Jake and Emily had a spending problem. He loved buying shoes, and spent $150 every couple of months on a new pair. She loved grabbing coffee with her friends, and spent a good $100 a month supporting her favorite barista.
They had a new baby coming in a few months, and realized that money was about to get tighter. Looking at their finances, it was obvious that they weren’t saving enough for retirement. They needed to start spending money more wisely.
Emily committed to get coffee just twice a week, which would save them about $500 a year. And Jake promised to buy new shoes only twice a year to save about $600.
This plan would save them $1,100 a year! Isn’t that great?
It wasn’t so great. The baby came, and the savings evaporated. Diapers. Daycare. Doctors. They still couldn’t save a thing.
The Big 3
Jake and Emily decided they couldn’t solve this on their own. So Jake found a financial coach, who explained that they were looking in the wrong place for savings. Sure, cutting out a few lattés and a couple pairs of shoes helped. But the biggest expenses were making them broke. Not the little ones.
Emily’s car payment was $711/month. They needed a safe, reliable vehicle for their newborn. So a brand-new SUV was the only option, right?
On top of that, Jake still had 2 years left on his $305/month used car loan.
Jake decided their 2-bedroom apartment wasn’t big enough for the 3 of them. Plus, they needed a guest bedroom for all the visitors they’d be getting! So they traded a $1,600 rent payment for a $2,300 mortgage. He didn’t think much about all the new furniture they would need. The maintenance they would be responsible for. Or the higher heating and cooling costs.
Eating healthy was important to both of them. And they enjoyed eating out a couple times a week. Between groceries and restaurants, they were spending $750/mo on food.
The biggest 3 expenses in the typical household are housing, transportation, and food. And Jake and Emily are no exception. After their coach showed them this table, they realized just how much more important these Big 3 were than coffee and shoes would ever be:
There was no comparison between their top 3 expenses and the two that they had focused on. And the gap grew even wider as they added the rest of their housing and transportation costs to the loan payments alone.
A 2021 survey found that the top 3 annual expenses for the average American were:
- $22,620 on housing (34%)
- $10,956 on transportation (16%)
- $8,292 on food (12%)
These 3 expenses make up 62% of overall spending. And they’ve grown even more as inflation picked up in 2022.
It’s easy to get caught up in the small things that you’re “wasting” money on. You certainly could be spending money more wisely in those categories. But when you look at these numbers and really want to make a difference in your finances, where do you think the focus should be?
Hint: it isn’t the $5 lattés.
Wise ways to reduce spending on the Big 3
I assume you’re convinced that the biggest opportunity for savings is in housing, transportation, and food. But you’d call me crazy if I told you to sell your brand-new house and car to save money. Is there anything less painful that will help just as much?
Unfortunately, for some the answer is no. If you have too much car or too much house for your income, there might be no other way to start building wealth than to downsize one or both.
Here are some good rules of thumb to help you decide if you should buy or have already bought too much:
Home
- Your mortgage (or rent) should be no more than 25% of your take-home pay
- Up to 35% is only okay for a mortgage if renting costs even more
- Save at least 25% of the home price in cash
- 20% for a down payment
- 5% for furnishings and surprises
- If 20% down doesn’t cover rule 1, save more to put more than 20% down
Vehicles
- Your vehicles altogether should cost less than 50% of your annual income
- Buy them 2-3 years old
- Drive them at least 8 years or 150,000 miles before trading them in
- No single vehicle should cost more than 30% of annual income
- No more than one car per driver
If your home or cars don’t meet these rules of thumb, you can’t afford it!
What if both house and car are too much?
If you can’t afford your home or cars, you need to make a quick change!
Vehicles first
First, take a deep breath…
Then, start with your most expensive vehicle since it’s an easier life change than selling a house or breaking a lease and moving. Sell or trade it in for a good used vehicle.
There are plenty of reliable 3-year-old Toyotas and Hondas that you can easily drive for 10 years, saving you thousands every year. Do some research on Consumer Reports or Motor Trend. Find a great used vehicle. And capture some major savings.
The average new car costs $10,728 per year to own and operate, according to AAA. That includes maintenance, insurance, and gas. Used cars cost about $1,500 less each year on average.
Actual costs vary widely depending on the type of vehicle that you own. The larger and more expensive your current vehicle is, the more opportunity you’ll have to save. A smaller, fuel-efficient vehicle will cost the least.
