Saturday, December 5, 2009

The Dangers of Excess Frugality – Budgeting and Balanced Living

"Virtue, then, is a state of character concerned with choice, lying in a mean… Now it is a mean between two vices, that which depends on excess and that which depends on defect; and again it is a mean because the vices respectively fall short of or exceed what is right in both passions and actions, while virtue both finds and chooses that which is intermediate." Aristotle, Nicomachean Ethics.

A Zen Garden

The dangers of excess frugality – The slippery slope of budgeting

The first steps in budgeting are usually a real eye opener. For the first time income and expanse are laid bare before our eyes more often than not resulting in surprise and disbelief as to the proportion of expense relative to income, the volume of different expenses and usually the inadequacy of income.

A little later on the potential hits. As with any new endeavor a significant portion of the benefit can be taken advantage on early on. Potential savings and sources of money leaks are easily identified and several quick and significant measures can be taken to materially improve the family's financials.

Newly discovered personal finance enthusiasm usually leads, then, to further interest and reading which in turn leads to discovering the power of finance and compound interest. The affects of saving early are empowering and goals are set to allocate a more significant portion of the budget to saving.

Frugality often follows. Each expenditure is carefully weighted and considered against the future alternative benefit which, when compounded over time, amounts to hefty sums. Considerations such as "This $1,000 vacation has an alternative cost of $1,800 in 10 years using a 6% interest rate" are not uncommon.

Retirement planning takes up more and more of one's time as a result. Thoughts of early retirement are fascinating with seemingly small sacrifices made on the way. Slowly but surely present time is replaced with imagery of retiring at 40.

Without noticing money becomes the object rather than the means. "I only need so and so much more and I'm settled". The present soon is sacrificed for the future.

Sacrificing the present for the future

The real danger of the slippery slope presented is sacrificing the present for the future. The American public as a whole is in no real danger of this happening and the future has already been sacrificing several times over on the altar of consumption. Still, many personal finance enthusiasts quickly find themselves torn apart when it comes to spending money.

Frugality, in its moderate form, is probably a good trait. However, any excess (or deficiency), as Aristotle had so eloquently put, lead us away from virtue. Virtue or sense, in this case as well as others, lies in the middle.

Excess frugality will usually results in forgetting our original goals altogether, abandoning them to the accumulation of wealth with no real purpose. The inheritance will surely benefit the next generation but our lives are ours to live, not to pass on (again, reasonably).

The problem with sacrificing the presence for the future is the unavoidable frustration. Any extreme behavior takes its toll on the person as well on the surroundings. Being happy in such circumstances isn't easy.

I should note I obviously do not suggest sacrificing the future for the present. I am only recommending a more balanced approach.

How to achieve Balance?

Balance will be represented, in this case, by the ratio of saving to consumption. In economics permanent income suggests a person wishes to average out his or her income over one's lifetime in such a way as to not consume to much in the present or, on the other hand, consume too little (by saving too much – There is such a thing).

The rule of thumb suggests middle class households should consume 75% of their income. The rest will serve as either an emergency fund for non-expected expanses and big planned expanses (which can be expected as I've elaborated on in Budgeting for unexpected expenses) or as long term savings (equally weighted).

If you're consuming less than 60% of your income or over 85% than an evaluation of income vs. expense is in order. Some circumstantial aspects obviously exist as dual income families with no kids would present higher levels of savings while others may present less available funds for savings.

Still, the rule of thumb serves as an indicator that something may be off. In higher income levels the ratio of saving out of income is obviously higher while in lower income levels saving money is something one can only dream of.

To some the idea of spending when you can save may sound careless. I argue the good mental health and happiness include the satisfaction of everyday needs. Stoic willpower may enable one to retire early but what of the years past? Usually the best years in life.

The illusion of having compounding interest working for you

There's a reason why the 30's are considered the consumption era in one's life. Investing in education, raising a family, buying a house and other significant financial obligations put a damper on any attempt to really save for the long run.

True enough, saving throughout 20's and 30's will result in compounding interest working for us but who of us has managed to save significantly without sacrificing our present? Amassing a considerable amount of money requires many concessions, maybe too many.

The illusion of saving early is frustrating since saving at such an age is extremely difficult. For one's good mental health savings should be balanced with consumption. The 40's and 50's are considered periods of wealth accumulation and will serve the purpose of amassing wealth as well (considering you are not intent on retiring at 40 – another illusion of you ask me).

A more balanced life and balanced goals will help achieve inner peace and acceptance that money is truly a means and not an end. This takes work and time. I suppose on cannot escape the slippery slope I've presented but understanding the need for balance early on will save considerable frustration and contribute to early happiness.

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ctreit said...

This is a very good post since most posts on the subject emphasize frugality. I agree with you that we all have to strike a balance between living well now and being frugal, which also implies that we need to deprive ourselves of some pleasures now.

pkamp3 said...

