Why Leaving A Little Fat In Your Budget Can Help You In The Long Run

Perfectly tweaking your budget so that you’re only paying the absolute minimum sounds like a frugal dream. However, if you don’t leave yourself something to cut, you can hurt your retirement planning.

Photo by jridgewayphotography.

As personal finance site Canadian Dream explains, if you reach a point where you’ve optimised your spending so much that you can’t possibly cut anything else, you might give yourself a false sense of how much money you might need in the future. This can hurt your retirement fund if you’ve only budgeted for typical spending:

So let’s compare two cases to demonstrate this: let’s say family A is spending $40,000 a year and they retire with $1 million saved. Then the stock market drops 40% and inflation spikes so their core spending goes up $1000 per year. So being reasonable people they look to cut $1000 per year out of their spending (or 2.5% of their yearly budget) and they go after a few things they haven’t optimized before and make up the difference. Then we have family B with $30,000 a year spending and only $750,000 saved. They have the same event and $1000/year increase in core spending from inflation. Now they have less to cut in the first place and they have the added bonus of the increase being a higher percent of their spending at 3.3% of their yearly budget. Over all family B’s ability to cut spending is more limited and the increased core spending dollar amount has a greater impact overall.

If you only account for a lower spending rate, you might assume that you don’t need as much money to retire on. If an unexpected expense crops up after you retire, you’re going to take out a disproportionate amount of your savings to cover it. Of course, this doesn’t mean that you have to go blowing through extra cash on worthless junk just to give yourself something to cut later. However, it does mean that you’re still OK if you leave a little extra fat in your budget. Plus it never hurts to save more than you think you’ll need.

Overly Optimised Spending [Canadian Dream via Rockstar Finance]