How to Manage Small-Item Spending to Boost Your Savings
Start with a mindset: Unspent, what could this dollar do for me?
Saving — which most households haven’t done nearly enough to prepare for retirement and life’s surprises — is the opposite of spending.
Fortunately, there are multiple ways to accumulate very large sums — $100,000-plus — by changing the way you manage large financial decisions, covered in a recent column.
But the small staff matters, too. A lot. We won’t revisit the well-trod Starbucks example (“Avoid that daily $5 latte!”), but instead focus on a handful of spending situations that, while small in the moment, add up to big dollars over time.
From our Econ-101 class we all vaguely remember the concept of opportunity cost:
- If I don’t spend a dollar on this, what else could I do with it?
- Unspent, what would the dollar’s future value be if I saved or invested it?
Reminding yourself to think opportunity cost when making any spending or borrowing decisions will help you naturally focus on your future financial health. A Post-it with just those two words near where you write checks or pay bills and shop online wouldn’t be a bad idea.
Consider these spending categories:
Upgrades on a big purchase. The base price of the new car is so big that, psychologically, we don’t flinch to add another $1,500 for a fancier package of finishes. What’s another $1,500 when you’re already spending $35,000?
But even if your car loan payment rises by “just” $25 a month, what else could you do with that $25? Over a 72-month loan, saving the $25 boosts your emergency fund by $1,800. Or plunk it into a Roth IRA for the 72 months, and then leave it growing for another 25 years, and you will have more than $7,000, assuming a conservative 5% annualized rate of return. Costly upgrades, of course, also occur when building or renovating a house or going on a vacation.
Bulk purchases to get a deal. Marketing mavens know how to appeal to our spending gene. One of their most obvious (and effective) ways to induce us to spend more is to make us think we’re getting a deal if we buy more. One bottle of your preferred extra virgin olive oil runs you $15, but you can get 2 for $27.50. You will use that olive oil.
But how often do you find yourself falling for the same trap on purchases you really don’t need. One sweater costs $45, but you can get two for $80. Take a spin through your closets, drawers, shelves and garage. Take a “deal” inventory. How many dollars did you lose to this spending trap?
Storing extra stuff you never should’ve bought. Are you among the legions of Americans renting storage space? Why? Heirlooms you want to pass along? Gear you actually use in-season? Some furniture you expect to use when you soon move to a new space? Or is there a whole lot of stuff you no longer need or use, but are just hanging on to? If you pay $150 a month, the opportunity cost can grow to more than $35,000; that’s how much you could have for retirement if you saved $150 a month for five years and then let it grow for another 25 years at a 5% annualized rate.
Paying more than necessary to invest. Using a mutual fund or exchange traded fund (ETF) is a super smart way to instantly own a diversified portfolio of dozens (often hundreds) of different stocks or bonds. But there is typically a cost to invest in funds and ETFs, called the annual expense ratio. This is the percentage the fund or ETF manager pockets each year to cover its cost (and profit).
The expense ratio is spending you incur to invest. The fee is not displayed like a sales tag when you buy a fund. Nor is it a line item you will see deducted on your periodic investment statements. It’s an embedded cost. But it’s easy to find with a quick online search. It will be on the first page of info when you log into the fund info at a discount brokerage, or your 401(k) provider’s website.
It will seem pretty puny. The average annual expense ratio for an actively managed mutual fund is 0.67% according to Morningstar. Yep, less than 1 percent. But keep in mind, there are plenty of index funds and ETFs that charge less than 0.10%.
Let’s say you invest $500 a month for 30 years and earn a 5% gross return (before accounting for the expense ratio). If you invest in a fund with an 0.67% expense ratio, you will have about $368,000 in 30 years. If your expense ratio charge is 0.1% per year you’d have $408,000. An extra $45,000 because you sweated the seemingly small cost of the annual expense ratio.
Etc. Other budget tips on prescription drugs, medical care, funerals, gift cards and more.