The Psychology of Money book (affiliate)
Have you ever overcommitted or underestimated the time it would take to do something? In our second look at the book Essentialism, we discuss how elimination and creating a buffer will help your budget, investing, and overall personal financial life. If you haven’t read or listened to part one where we talk about discerning what’s important and exploring your options.
Eliminate to financial freedom
It’s so easy to say yes to too many things. Whether that be outings with friends and family, the Netflix/Hulu/Apple TV subscriptions, or the upsell at the store.
We’re not taught how to say no. And once we’ve said yes, it is hard to back out or uncommit.
Sometimes it’s because we don’t want to disappoint or have the conversation we’d have to have. Other times it’s because of biases we have.
Let’s talk about some strategies we can use to get better at eliminating things in our lives.
Examine the sunk costs
Sunk cost bias makes unwilling to cut the cord even when we have a loser.
Examine the true value being provided
We tend to hold onto things that we’ve done in the past. This is known as the endowment effect. We undervalue things that aren’t ours and to overvalue things because w e already own them.
Ask yourself: what is truly providing me value?
Reevaluate past decisions
We make decisions and then continue on into perpetuity. Instead, we should set points where we reevaluate those past decisions.
A great way to do this is a decision journal. By writing down why you made the decision, you can constantly evaluate if the conditions have changed.
Create a buffer in your time and monetary commitments
All of our lives are full. We commit to things up to the very end of our leash. We don’t want to miss out on any potential excitement available to us. We don’t want to disappoint those around us.
This leaves us with no buffer.
If something runs 30 minutes over, that makes us 30 minutes late somewhere else.
If there is a cost overrun on the renovation, we don’t have enough money to finish it.
The way of the nonessentialist is to go big on everything: to try to do it all, have it all, fit it all in. The nonessentialist operates under the false logic that the more he strives, the more he will achieve, but reality is, the more we reach for the stars, the harder it is to get ourselves off the ground.
We can operate with buffer in a few ways:
- Make less commitments
- Increase our time, monetary, and effort estimates by 50%
- Start small and celebrate progress
- Focus on minimum viable progress
Make less commitments
Duh… nothing groundbreaking here. You don’t owe anyone anything.
Stop committing to too many things.
Increase our time, monetary, and effort estimates by 50%
The idea here is simple: create a buffer… 50% more than expected. If you think it’ll cost $100, plan for $200. If you think it’ll take 2 hours, plan for 4.
The reality is, we perpetually underestimate the time, money, and effort taken to get things done. By creating this buffer, we’ll allow ourselves the room to give our best to what we’ve committed to.
Start small and celebrate progress
By starting small with new commitments, we can get a better idea how long it will take to complete. As we go along, celebrate how well you’re doing. This will help you from committing to too much.
Too often we take on too much too quick, and then sabotage ourselves when we didn’t get it ALL done.
Focus on minimum viable progress
I loved this concept in the book, as it talks about after making a commitment, doing the minimum immediately.
A good example is a project at work. Put together 10 basic PowerPoint slides as soon as you commit, even if the project isn’t for weeks.
This means that even if something comes up, you have something. You’ve made some progress and if other things come up you can still follow through on the commitment.
The reality is that most of the time we’re creating the high expectations. You’ll be shocked how that minimum viable option could be good enough.
Have an emergency fund
An emergency fund is essential to any financial plan. Without one, you’re susceptible to one unexpected expense or a lost job.
Most Americans couldn’t cover a $1,000 emergency. Don’t be most Americans.
For an emergency fund, you need to keep 3-6 months expenses in liquid cash. liquid cash means in a high-yield savings account. I currently use M1 Finance (affiliate link), which provides 1% interest.
Whether it is 3 or 6 or in between depends on your financial situation. Do you have 1 or 2 incomes? How hard would it be to replace an income? What are your expenses as a percentage of your income?
I also have started keeping anything over 3 months in stable coins that offer higher returns. This is not for everyone, but it has given me the peace of mind that I’m not losing money to inflation. Only do this if well versed in Cryptocurrency and with cash that you don’t need to be as liquid.
Other non-traditional places to access cash would be your Roth IRA contributions and HSA receipts.
Create a “buffer” account
For almost a year, it seemed like every month we had a budget crisis. I couldn’t figure out the reason.
Turns out, there were a few.
First, I’d done a bad job accounting for irregular expenses. Once I mapped them out over a year and got more specific on my categories, this problem solved itself.
But we can never account for everything. So how do we solve that?
Second, I created an account called “Buffer”. This was in addition to my emergency fund and allowed some room so that if something unexpected came up we had the funds. I would fund this account with $50-100, but now have gotten to where we don’t have to fund it unless we spend it.
This removed anxiety and created a little extra room in our budget.
Allow yourself to “overfund” accounts and let it build
This strategy is perfect for gas or utilities. These types of expenses are variable and unpredictable.
By overfunding them, you’ll be able to cover it when they go up.
Another good one is entertainment. We don’t spend very much on a regular basis, but if we choose a concert or sporting event to go to, they can be rather expensive.
By having a buffer we don’t have to make trade-offs.
Understanding investment allocations
This topic deserves its own post and podcast at some point, so for now we’ll just do a real quick intro.
Understanding risk is hard. Having a proper allocation in your portfolio helps protect you from risks you’re not even aware of.
There are a few things to think about when determining asset allocation and the biggest factor is age.
Current age and retirement age determines how much time you have in the market.
If you have less time, you’re unable to take on as much risk.
If you have more time, embracing more risk means higher potential returns.
Here are a few methods you can use for determining asset allocation:
- Use a target-date fund to set it and forget it. If you’re 20 and will retire in 2066, you can choose a 2065 or 2070 dated fund and the asset allocation will change as you go.
- Take 100 minus your age. If you’re 25, you’d put 25% in bonds and 75% in stocks. More recently, because of lackluster bond performance, there have been recommendations of using 110 or 120 as the base, instead of 100. It’s a choice, but know that the higher the number the more risk you’re taking on.
- Warren Buffett has written that he has directed that after he passes, the trustee of his wife’s inheritance has been told to put 90% of her money into a stock index fund and 10% into short-term government bonds.
- Benjamin Graham said to use 75% stocks, 25% bonds.
Here are so failure rates based on the historical performance of different allocations:
These decisions are extremely important but also extremely personal. Everyone has different motivations.
I’ve chosen to go with a more risky allocation because I have a long time horizon and the possibility of outsized returns earlier could drastically change our lives.
But, if the bets don’t pay off, we still have a reasonable long-term plan.