Have you ever heard the saying “penny wise pound foolish”?
It refers to being watchful with your spending over small cost items, yet not as mindful when making larger purchases. It is an extremely common problem, and I see it all the time.
It makes no sense to turn off electrical sockets on household appliances to save a few cents, yet spend big money on a nice car or a nice house. If cost cutting is your aim, that is not going to achieve anything.
The most effective way to go about cost cutting is by focusing on the biggest expenses first.
The Pareto principle
Also known as the 80/20 rule, where 80% of results come from just 20% of efforts. This means that the other 80% of effort only produces 20% of results.
That is why it is so much easier to focus on the big expenses of food, housing, and transport since they take up 62% of a typical household budget in New Zealand.
By starting off your focus on just these three expense categories, then you will produce huge results with not much effort. When budgets are often considered as deprivation, doesn’t this sound much easier?
The big three expenses
Food, housing and transportation expenses can often overlap too. For example, if you move in to a house close to your work you may be able to ditch a car. Or if you do keep a car, you will spend much less on fuel and maintenance. Also, if you live closer to work you may have more time available to cook at home since you aren’t stuck in traffic. Being close to work or the CBD will also be easier to find roommates to share your living quarters with.
Conversely if you move to a house further from the city you may be able to save plenty on the house price or on rent. Being further from the CBD you are also more likely to get more land with your house, which raises the opportunity for a vegetable garden, chickens, etc saving money on food. The downside to living further from work though is the further distance affecting transportation costs. Living close to public transport could be a good hack here.
The key is to look at what option is easiest for you to implement. Best effect for the least hassle is what you are after.
Also, don’t look at one cost (i.e. housing) in isolation. Consider how changing one expense will impact (if at all) on other areas of your budget. It is the total cost of these three expense categories you should be focusing on.
I saved tens of thousands of dollars a year by downsizing house and getting a job with a car. Now I don’t have to worry too much about trying to save a few dollars unplugging electrical appliances around the house, clipping coupons, or occasionally eating out. Yes, that spending all adds up and I am still careful, but not to the extent where I am depriving myself. And this is thanks to the 20% effort delivering 80% of my results. Sure, I could cut my budget further, but it would be a lot more hard work and would probably affect my happiness levels. Not what I want. If I had to I would, but I don’t have to thanks to my bigger cuts.
Final Thoughts
Sure, you can spend a lot of effort cutting back on low cost expenses, they do add up after all. But I think it is far more effective (and easier) to go after the low lying fruit. The big costs of housing, transportation and food are where you can really make a huge impact on your financial progress.
Only once you have optimised your biggest expenses, then turn your attention to your smaller expenses if you still want or need to. Sometimes cutting the big expenses is all you need, and you can still be allowed to enjoy your daily coffee. If you can save $10,000 a year on housing or transport then it is OK to spend $2,500 a year on coffees. I bet you would never hear a financial adviser say that!
But if cutting out coffees makes you miserable then why not go for the big win, least effort option. At least then you won’t feel like you are depriving yourself and you are much more likely to stick with your plans.
Just make sure you don’t let the little expenses creep up on you over time. Quarterly tracking of your spending and net worth progress are good ways to prevent this from happening so you can continue to increase your savings rate.
The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here