I went into the doctor’s office the other day to have a minor procedure done. After the doctor walked in, I started the slightly uncomfortable small talk that ensues when silence is more awkward than talking. The doctor had a good bed-side manner and asked me what I do for a living. I explained that I am financial planner with a focus on providing people sound financial advice. He naturally then asked me, “So, what is your best piece of financial advice?”. I was a little caught off-guard by this question because normally people don’t ask me that question after I explain what I do. Also I was a little scattered brained since I was trying not focus on the procedure that was underway. I jokingly answered, “Don’t get a divorce.” I could tell from his reaction that my answer completely surprised him!
Spend Less Than you Make
If I had a second chance to answer the question I would have said, “The best piece of financial advice I can give is to establish a lifestyle below your means.” In a nutshell spend less than you make. You probably thinking right now, ” Come on Rich! After all these years studying and practicing financial planning your best piece of advice is what I can get from a SNL skit!”
Less Expensive Lifestyle = More Flexibility
My simple answer is yes. There are several reasons why establishing a lifestyle below your means is so important. First and foremost, it provides the margin needed to save and invest for the future. Second, it is the basis for determining how much you need for other financial goals like an emergency fund or retirement. Third, it provides flexibility needed to adjust to life’s unpredictable nature. Flexibility can provide opportunities such as starting a business, taking a year off to travel, or enabling a spouse to stay home to raise children. Flexibility also allows you to better adsorb the trials of life whether that be a loss of job, an unforeseen accident, or an unfavorable medical diagnosis. The simple drawing below illustrates that as your lifestyle increases your flexibility decreases.
As with most things in life the best advice is simple but extremely hard to consistently implement. “Buy low, sell high“, “Eat less, work out more,” “Do unto others as you would have them do unto you.” I am sure you can think of other adages that are easy to say but hard to practice. So why is it so hard to establish a lifestyle below your means? It would be easy to focus on a single factor such as we live in a consumer society or that money was never talked about in your family, but the truth is there are many factors that affect how we view and use our money.
Extremes vs. Situational Judgment
What I want to focus on is how to be successful at establishing a lifestyle below your means. There are two main ways to live below your means. A simple way is to have a mindset of extreme frugality. A more involved, but in my opinion the more successful and rewarding way, is to exercise situational judgment based on your values and goals. As humans it is easier for our brains to think in extremes rather than exercising situational judgment.
I will use a grocery and clothes shopping as an example to compare the different mindsets. If you are exercising extreme frugality, your goal is to spend as little as possible on food and clothes. You go to Walmart and buy the cheapest rice and beans you can find. Then ask yourself if you really need to spend money on clothes which the answer is, “No”. In this example you have maximized flexibility and established a lifestyle below your means.
Using the same example, here is how situational judgement works based on your goals and values. Let’s say one of your most important values is your physical health and environment. You have a goal of saving for downpayment on a house because you want a home to start a family. The home will provide a better environment for your family than your small apartment. You go grocery shopping and decide to spend additional money on fresh vegetables and fruit. Since you have used your money on something you value (physical health), you now decide to forgo buying clothes for the next couple of months. You now save the extra money for the downpayment on a house. Although you have not maximized flexibility, you have made decisions based on what you value.