Making Cents: Bono and a cheeky red wine

IN THIS article, I’m going to tell you about two people I met last year. And they had six things in common.

The first two were good i.e. they had big titled jobs and they were earning big salaries (six figures) but the next two were the problem i.e. they had very little savings (less than €1,500) and they had an inability to save a regular amount each month and when I say save a regular amount, I mean they were saving nothing.

And the problem with both wasn’t that they had big mortgages or that they weren’t earning enough, the problem was that they were spending too much on themselves, and that was the fifth thing they had in common.

You see one of them, just before she had met me, had bought tickets to go see U2 in Las Vegas.

She was going with friends on a week-long trip but was still wondering why she had no money and why she couldn’t save.

The other person told me that he and his wife allow each other to spend €1,000 every month on whatever they want to and he said there wasn’t a month that went by when they didn’t.

He went on to say that he had saved about €1,000 over the course of last year but that money was earmarked for wine he was going to purchase for Christmas. And it wasn’t that he bought a hundred bottles either, he told me it was much less because they like nice wine. Record scratch.

Big incomes but big outgoings and it’s really not that difficult to figure out why both of these people have a savings problem but they couldn’t see what it was. Or maybe they could and they just didn’t want to admit it to themselves.

And sometimes when people are struggling with money issues, they look to others they can blame for the situation they find themselves in, when in reality they are most to blame for the problem they are going through. That might sound harsh but in some situations it's true and with these two people, it was certainly the case.

Because their particular problem was very obvious i.e. their discretionary spending was excessive and frivolous.

And just to define what discretionary spending is, in my books it's all of your nonessential spending. In other words, it's spending on things that aren't necessary for you and your family's basic needs.

Excessive discretionary spending isn’t that unusual a problem either because I read an article recently that claimed the number one financial mistake people make was excessive spending on themselves. So, it seems the problem with the two people I met isn’t that uncommon.

Anyway, the good news was that they both reached out looking for help because they both recognised they needed it. They realised they were living pay cheque to pay cheque and if anything happened to either of them from an illness or income perspective, what little savings they had meant they were about 10 days away from running out of money, and that was the sixth thing they had in common.

When we sat down to talk about her finances, she said, ‘scare me into something I should be doing’ and you know sometimes people need to be scared in order for them to take action.

And that scare might be telling someone that if they continue spending as they are they’ll be working until they’re 70 and/or they’re income is going to drop by 80% so they better enjoy their holidays now because when they’re older they’re going nowhere because they won’t have the money.

Before I scared her, I asked her what was it that she’d like to happen from a financial perspective now and in the future?

And she didn’t know and that was a problem.

Because if she didn’t have any financial goals, she couldn’t know what impact her overspending was having on her finances. When we fleshed out what her goals were and what she needed to do to achieve them, they became a huge source of motivation for her.

Knowing what she needed to do to achieve them, was now going to come before any tickets to concerts or expensive trips were made, because these goals were more important to her.

And she had two goals by the way, she wanted to retire at 62 and she wanted to have her mortgage paid off at that age as well. Her work was very stressful and she didn’t want to work beyond that age. It was important she gave herself the option to dial things back when she was older before she burnt herself out.

When I ran the numbers for her based on her current lifestyle and lack of savings, she could see what those expensive trips were doing to her future self and how big an impediment they were to achieving her goals and once she knew the impact, it was like a light bulb moment for her.

She now knew she was going to get an even better feeling by not spending as much money than she used to. And that was all because she knew what she was going to do now was going to have a much bigger and lasting impact than memories of a concert in Vegas ever could.

But that’s not to say, she should never enjoy herself either and never go away on trips or treat herself, of course she should, but it has to be done in conjunction with two things (a) her present income and outgoings and (b) planning for her future.

It’s trying to find that balance between enjoying herself and rewarding herself now for working hard as well as preparing for the future when she isn’t working. There’s no point in going to all the cities and concerts now but not having enough money to go see the tribute act in the local pub when she’s older.

And the reason why discretionary spending becomes an issue for some people could be down to any number of reasons i.e. perhaps they feel the need to spend money because they have a stressful job and they need to reward themselves or it can be tempting to buy what you see other people buying as a way to signal that you can afford it too or sadness is also a trigger for some to spend more than they should because for a short period of time it might help distract them from something going on their life that they are unhappy with.

As I said there could be any number of reasons why people overspend but there is normally an underlying reason why they have a lack of savings and why they’re unable to save on a regular basis.

Anyway, if anyone is looking for a number that is an acceptable amount that can be classified as discretionary spending then I think somewhere between 5% and 10% of their net monthly income is okay.

Ultimately, the amount you should budget to spend depends on your income, your expenses, and your financial goals. If your income is low or you have a lot of debt payments, for instance, it might make sense to cut back on your discretionary spending to increase your ability to save or pay down debt.

On the other hand, if you have a lot of income to work with, you may be able to afford to spend more on your lifestyle but I think the optimum amount people should spend in this area is between 5% and 10% of their monthly net income.

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And if you've found that you're spending too much on non-essential expenses then I’d say the first thing you should do is track your spending. Take a look at what you’ve spent your money on for the past three months and put each expenditure into a particular category so you have an idea of where your money is going. And when you have all of your expenses laid out, it will help you pinpoint (a) what and where you’re spending your money on and (b) what you need to do to reduce that non-essential spending.

And having a reason to redirect these monies into will help no end. Having that bigger goal and knowing the impact of spending less and saving more means you can for example, retire earlier or become mortgage free earlier or getting a deposit for a house or whatever is important to you, will help you follow through with spending less. Because I know the mere thought of having to do this is not pleasant but knowing the impact it will have should make it easier for you.

And I’ll finish by saying that while there's nothing wrong with making the occasional unplanned purchase but doing it too often can wreck your finances. So, maybe look at cheaper ways to maintain your lifestyle. And take a look at aspects of your lifestyle you don't want to downgrade and see if you can maintain them while also cutting down on their cost.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at [email protected] or www.harmonics.ie