A few months ago, I made reference to my conscious spending plan. The conscious spending plan is a tool used by Ramit Sethi in his books, courses, podcasts, and most recently, a series on Netflix. I love Ramit – I’ve taken several of his courses – and whenever he says something, I listen.
Quick side note – I used one of Ramit’s courses to launch my very own online course during the pandemic and earned about $30k in the first few months of sales. I’m no longer actively selling that course, but I mention this to show that Ramit knows his stuff!
Here is the general idea of the how you can use the conscious spending plan to help you reach your financial goals and live what Ramit calls a “rich life”.
Table of Contents
Breaking Down the Conscious Spending Plan
There are several parts to the conscious spending plan and we will review them all here. First there is your monthly income, then your fixed costs. These are the two biggest parts of the conscious spending plan that drive everything else. From there you have your investment goals, your savings goals and your guilt-free spending. Let’s take these all one at a time.
Your Monthly Income
You will start by looking at your monthly income. There are two numbers that are important here – your gross monthly income and your net monthly income. In listening to Ramit’s podcast, it is amazing to me how many people don’t actually know what these numbers are. Don’t be one of those people!
Your gross monthly income is all of your monthly income from all sources before you account for taxes. If you receive an annual bonus, you could divide that number by 12 and add it to your monthly number (or you could leave it out entirely depending on how you spend that money).
Your net monthly income is the amount that actually goes into your bank account after taxes. If your employer deducts health insurance or retirement from your paycheck, you will add these amounts back and then deduct them later on your spreadsheet.
If you are self-employed, then the monthly net income should be an average of your past 3 months of income. Any longer than that and it is too distant. But if you are only looking at once month at a time, then you could be looking at a good month or a bad month. I personally am self-employed and I use YNAB to manage my personal finances (if you use this link to sign up you will receive one free month!). If you are diligent in tracking your spending in YNAB, you can pull up a report that show your historic income and expense numbers. This is how I determine my average monthly income.
Next we need to look at your fixed costs.
Identifying Fixed Costs (ideally 50-60% of your take home pay)
Your fixed costs are exactly what they sound like. They are the expenses that stay roughly the same each month and are not discretionary. These are things such as your:
- Mortgage or rent payment
- Utilities such as electric, gas, water, trash, internet/cable, phone
- Insurance (health, auto, renters/property, life)
- Car payments or transportation expenses (i.e. subway, bus, rideshare)
- Fixed debt payments (Personal loan, student loans, back taxes, etc.)
- Groceries
- Child Support/Alimony
- Subscriptions (Netflix, Amazon Prime, Gym membership, etc.)
As referenced in the heading, you would ideally keep these expenses to a maximum of 50-60% of your take home pay. On a personal note, during my entire marriage our expenses were much higher than this. They were probably varied between 90-110%. If you find yourself in a similar situation, then you are probably really stressed about money. Taking a cold, hard look at your fixed costs is the absolute best way to start to get control of your finances.
There are only two ways to lower your fixed costs. First, you can trim those expenses. Sell your car and buy a different car with cash. Pay off your fixed debts. Start shopping in bulk at Costco to lower your grocery bill. Cut your monthly subscriptions. Downsize your house.
But for some people who are already living very modestly, the problem is their income. A different way to get those fixed costs down as a percentage of your monthly take-home pay is to level up your income. This could mean getting a better job, starting a side hustle or doing some freelancing or gig work on the nights or weekends to supplement your income.
Another good idea to cut into your fixed costs is to sell items that are wasting away in your home and use that money to pay off debt.
Once you’ve taken a look at your fixed costs, next you must review your savings goals.
Savings Goals – Short-Term and Long-Term Objectives (5-10%)
The very first savings goal you should have is to create an emergency fund. Ideally, an emergency fund will be 3-6 months of your monthly take home pay. Dave Ramsey (who I have a love-hate relationship with – I’m not a huge fan, but I do like the idea of banking $1,000 to prop you up if you have an emergency come up so you don’t have to dip into credit cards). Just last month I got a flat tire that turned into a $450 bill at the tire shop. My emergency fund saved me as a result.
If you have a lot of debt, I would get that initial $1,000 saved up as quickly as possible and then put a modest amount away (even $25 or $50 a month can help you psychologically to get into the habit of saving) each month. The rest of your savings goals will likely have to wait until you have paid off your debts.
But once your debt is paid off, then you can add different categories to your savings goals. These could be things like a family vacation, gifts, a down payment for a house or even a new car.
