Why Low Fat in Your Budget Can Help You Long Term
Perfectly adjusting your budget so that you only pay the absolute minimum sounds like a dream of frugality. However, if you don’t leave yourself with something to cut out, you could hurt your retirement plan.
As the Canadian Dream personal finance website explains, if you get to the point where you’ve optimized your spending so much that you can’t cut anything else, you could create a false idea of how much money you might need in the future. This can hurt your retirement fund if you only budget for typical expenses:
So let’s compare two cases to demonstrate this: Let’s say Family A spends $ 40,000 a year and retires, saving $ 1 million. Then the stock market drops 40% and inflation rises sharply, so their core spending goes up by $ 1,000 a year. So, being sensible people, they aim to cut their spending by $ 1,000 per year (or 2.5% of the annual budget) and then do a few things they haven’t optimized before and make up for the difference. Then we have Family B who spends $ 30,000 a year and only saves $ 750,000. They have the same event and an increase in basic expenses of $ 1000 per year due to inflation. They now need to cut less in the first place, and have the added bonus of increasing their percentage of spending by 3.3% of their annual budget. Overall, Family B’s ability to cut spending is more limited, and an increase in basic spending in dollars has a larger impact overall.
If you only consider lower spending, you can assume that you don’t need that much money to retire. If there are unexpected expenses after retirement, you will spend a disproportionate amount of your savings to cover them. Of course, that doesn’t mean you have to spend extra money on useless junk just to give yourself something to cut out later. However, this means that you are still fine if you leave a little extra fat in your budget. Plus, it never hurts to save more than you think you need.
Overly Optimized Costs | Canadian Dream via Rockstar Finance