Too true. You nailed it; there is danger in saving too much as well as too little. You've got to live your life with that in mind.

Des said...

While I think you have a good point about the phases new frugal converts go through, I disagree that people inherently "need" to spend money to maintain their "mental health". Can you cite one single instance of someone's mental health actually suffering from not buying consumer goods? Also, do you really think someone who sacrificed through their 20s and 30s to retire at age 40 regrets the decision? I would like to see you find a single 40 year old retiree that regrets their choice to live like a starving grad student for 20 years to achieve financial freedom so early in life. If you are unable to find such people, as I am, then perhaps you should rethink your philosophy.

Also, you mean "present", not "presence". You are sacrificing the present (as in the here and now), not presence (as in, your physical presence in a room).

Dorian Wales said...

Thank you all for your comments. @Des - Thanks for spotting the Typo. On the issue of the 40 year old retiree - I would first like to find a single 40 year old retiree. Maybe than I can ask him/her which sacrifices did they make. I'm guessing any 40 year old retiree caught a major break and made a significant amount of money somehow. Retiring from a salary by the age of 40 is an illusion for all but a selected few. The monk like living style you have to adopt will most certainly cost in mental health for the average person. Eating a sandwich for lunch every day for 20 years with your colleagues eating out, occasionally, is not a good behavior pattern.

Eugenia said...

I was with you until that last part, and, I couldn't disagree more with how you ended it.

First of all, where do you get that 85% figure? Do you have *any* facts, studies, statistics, to back up WHY that should be the proper percentage for ANYBODY?

2ndly, this idea that how much we spend should be based on how much income we bring in. Why is that more important than taking the time to figure out my financial needs in an intelligent way, based on fulfilling both my needs, and enough of my wants to reach that sweet-stop of happy? Why is following a seemingly random percentage a better idea than taking a look at what I think the scope of my life will be like, and adjusting it accordingly?

Especially today, when so many people have lost their jobs...if I know that I need $XXXX a month available to me, to fulfill my needs & wants, why should I care what percentage of my income that is (provided that I'm saving well for retirement). Take somebody who was making upwards of 100K. Did they *really* need to spend 85% of their income to be happy? Why? If/when they get laid off, wouldn't be better to be spending far far LESS than that, so that if a new 100% job wasn't forthcoming, they'd still be happy & not feel an acute pinch?

I make close to 100K. I spend about 50% (net) of what I make. & that is more than enough to keep me happy. I still buy things for my home. I go on trips. I buy clothing & things when I need it.

I have, for the past 10 years, continuously negotiated for higher salaries & worked hard for better bonuses, not to spend that money each month, just trickling out a percent of what I make, but to save it, to use so that I'm not nailed down to a job that I hate, so I can walk away from poisonous jobs, so that I can have more freedom, more choice, in my life.

In a few years, I'm going to switch to working for a year or two, then living off of what I've saved for a year or two (while doing a little freelancing on the side). I'm lucky enough to be in an industry where I can do that.

And if I just blindly accepted that I should spend XX% of what I make, without thinking about what I *really* want out of life, I wouldn't be doing that. I wouldn't be able to take a year or two off, to travel, to enjoy myself, to go home to my family for a few months.

Instead of giving people a cookie-cutter number, and accepting that working 9-6 until you retire is *the* way to go, how about talking about all the other ways that you can make your money work for you? There's so much more to life than either spending nearly everything you earn RIGHT NOW, or overdoing it with frugality until you retire.

Anonymous said...

Part of the save/spend balance equation should
probably involve income uncertainty and our
risk tolerance. I don't think it would be
unreasonable for someone with large financial
commitments and who fears possible job loss
to squirrel away half his disposable income.
I've personally taken this route and have
reached the point where I can realistically
treat a layoff (which would be my first) as
an early retirement. This peace of mind is
pretty rare at my workplace, and it didn't
come for free. My opinion is that it is
well worth the nights on the town I gave up
in my youth.

Anonymous said...

I totally agree with Eugenia. Good comment!

Bret @ Hope to Prosper said...

I tend to agree with Eugenia. It's neither practical nor constructive to cast down hard percentages upon people, who's life situations are completely different.

Having said all of that, I think this is a great post and you offer some sage advice for balancing life with finances.

I have written on this subject a couple of times. Having been far too frugal in my early days, I regret some of the things I missed out on. Balance is the key to a happy and prosperous life.

Bret @ Hope to Prosper said...

I tend to agree with Eugenia. It's neither practical nor constructive to cast down hard percentages upon people, who's life situations are completely different.

Having said all of that, I think this is a great post and you offer some sage advice for balancing life with finances.

I have written on this subject a couple of times. Having been far too frugal in my early days, I regret some of the things I missed out on. Balance is the key.