You should strive for a total amount equal to 5-10% of your take home pay.
Important Investment Goals (10%)
Ramit says that your investment goals should be 10% of your take home pay. I disagree with this. I think that 10% should be the absolute MINIMUM you should be saving each month. Ideally, this number should be much higher, especially if you are thinking about an early retirement. Personally, once I pay off my debt, I’m striving for 40-50% or higher savings rate.
Why so high? Because I see the light at the end of the tunnel. I know that I can retire within 5-7 years if I hunker down and rapidly increase my savings.
Here is how I plan to allocate those funds to my retirement accounts once my debt is paid off…
- Maximize my retirement account. Beginning in 2025 I will be creating a Simple IRA for myself and my employees. I will be writing another post on why I chose this account as opposed to a SEP IRA or 401(k). If you work for an employer that offers a company match, I recommend contributing up to the employer match first.
- Maximize your IRA. There are income limitations to this, and if you fall under those limitations, this is a great option to maximize your retirement contributions. Whether you decide to do a Roth or a traditional IRA really depends on your age and your income level. Generally speaking, if you are younger and have a lower income, the Roth will be a better choice. If you are older and in a higher tax bracket, you want to do a traditional IRA. Do this after you have contributed enough to get the company match from your employer-sponsored plan.
- Maximize your HSA if you can. If you have a high-deductible health plan, you will want to take advantage of your HSA. I set mine up through Fidelity Investments. There are no income limitations, it is tax deductible, the funds grow tax-free, and if you withdraw the money for health care expenses, you won’t pay tax on the withdrawals either. It is an amazing deal and I’m not sure why more people don’t take advantage of this. I save all of my health care receipts to Evernote so that when I’m ready to pull money from this account I can easily access the proof that the withdrawal was to reimburse me for a healthcare cost.
- Max out the remainder of your employer sponsored plan.
- Anything else you want to save should go to your after-tax investment accounts in a low cost index fund. Set it and forget it!
Anyway, this is how I plan to max out my retirement savings once my debt is completely paid off. The only difference for me is that because I am self-employed, my Simple IRA will be set up at Fidelity Investments as well, and I will just max that out before contributing to my IRA and HSA. And whether you max out your IRA first or your HSA is purely up to you.
And now for the last piece of the conscious spending plan, the fun stuff – guilt-free spending.
Allocating funds for Guilt-free Spending (20-35%)
In the last section, I mentioned that I thought that 10% was the minimum amount you should be saving each month if you hope to reach FIRE in this lifetime. You might be wondering where that extra savings will come from?
In my opinion, that extra long-term savings comes from guilt free spending. Ramit would disagree with this, (or maybe not, it is very possible he would ask me what my rich life looks like and then congratulate me for piecing together a financial plan that will allow me to reach that life within 5-7 years!)
Regardless, the guilt-free spending section will tell you what your actual spending habits are. This is where you spend money on the things that, consciously or unconsciously, are the most important to your life. This is the “fun spending”.
What goes into the guilt-free spending category?
For me, this included things like my subscriptions (I realize there is a category for this in fixed costs – but I see Sunday Ticket as more of “guilt-free” spending because I like to watch my favorite NFL team lost each week… kidding, not kidding), tennis lessons, eating out, things I buy for my kids, the Couch 25k running app, etc.
Rather than mindlessly spending your money, you should include on this list those things that you intentionally want to spend money on to create a better life for yourself. These are typically variable expenses and really highlight the type of spending you do on a month to month basis.
What you can learn from creating a Conscious Spending Plan
If you take the time to go through this exercise and create a conscious spending plan, you will be taking the first step towards reaching your financial goals. My favorite thing about completing a conscious spending plan the first time for myself was that I realized that I can make a deliberate choice about how I spend or don’t spend my money.
Right now, where I am at in my life almost 3 months after separating from my spouse, I value financial stability above all else. I am prioritizing debt repayment so that I can improve my financial situation.
A lot of people may look at this as creating a personal budget, and in some ways it is. But it can also help you to get over your money guilt and set some short-term goals about how you want to handle your money. Traditional budgeting, for most people, simply does not work. Mindless spending does not work.
But by going through the exercise of creating a conscious spending plan and setting some parameters about how you will allocate your monthly expenses, you can take the next step towards achieving FIRE.
In the coming weeks, I’ll be creating a separate post that outlines my own personal conscious spending plan (as well as my own target percentages) so you can see how I’ve starting to be more conscious about my spending and make more informed decisions to help me reach my money goals faster.
