Editor’s note: The following is a guest post by Ramit Sethi, author of the New York Times bestseller I Will Teach You To Be Rich and founder of the personal finance blog I Will Teach You To Be Rich. Take it away, Ramit . . .
A couple of friends and I were talking about where we want to travel this year, and one of them said something that surprised me. "You probably wouldn't approve, but I want to go to the Caribbean this year." Huh? Why wouldn't I approve? I thought about this in a pensive stare for many moments, taking the form of Rodin's Thinking Man and wishing that I had a pipe and perhaps a tweed jacket. Apparently, I'm the personal-finance guy to some people, who just talks about automating your finances, earning more money, and asset allocation. On top of that, I realized with a sinking feeling, "the personal-finance guy" means "the guy who tells me what I can't spend on."
Nothing could be further from the truth. Today, I present three friends who spend loads of money on things you might consider frivolous – like shoes and going out – but they're perfectly justified and perfect examples of what we should all be doing. Keep reading for my study and analysis.
My Three Friends
The shoe lover. My first friend is a girl who spends about $5,000 a year on shoes. Since expensive shoes cost about $300 to $500 each, this is around 10 or 15 shoes annually. "That's ridiculous!!!" you might be saying. And on the surface, that number is indeed large. But I think you can look a little deeper. This girl makes a healthy six-figure salary. She has a roommate, eats free at work, and doesn't spend much on electronics, gym, etc. She loves shoes. A lot. And so, after funding her 401(k) and a taxable investment account, she has money left over. "But Ramit," you might say, "it doesn't matter. $500 shoes are ridiculous!!!"
I want to take that statement apart. First, I bet most people who are astounded at the price of her shoes haven't even done what she's done. Have you funded your 401(k) and started outside investment accounts? Do you keep a strict budget of how much you spend? Second, when you have extra money (extra = after maxing out your investment options), what's better: Making a strategic decision to spend on what you love? Or just spending it on random things and watch it trickle out?
The partier. My second friend spends over $21,000 on year going out. "Oh my god, that's so much *#%(#%(#%!" a couple people said yesterday. Let's break it down. Let's say you go out 4 times a week – to dinners and bars – and spend an average of $100/night. That's easily $400/week. Now, this guy also makes a healthy six-figure salary, and he's similarly invested quite a bit in his 401(k) and outside investments. He works such long hours that he's only free Friday and Saturday nights. And so he goes out. Hard.
This guy has saved more than almost any of my friends. He's also spent more on going out than anybody I know. And although $21,000 sounds outrageous on the surface, look at his spending by percentage: Just for easy calculations, if this guy makes $210,000/year, his going-out budget is roughly 10% of his income. For my friends who make $35,000/year, you can be sure that they're spending more than $3,500/year ($67/week) on going out.
The subscription nut. The third friend is a tech guy with about nine different monthly accounts (from TiVo to music to gym). Typically we discount the cumulative effect of our subscriptions—we forget to add them all up to see the total amount – which is usually a lot
When I pointed this out, my friend just shrugged. I started to get angry and use a line I've always wanted to use – "Do you know who I am?"–but he then explained that his subscriptions came out of his entertainment budget, which he'd carefully thought about and revised every few months. And, not surprisingly, he has a savings plan that is automatically deducted from his paycheck. If he had decided he wanted to spend $8,000 per year on furry donkey costumes and Faberge eggs, that would have been great. At least he has a plan.
The friends I wrote about above are an exception to most people our age. Instead of frivolously spending money without a holistic goal, they took a few hours, wrote down where each percentage of every dollar should go, and then built an infrastructure to do it automatically.
It's all about conscious spending. Conscious spending means you decide exactly where you're going to spend your money–for going out, for saving, for investing, for rent – and you free yourself from feeling guilty about your spending. Plus, a plan lets you continue growing towards your goals instead of just treading water.
This is an enviable position to be in: cutting costs on what you don't care about, and spending extravagantly on the things you do. You too could be doing what one of these friends is–spending whatever you planned without thinking twice–and it can make perfect financial sense.
It sounds good. But the catch is, there are no stupid, simple secrets like "No Starbucks." You need to work to change your spending habits for a year, or maybe two or three. Would you be prepared to work that long to get to a place where you knew exactly what you're spending, and you could spend extravagantly on the things you value? You can. It just takes a plan.
Thanks for reading. If you're interested in learning how to spend extravagantly on the things you love, I've put together a 6-week program in my book, I Will Teach You To Be Rich. Get the first chapter for free and learn credit card tips to negotiate your rate, waive fees, and payoff debt quickly and easily.