Financial coach and author Ramit Sethi was never an advocate of strict budgets.
He always maintained that it is difficult to track every single expense. Also, it just points out to what you have already spent on. And the result is that you feel horrible and guilty and bad about yourself.
Recently, in a podcast with Morningstar’s Christine Benz and Jeff Ptak, he addresses that point again.
Why budgets don’t work
I’m not a fan of budgets, and I don’t know anyone who effectively maintains a budget over the long term.
My worst hell on this planet is sitting at 58 years old and tracking the price of asparagus at Safeway. I don’t ever want to live that life.
Furthermore, I actually find it very uninteresting. I spent this much last month—what does that tell me about going forward? And when you apply psychology to budgets, you recognize quickly why it does not stick.
OK, everyday-person-on-the-street who doesn’t really pay attention to their money, I want you to open up a spreadsheet—again most people don’t even use Excel.
I want you to find all the spending that you spent in the last 12 months. The spending that you don’t track at all and that you feel really guilty about.
Go ahead and spend the next two months trying to gather all that information and type it in or integrate it somehow. And then you see a bunch of numbers and I want you to magically make sense of it and then use that to decide what to do next. By the way, you have to do this for the rest of your life.
Now is it any surprise that no one actually keeps a budget for the long term?
How to get smart about spending
Studying psychology at Stanford University made me realize that we are cognitive misers, that we carefully ration out our attention on the things that matter.
I want to simplify and focus on the high-leverage items in personal finance. I call them “the big wins.” And with a conscious spending plan, there’s four numbers that I track:
- Fixed Costs. Give a percentage because specificity is really helpful. I would put it at 50% to 60% of take-home pay. That includes your rent, mortgage, society outgoings, debt payments, groceries, electricity bill, school fees, salaries to house help - all the fixed stuff.
- Savings. Aim for a minimum of 5% to 10% of take home.
- Investments. Which should be 5% to 10% of take home. The more you invest, the better because that’s where real wealth is generated.
- Guilt-free spending. That’s 20% to 35% of take-home pay. The guilt-free spending category allows you to buy what you want while knowing that your other important expenses are taken care of.
How does this help?
You flip your spending and saving from looking backwards to looking forwards. Instead of agonizing over past spends, look ahead with the question: Where do I want my money to go?
So, you have those four numbers, you can actually sit down solo or with a partner. And you can say, “OK, let’s map it out—this takes us 15 minutes to get 85% of the way there. Let’s decide what do we want to do this year. Do we want to go to this great restaurant? Do we want to take a trip with our family? Do we care about a nice hotel? Oops, that doesn’t fit into our numbers. All right, let’s save a little bit more this year and we can do it next year.
