clean.
With your freed up income, you’ll be able to pay off the credit card in less than 7 months. After that, you’ll have about $2000 even to tackle the student loan. That should be wipe out in 2 years. So you will live in this crappy way for 2.5 years.
This 2.5 years will be the hardest money time of your life. Because it’ll be the time when you’re most ignorant about how to be happy without spending money. It’ll be the time when you have the lowest material quality of life and the least financial certainty. Things will only get better from here. And… the 2.5 years will end. Just think of yourself 2.5 years ago. If you’d started then, you’d be done by now. In 2.5 years, there will come a day when you wake up and a *poof* all this money stress is gone, and without the payments, it’s like your income doubled.
During the 2.5 years, really from now until the end of your life, you’ll focus your energy on learning the psychological tricks to enjoying life while spending less money. You won’t be 100% successful with your new budget immediately, but since you aren’t watching as much cable TV, you now have time to strategize how you’re going to solve your new budget problems.
That’s really the magic here: if you dedicate time to learning how to enjoy life doing things that don’t involve money, if you disconnect spending from happiness, then you get “free” happiness. You’re no longer addicted to spending money to be happier. So then it’s no big deal when you stay for years at this lower spend level. And as you see your wealth grow, and you learn more about how that wealth can best be used to accomplish your big life goals, your long term baseline happiness grows also.
In 2.5 years, you will be debt free, and you’ll be used to living on $3400 of your $6000 income. At $2600/month, you can save up $20k for a down payment on a $100k condo in less than a year (4 months for an emergency fund, 8 months for the down payment). That’s only about 3.5 years from your starting point.
You can pay off that $100k condo in about 3 years. Then you can upgrade to a $150k condo if you want, or you can start spending $3.6k on faberge eggs every month. During this 6.5 year period, you will have gotten very good at being happy while spending very little money, so you probably won’t even want the champagne anymore. You’ll probably just take a walk and smell some flowers.
During this time, your income has probably gone up. If you started at 30, you’re only 36. If you started at 22, you’re only 28. You’ll have a paid for house and you’ll be happy living on less than half of your income. You’re aren’t Bill Gates (yet), but disaster will have a hard time touching you. You’ll get a super big discount paying for your kids college education, because you’ll have the money early on to stick in a tax sheltered 529 account. If you back off and stick only $2k of that $3.6k into index funds in tax advantaged retirement accounts, you’ll still retire millionaires. If you decide you want to go on a vacation, you won’t have to borrow any money. You can just sacrifice a month of saving.
And I have even mentioned the gobs and gobs of interest you didn’t pay b/c you decided to live like crap for a few years early in your life?
Honestly, after about 6 months of living this way, you don’t really care about spending the money anymore. You’ve started to develop habits that reward you regardless of what you do or don’t spend. You care about the fabulous progress you’re making on the debt, and you care about reaching the light at the end of the tunnel. When you have no plan, when you can’t see the light, you have nothing to run towards. But once you see the light and you start running, you don’t really notice when you run right past the Best Buy and the Starbucks without stopping inside. After you don’t have any debt and you have an emergency fund, your overall stress level goes down so much that buying crap and going back into debt isn’t even appealing.
As you can see, this process snowballs. Cutting the housing cost is big way of jumpstarting the process but also a good way of keeping the process going. Maybe you have a crap month and you want to splurge some. With $500 of housing savings a month, if you buy a nice bottle of whiskey for $200, it isn’t that big of a deal. Just make sure to let it sit on the shelf for a month before drinking it, to remind yourself of how fancy and overspendy you are. You want to milk that whiskey for all its psychological guilting value as much as you want to get drunk.
My Housing Costs
I’ve always hated high fixed costs. Not necessarily because I’ve always been super financial responsible. Mostly because I like buying toys, and the less I pay on housing, the more toys I can buy.
Q: How many square feet per person? I.e. What is the square footage past which a person doesn’t get much additional happiness?
11 days to spend it if I bring home that sandwich tonight. What you don’t think about matters as much as what you do. E.g. if I spend my time obsessing over bringing a sandwich home, I don’t spend it obsessing over buying a new video game system. Thinking about a sandwich isn’t the most productive thing in the world, but it’s better than thinking about spending money. A free sandwich isn’t going to get me to my goals really, but avoiding thinking about spending $6k on a motorcycle will.
186/11 is up to $16.9 dollars a day for the remaining period. I’m riiiiiiiich.
Savings protect against disaster, but they also let you drop $18k on a good opportunity when it comes up, like this guy:
i am too tempted to spend my savings outside edward jones, so lately I’ve been dumping big chunks into lending club. I wonder how software engineers rates of default compare with other professions?
I spend approximately as much as someone making $60k/year. This isn’t horrible, but I bet I can do even better. More to experiment with happiness levels and test efficient than the necessity of saving the money. Ideas for cutting spending:
– cut internet speed
– cut cell phone bill to $10
– stop spending on Paizo
– stop buying shit on Amazon/paypal [this is really the elephant]
– Kill Github
– Cut back on car insurance
$3.1k a month isn’t horrible and is more or less where I was targeting myself with my budget, but we always want to be moving in a more efficient direction!
It’s when you have X many dollars left and Y many days until your next paycheck, and you’re wondering how many weekends you’ll have to survive through. My weekends are usually more expensive b/c I have to pay for lunch, and friends are more often available for activities. February treats us semi-monthly salaried workers well, as we get the most dollars per day. This year, February matched up exactly with a Sunday – Saturday, pleasing the heck out of many OCD people. As a result, March starts on a Sunday, and I only have to survive for 1 weekend before my next paycheck, which is the mid-month paycheck that replenishes the food money. Not too shabby! Only 12 days to survive. At $180 remaining, that’s $15 a day. Breakfast is definitely < $5 a day, and dinner is typically <$10 a day, so as long as I can resist all non-food related temptations, I’m gold
Not that that’s easy… Okay, I’m removing the debit card from my wallet now.