Structure Your Spending to Drive Your Savings

Background

I consider myself financially organized. I’m well budgeted. I meet my savings objectives each month, transferring funds to their respective buckets before the opportunity to spend away earnings sabotages my goals. I’d like to believe I follow the rules experts recommend to achieve one’s financial ambitions. Yet, while reviewing my finances one day, I was alarmed by a certain revelation: as amounts of income vary month-to-month, I found myself absorbing the additional income with marginal spending.

Root of the Problem

After a period of self-reflection, I began to suspect there may be a variety of a wealth effect at play leading to a small degree of lifestyle inflation. Generally, concepts like these are thought to be more longer-term, slower processes. The traditional example, when home values rise over time, consumers are left feeling more financially secure and wealthier. Consequently, this confidence leaves consumers susceptible to increasing their discretionary spending.

A scaled down wealth effect may be affecting my spending habits, subconsciously. When more is deposited in my checking/general spending account, I find myself more likely to increase spending just enough to offset the additional income. My checking account always seems to return to the same level regardless of inflows.

Another contributing factor, my existing savings program may be providing for a false sense of security. In following my program, I know my objectives are being met. So long as I’m not drawing down my checking balance month-over-month, all is well.

Keep Spending Flat (At Least in the Near Term)

Why would increasing your spending in response to more income be problematic? It may or may not be. If the increase in income is permanent, perhaps lifestyle inflation is a justified and practical self-reward for your diligent efforts in advancing your career and life. However, if it turns out you desire to increase your spending, consider doing so within the context of your budgeting efforts.

Evaluate your circumstances. Determine if the increase in income is permanent or just a temporary aberration. If the increase is temporary, perhaps a decrease in income is likely to follow. Ask yourself, do I need to prepare for a future decline and place additional funds aside?

Outside of a budget re-evaluation, keep your spending flat(ish). Even spending isn’t possible, as I’ll discuss further along. But you should have an idea of what reasonable discretionary spending looks like for your income level. If you’re deviating from this routinely, then there’s an issue.

The problem may not be overspending. Perhaps your goal was unreasonably restrictive. A goal should be attainable, or the purpose is defeated. Unless the objective of formulating the budget was just to feel good about formulating the budget. We’ve all encountered a moral elitist like this, eschewing the superiority of their recently adopted habit. But let’s assume we’ve made a goal for the practical sense of keeping it.

The Problem with Fixed Savings

Many personal finance experts recommend moving money to savings right when your earnings come through the door. You’ve probably heard the term ‘Pay Yourself First.’ Sure, this is a great way to ensure that savings goals are prioritized. However, if your saving strategy ends here, then you allow for the spending that follows to be unrestrained.

A Practical Solution

How, instead, do we establish a program to keep spending controlled? Keep one of your savings objectives variable, and contribute whatever cash remains at the end of the month (or whatever timeframe you’ve implemented this approach on) towards your savings goal. This way, you’ve established the psychological connection of knowing each additional until of marginal spending is an equal step away from reaching your objective. Your desire to attain your goal has been given a voice in determining if additional expense is warranted.

Are the hundreds of dollars spent on date night this month worth postponing purchasing a home? You’ve now brought these decisions together rather than allowing real tradeoffs to be decoupled. There’s an opportunity cost to every dollar spent.

Things to Keep in Mind

For this strategy to work without too much complexity, you'll need to smooth your spending and income. If in some months you pay your mortgage at the end of the month, and others in the beginning, then it will be difficult to determine what your ‘excess’  is that should be contributed to savings. To manage this, I try to keep as many transactions nearer to the middle of the month as is feasible. That way, I don’t have items appearing twice in one period, then absent the next.

This might not always be practical. You may not be able to determine when your earnings are deposited into your account. But most other transactions you can control such as credit card payment dates.

Allow for a Margin of Error

Why not sweep the entirety of the surplus towards your savings objective? I allocate funds exceeding a certain amount for two reasons: First, there’s bound to be some noise in your spending habits, even if you haven’t relaxed your discipline. The chances of remaining perfectly within budget are remote. Some months you’ll spend less, others you’ll spend more. Consider what this variance is likely to be. Second, prices rise over time. The amount of transactional cash you’ll need to keep in your checking account will need to be increased at some point.

Implementation

The savings goal that I keep variable for this strategy is my allocation towards real estate investing. Each month, I compare my checking account’s beginning balance with its ending balance. Any accumulation beyond $350 USD is swept into a high yield savings account. The balance builds in this account until I have sufficient funds to make an investment.

Limitation

The most obvious limitation is the labor element. This is not a handsfree system. It doesn’t take much time, but there is still analysis needing to be performed each cycle to calculate the excess and make the transfers. If you’re worried about follow-through, perhaps adopt a hybrid approach of transferring a smaller amount each month on a fixed, recurring basis and then transfer the remaining excess at the end of the month. That way, if you forget one month, at least you’re still making progress.

Conclusion

Using my desire to build my real estate portfolio as motivation to restrain spending has proved to be effective. I find myself more conscious about spending. This approach has also added an element of gamification to my savings. There’s a small amount of entertainment value in seeing how much I can limit spending to maximize the savings contribution. I've found my specific goal to be a strong motivator, perhaps you'll choose another. Select an objective that you'll prioritize. 

The reward of seeing each month the progress being made towards achieving my goal fuels this cycle. It may not be the ideal strategy for everyone, but it has noticeably improved both my savings and spending habits. I recommend giving it a try for yourself.