For the average person, buying one $900 television set every ten years is a reasonable spending, and buying the latest $900 television every week is outrageously unreasonable. The problem with infrequent costly purchases is that they don’t happen often enough to let people intuitively sense whether they’re overspending. They’re simply not on the same scale as everyday purchases.
To help me decide whether an expense is acceptable or not, I use a scaling technique that lets me see the actual cost of every purchase on the same scale as an amortized daily spending budget.
Daily Spending Budget
Every year, the average American income is $31,410 (€24,660 in France). If that average person split their income over the 365 days, they would have a spending budget of $86/day (€67/day). A large percentage of that will be spent on housing (rent/mortgage), credit card payments, various taxes, and utility bills. Another part of that is hopefully saved for retirement, college tuition or emergencies.
To estimate your current daily spending budget:
- Add up your monthly payments and savings. Every cent that leaves your account on a predictable, monthly basis, should be counted here. Multiply by twelve.
- Add your yearly taxes (estimated, if needed) to the total.
- If you have any annual spending (such as a yearly subway card or a magazine subscription), you can also add it to the total.
- Subtract this total from your yearly disposable income.
- Divide the result by 365.
The result is the amount you can use every day for variable or exceptional spending: food, movies, music, video games, brand new television sets, iPhone applications… sounds small? It is.
When evaluating this budget, don’t take into account expected future changes (such as a long being repaid in full or a raise that’s going to happen). You should be extremely careful about basing today’s spending strategy on future events (that might never happen).
Amortized Daily Spending Budget
The standard spending budget doesn’t help, because most exceptionally large expenses exceed that daily budget anyway. So, what I do is amortize those purchases by spreading their cost over several days, and automatically subtracting the daily amount from my daily spending budget.
Quick example:
Jane has a $23/day spending budget, and she buys a $900 television on Monday. She could try amortizing that television over a single month, but that would cost her $30/day, which exceeds her daily budget. She could try amortizing that purchase over two months, which would cost her $15/day and leave her with a $8/day budget—too small. So, instead, she decides to amortize the television over three months. This only costs $10/day and leaves her with a $13/day budget.
The main benefit of this system is that it turns a $900 price tag that is fairly vague and difficult to compare into an easily compared daily cost (such as «you’re spending almost 50% of your daily budget on this television for the next three months»).
At the end of each day, add up your total spending for that day (excluding any purchases you are amortizing). If you didn’t spend all your money, use it to pay for purchases that you are amortizing.
On Tuesday, Jane spends $1 on coffee and $8 on lunch, leaving her with an extra unspent $4. She decides to subtract that from the television purchase. The daily cost of the television is now $9.96 (she paid $14, which leaves $886 to pay over the next 89 days).
Should you overspend, carry the balance over to the next day. Since the cost of your amortized purchases is already taken out of your daily budget, this means you pay for those purchases even when you overspend.
On Wednesday, she pays for her friend’s lunch for a total of $20. This exceeds her daily of $13.04 so the negative balance is carried over to the next day.
When you overspend so much that your budget for the next day dives below zero, it means your purchase is too large. Ask yourself whether it’s worth it, and if it is, amortize it over one month.
On Thursday, Jane has a budget of only $6.08, but in addition to her $8 lunch she decides to buy a beautiful $30 sweater. Not only does this exceed her daily budget, but it also exceeds her $13 budget for the next day! She needs to amortize the sweater over one month. The sweater will cost her $1/day (her new amortized daily budget is $23 – $9.96 – $1 = $12.04). Also, out of the $8 lunch, $1.92 are carried over and deducted from the next day’s budget: $10.12.
If you’re currently amortizing several purchases, and you underspend, start paying for the purchase that has the lowest amount left to amortize.
On Friday, Jane decides to be excessively frugal, and only buys a $3 salad from the cafeteria at work. This means she has a $7.12 surplus from the day, which is used to pay for the purchase with the lowest non-amortized value : the sweater.
On Saturday morning, her outstanding amortization debt consists of:
→ $856.12 over 86 days ($9.95/day) for the television
→ $21.88 over 29 days ($0.75/day) for the sweater
This leaves her with a daily budget of $12.30
As you can see, if you overspend, your amortized expenses start clogging your daily budget to the point where you have to amortize the purchase of a $10 lunch over an entire year. If that doesn’t knock some budgeting sense into you, I don’t know what will.
This approach can be used in a weekly version instead of a daily version, but it’s harder to notice when you’re going over budget if you only catch up with your expenses once every seven days. I would suggest using the daily version anyway, even if you only compute the values weekly anyway.
You can download an Excel Spreadsheet to help you compute your daily budget easily. It should be compatible with OpenOffice. Let me know if it gives you any trouble!
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