Budgeting Below Your Means

small-budget

I’ve read a lot of articles teaching people how to budget properly, but every article I read always assumes that the entire budget represents your monthly income. Why not change it for once? Let’s assume you make way less!

It might seem logical to most people that if you get a raise it means you can buy more stuff. Making more money means being able to buy a new Canada goose jacket. Or maybe now you can upgrade from a Civic to an Audi. But should making more money always equate to more luxury goods? Is spending money the only goal in life that makes us happy?

Prioritize Financial Independence

I created a sample budget in one of my previous posts where it represented a very modest person living in a very expensive city, like Toronto, while trying to get by on only $56,000 a year.

Now what if that person got a raise and now made $70,000 a year instead? This situation might happen to someone who just got a big raise after 2 years at their company. In this situation what would that person do with an additional $10,000 to spend after taxes? That’s slightly more than $800 a month. Exactly the monthly cost for an Audi A4 perhaps?

What if the person decides buying an Audi A4 isn’t practical? Instead this person decides to keep the same monthly budget as someone earning $56,000 and decides to put the money away into long term savings. Despite making more money, the person’s standard of living doesn’t change, but her savings goes up instead.

sample_budget_below

 

Accelerating Your Savings

So what does $800 extra a month look like when saving for the long term? I might seem like a small amount to some, but the savings do really add up when you look at a 10 year investment plan.

So let’s see what would happen. If the money was saved in a balanced investment portfolio that averaged 6% annual gains over 10 years, what would the outcome be?

accelerate_savings

The person that decided to stick with the same amount of savings and spent the additional $800 a month would end up with slightly over $79,000 in their portfolio after 10 years.

If the person decided to save just 10% of the additional income or $1000 more a year, in 10 years it would accumulate to just over $92,000.

So what happens when the person saves the entire $800 a month? That person ends up saving $16,900 or an additional $10,600 more than her original amount. After ten years that person would have almost $223,000 in their investment. That’s a staggering $144,000 more!

Granted the person saved $106,000 more over that period, but the investment gains over that period is almost $38,000 more! With so much more equity saved up, this strategy of budgeting less means that at year 10 the passive income that the investment portfolio would be generating would be $8,600 more. That’s an additional $720 a month in income!

Reaching Independence

Remember that goal of financial independence means getting passive income from your investments to cover all your living expenses. If your standard of living continues to grow with your income, it will be much more difficult to earn enough passive income to retire on.

By setting a standard of living that you are comfortable with, it helps set a ceiling. In order to know how much income you need, you need to set a budget where you will be happy with your lifestyle. This sets your level of income that you need to earn monthly in order to be happy. At this point, any additional income you earn can become that “extra” little bit that will help you get to financial independence faster. Remember that the larger percentage of income you can save per month, the faster you can reach financial independence.

If you’re still not convinced, you should try it one time. Set aside a larger amount of income to savings and try to live on less. You would be amazed how many creative ways you can find entertainment that will not only let you save money, but will also make you happier. Once you start seeing the benefits of your commitment to saving, you’ll also become much happier that you’re striving closer to financial independence.

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