Help! Can I afford to buy ___?
The 5 Golden Guidelines to Worry-free Spending.
Do you have something you genuinely love spending money on, but when you do, you start to worry and feel a little guilty?
It’s normal, even for people with good jobs. A friend recently told me, “I make too much money to feel restricted all the time.” And yet she still does. We all do to some extent.
There is some hope. If you follow just a few important spending guidelines, you can enjoy the rest of your money.
So, what have you been thinking about spending extra on?
Is it ordering at the restaurant this weekend and completely ignoring the price?
Is it booking the awesome waterfront hotel to spend the week snorkeling in Belize?
Is it buying that new jacket you’ve been internally debating for a while?
How good would it feel to do that with zero worry, guilt, or buyer's remorse?
Enter the 5 Golden Guidelines.
The 5 Golden Guidelines to Worry-free Spending
You can spend on whatever you want if you follow these guidelines1:
You pay off your credit card each month
Invest at least 15% of your take-home pay for retirement.2
Save 5-10% for future big expenses.
Spend less than <30% on housing (rent or mortgage/tax/insurance.)
Spend less than <10% on transportation (car payment, gas, maintenance, etc.)
If you follow these guidelines, yes, you can feel absolutely free to spend on whatever you want without worrying about whether you can afford it—because you can!
Read on to understand why and the framework behind these guidelines.
Starting with life goals
These guidelines are designed to achieve two goals and are real-world tested through the actual spending of real people.
Our goals:
We don’t want to work forward, and many of us want to have the option to stop sooner rather than later.
We also want to enjoy life along the way and not defer happiness to some distant future that may or may not come.
Goal 1 needs no explanation. Only a few folks are out there to work until they die. Good for them. But that’s not most of us.
Goal 2 is also self-evident. But it’s worth reflecting for a moment on what you want to do in your life that will not be possible in the future.
If you want to take your kids to Disneyland, the experience you can give them when they are young is something you can’t repeat when they are older. There’s a real cost to deferring everything to the future.3
Guideline #1. Pay off your credit card each month.
If you pay interest on a credit card balance, you can’t afford to keep spending at the current level. And your challenge gets tougher each month when the bank charges you more interest for the privilege of falling deeper into debt.
Your first priority should be to enact a plan to pay off credit cards and other high-interest debt. For strategies, Google the “Snowball Method” and “Avalanche Method.”
Guideline #2. Invest at least 15+% so you don’t have to work forever.
To have the opportunity to stop working, you need to save the percentage of your income that matches your retirement timeline.
To be able to stop working, you need to invest a portion of your current income so that the return on those investments eventually can fund your spending without having to work.
This is a key insight because our retirement investments don’t need to replace our total income. They need to replace our spending.
The implication is that the percentage of your current income you are saving rather than the actual dollar amount matters most.
How much?
Starting with standard assumptions
Your investments generate a 6% real rate of return (after inflation).
You live off a 4% withdrawal rate of your investments during retirement.
You start investing at age 25 with $0 in your portfolio.
If you start investing from another age, you can add or subtract the difference in years. For example, if you start at 27 years old, add 2 years.
If your goal is to stop working by Age 65: Save and invest 15% of your take-home pay.
If your goal is to stop working by Age 55: Save and Invest 25% of your take-home pay.4
That’s it.
If your combined 401k and IRA contributions are hitting these percentage targets, you are on track and can move on. See here for how to make sure you aren’t making any big mistakes in your 401k.
Guideline #3. Make sure you are ready for big future expenses by saving 5-10%
What big expenses are important for the life you want to build? Do you want to own a home? Pay for your kid’s college? Go on a big vacation?
Saving 5-10% of your take-home pay for these will often be enough to put you on track to pay for them when they come up.
You should also include savings for an emergency fund here. These are valuable tools for avoiding letting an unplanned expense derail your life.
To figure out how much to save, work backward from the amount you need and when you need it. For example, if you want to save $4,000 for a vacation in 20 months, you should save $200/month.
If you do the math and realize it’s going to make more than 10% to save for your goals, it’s ok to start with 10% and then slowly increase that amount over time.
See here for a step-by-step guide to what to do first in your saving and investing journey.
Guidelines #4 and #5. Managing your fixed costs ensures there’s something left over
Fixed Costs are all the daily costs and bills for housing, cars, utilities, insurance, groceries, out-of-pocket medical costs, pets, and debt.
Fixed Costs are super important because if you manage them effectively, you can ensure you have enough money left over each month to spend on what you want.
To manage them effectively, you only need to get two parts of your Fixed Costs right - Housing and Transportation.
Guideline #4. Spend less than <30% on Housing
Housing - your rent or your mortgage, taxes, and insurance - is the biggest driver of your fixed costs.
Housing generally has to be below <30% of your take-home pay to avoid being house-poor and sacrificing other parts of your life. You can go slightly above 30% if you can reduce transportation costs to very low levels (like if you live and work downtown and don’t own a car.)
In many places, <30% is only possible when living with a roommate or partner. I’ve had roommates my whole life, and it’s been great for me. It’s allowed me to keep fixed costs below <25% even during my first job, making very little in the Bay Area.
The alternative, living alone, comes with significant costs. It’s worth it for some people, but you will often have a much lower remaining percentage for other things you want to spend. Unless your income is high, this will mean less eating out with friends, travel, clothes, etc.
Guideline #5. Spend less than <10% on Transportation
Transportation is the second most important cost. These costs include not just your car payment and fuel but also maintenance, registration, and insurance, which can be easy to forget when car shopping.
Generally speaking, the best way to keep these costs below <10% is to buy used cars and hold them for a long time. If you live in a place where you can rely on public transportation, that can also be a significant cost advantage.
If you find it difficult to invest and save while also having enough left over to spend on things you want, Housing or Transportation are almost always the problem. Focus on getting those down, and your options will open up.
Freedom! You can spend on the things you want and stop worrying.
These guidelines are designed to maximize flexibility for spending the remainder of your money on things you want.
With your remaining money, you can buy anything you want and know you can afford it.
So, when you start to worry or feel guilty, remind yourself that you are following the guidelines and are on track with your goals.
Take that weekend getaway or grab drinks with friends. Go out and savor life!
Do not violate rules #1 and #2 ever! The only time you can violate them is if when you are agressively paying down credit card debt. However, #3 - 5 are more loose. You can deviate from them if you have thoughtfully decided that’s the right thing for your priorities and have weighed the tradeoffs. For example, maybe you are ok with never going to a restaurant so that you can live right on the beach and surf every day. Create the life that you want to live!
All percentages in this article are based on your takehome pay (after taxes are deducted.) You should also add back in any 401k or other savings deductions since you are receiving these as well, they are just getting saved automatically for you.
I like how Bill Perkins frames these, which hs calls “Windows of Opportunity” in his book Die with Zero.
If you want to retire even faster. Saving and investing 45% of your pay will let you retire by around age 45.