So ask yourself if it’s worth driving a big gas-guzzling truck. If you don’t need it for your job, you can probably live just fine with a smaller vehicle for a while. And by spending money wisely now, you can save up and buy a truck with cash in the future!
Home second
After you downsize your transportation expenses, look at your home expenses.
If you simply can’t afford to pay the rent or mortgage and it’s killing you financially, the house has to go. Get out of that expensive rental and live somewhere affordable until you’ve saved enough to buy a home. But if you own the home and love it, you might want to fight to stay.
First, increase your income in any way possible. Can you get the mortgage under the 25% rule by next year by putting more money down and refinancing?
Next, get your other expenses—including transportation and food—under control. Then see if you can pay the mortgage without taking on more debt. You might be able to make it work before paying a realtor to sell and a mover to move.
If you can’t find a combination of higher income, lower expenses, and refinancing that makes your home affordable, you may be forced to sell to make your finances work.
Food
Food is typically less expensive than cars and houses. But it can vary widely from one family to the next. Even with high inflation, dietary restrictions, and health considerations, you may have more control over it than you think.
Start with restaurants. Your most expensive meals come from eating out. So reduce the number of meals out. Or, if you’re dining at high-priced gourmet restaurants, go to less expensive places for a while.
Fine dining is nice. But if you can’t afford it, you need to prioritize your finances before going to those places again. This doesn’t have to be forever!
By eating out less, you’ll naturally eat healthier. So if you’re a health nut like me, you can count that as a bonus.
Speaking of healthy eating, it seems like the healthiest food in your shopping cart is also the most expensive. Organic fruits, vegetables, dairy, and meat can cost twice as much as non-organic products. And many times more than packaged, highly processed food.
My family eats a lot of organic produce. But some things that we’re doing to keep costs down are:
- Eat less meat
- Buy mostly fruit and vegetables that are in season
- Buy non-organic if it isn’t part of the dirty dozen — particularly if it has a peel or outer layer that isn’t eaten
- Focus on antibiotic-free eggs, chicken, and turkey and grass-fed beef rather than fully organic
- Buy in bulk and frozen when possible — nuts, grains, seeds, frozen blueberries, and frozen fish from Costco save my family a lot of money over our local grocery store
- Be flexible — when egg prices spiked recently, my family stopped eating as many eggs and had more oatmeal for breakfast instead
And, of course, making good organic coffee from home saves money over the coffee shop. It just isn’t enough on its own. And if your coffee shop is your social gathering, it might not be worth cutting altogether.
How did Jake and Emily end up?
The most that Jake and Emily could possibly cut on coffee and shoes was $2,100. No new shoes and no coffee made almost as much sense to them as no car or no fruit. So, as we already covered, they cut that budget to $1,000 a year.
Emily’s new SUV was too expensive to keep. So she traded it in for a more fuel-efficient used one. That cut monthly payments by $216/month and saved about $50/month in gas and $30/month in insurance. Total savings was $3,552 a year from this move alone!
They decided that they loved the house enough that they would find a way to stay. So they bought most of their furniture from Craigslist and Facebook Marketplace. And Jake picked up a few hours of overtime to bring in more income.
They decided to go to restaurants only twice a month when friends and family were around. Or for the occasional date. And they shopped for groceries more carefully. Combined, this brought their monthly food bill down by $200 for a yearly savings of $2,400.
As you can see, Jake and Emily were able to save more money in the vehicle and food categories than the entire coffee and shoes categories combined. By making those adjustments, they brought their total annual savings from $1,100 to $7,052!
This gave them the room they needed to afford their mortgage and start putting some money away for the future. And as their income grew, the mortgage became easier to pay and they were able to invest a larger portion of their income.
Summary
Smaller expenses add up. But they aren’t usually the reason that people live paycheck-to-paycheck.
The Big 3 expenses — housing, transportation, and food — are the top areas to focus on when expenses are too high. If these categories aren’t under control, cutting smaller expenses just won’t be enough.
Follow the rules of thumb in this article to find out if your vehicle and home expenses are unaffordable. Then make the necessary changes that will change your financial life.
Ideally, these rules of thumb will help you avoid buying too much car or house in the first place!
Your future self will thank you.
If you enjoyed this article, you’ll also like I Don’t Regret Spending Big on These 4 Things.
And don’t forget to sign up for FREE at the bottom of the page to get much more value from PathwayToFI.
Join me on the Pathway to FI!
