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When I first started taking more interest in personal finance, the learning was very theoretical. I used it all: personal finance blogs, money websites, podcasts, mainstream financial media, books, magazines, etc. Everything I read taught me something new.
All of my learning came down to two main ideas:
- Save more money
- Invest that money at a higher rate of return
For the second part, I was provided with many practical techniques to increase my return. Whether in investments in property, shares, or many other asset classes, I discovered many ways to improve my ROI by 1% or 2%. I understood the massive impact that a 1% improvement could have. All good stuff, but something was missing.
What I was lacking was actionable advice related to saving more money. I knew from my research that it was integral to reduce spending. However, the advice which followed was either overly generic, or overly specific:
- Stop spending as much => too generic
- Make your own laundry detergent to save $1 a month => too specific
- Pay yourself first => too generic
- How to save money on potatoes in the supermarket => too specific
Therefore, I would like to share with you three simple tips that I actually use to reduce spending on things that I don’t actually NEED. You can start using all of these tips right now, and they apply to all forms of spending.
Tip #1: Value items in terms of hours worked
The first cheat I use is to understand the cost of spending (and earning) in terms of how long I will have to work based on my current wage to afford a certain item. For example, let’s imagine that you are considering going out for a meal tonight, which will cost you £40. How many hours do you need to work to pay for this meal?
1.1 Calculate your hourly take home pay
Your annual wage is currently £26,500.
The first part of this technique is to calculate your hourly take home pay. You may get paid hourly, which makes this easier. If you get paid annually, then you will have to calculate this figure.
For example, perhaps you contribute 5% to an employer pension and you are repaying your student loan.
Your annual take home pay is therefore approximately £18,230.
Assuming we work 230 days in the year, which is approximately the average in the UK, and we work 8 hours per working day (probably an underestimate for most), t our hourly wage is £10 per hour.
You only have to work this out each time that your salary or working hours change.
1.2 How many hours do you have to work to pay for the item
This is the easy part. Simply divide the cost by the hourly wage.
Before: £40 for the meal, why not?
After: £40 for the meal. I’m not working 4 whole hours (an entire morning at work) to pay for that meal. Get the oven on!!
Voilà, £40 saved!
Tip #2: Future pricing strategy
In my opinion, the second strategy is slightly more complicated, but even more effective.
The idea is to calculate the cost of something now not at its current price, but instead at its future cost.
Let’s use the meal example again. Again, we have two choices.
- Spend £40 on the fancy meal now
- Not eat out, and instead add £40 to my long-term investments
2.1 Calculate your investment returns
I want the calculation to be easy to perform on the spot. Therefore, I use the rule of 72.
-The rule of 72 says that if you divide your annual interest rate into 72, this is the number of years it will take to double your money.
Based on the historical returns of financial markets, I’m going to assume that I can earn 9% on my investments. If we then consider average inflation of 4% in the long-term, we would obtain a 5% net return.
Therefore, I calculate 72 / 5 to determine that it will take approximately 14 to double my money.
2.2 Work out the number years until a significant date in the future
The most commonly used date (and the data I would suggest using) is a retirement date. I currently use the period between now and my state retirement age (which I estimate will be 70 years old when I reach retirement). Personally, this is 42 years.
I will, therefore, double my money three times before retirement. So, £1 invested today with double three times when I retire – £1 x 2 x 2 x 2 = £8.
2.3 Work out your future cost
When I calculate the cost of something now in future terms, based on my prior calculation, I need to multiply its cost now by 8 (2 x 2 x 2).
Instead of the fancy meal costing £40, the true future cost of that meal is £320!
Suddenly, I’m not so keen to go out tonight!
I said in the title that I used this technique when I wrote this post. Whilst writing this post, I was tempted by some expenditure. We were thinking about ordering a take away curry. It was Sunday night, I was pretty tired, I was VERY hungry. It had seemed that the stars had aligned. I went online and the takeaway special was £25. Not too bad. However, when I then applied this strategy and remembered that this was costing my future self £200, I couldn’t justify spending £200 on a takeaway.
If you use this on every purchase, you suddenly stop spending money on everything other than those things that you really need.
Tip #3: The “30 day” rule
This strategy is slightly more common, but it is incredibly effective.
For any major expenditure (my limit is £30), I will not allow myself to purchase an item immediately. Instead, I always wait 30 days.
3.1 Write down your items on a list
Keep one single list. Each time you want to buy something major (whether it is home improvement, a new TV or some new clothing), write it down on the list with 3 things:
- The name and description of the product
- The cost
- The date at which you wanted the product
So, today, I wrote down “New shoes – £40 – 24/02/2014” on the list.
3.2 Choose one thing from your list
Then, after 30 days, if you still really want the item, then buy it. No more instant gratification. You will save money and you will appreciate the product that you have bought so much more.
3.3 Reset your list
This is the part of this technique that I use, that I have never seen written elsewhere. You may have noticed that in 3.1, I said “keep one single list”. This is because I add everything I want onto one single list. Then, when I am about to buy something, I have to choose the item which has been on the list for over 30 days, and I cross everything else off.
I then restart my list.
Therefore, I buy the new shoes, but I don’t buy the ipad and new coat that are also on the list. I decided that the shoes were the most important purchase and the others will have to wait.
I then start a new list and add the ipad back on (but not the coat as I have decided that I don’t really need it after all).
This part of the technique stops me writing down everything I want and giving myself the permission to buy everything 30 days after I have written it down.
I hope these methods help you. Let me know what you think of these methods? Do you already use any of them? What other methods do you use to help you restrict discretionary spending?
This article was written by Graham from moneystepper.com.
Moneystepper provides advice on taking small steps every day, which have a much bigger impact over the long-term. Daily posts cover every aspect of money, investing, saving, real estate, taxes & the economy: everything you need to increase your net wealth in the short, medium and long term.