The Pyramid of Expenses
"If you buy things you do not need, soon you will have to sell things you need." — Warren Buffett
Half of high-earners live paycheck to paycheck in America. According to Forbes, the average American spends $3,372 on essential expenses. This includes housing, transportation, or healthcare. However, only 15% of Americans have more than $2,000 in savings.
In other words, 85% of Americans are two payslips away from bankruptcy.
Europeans are doing better. The average gross savings per capita was €3,443 in 2022. Whether you’re in Europe, the US, or any other country, expenses matter to you.
‘No’ should be the default
How much you earn is irrelevant if you can’t manage your expenses. Parkinson’s Law states that work expands enough to fit the time you have to complete it. This idea goes beyond work though. Expenses become large enough to wipe out your entire income. It’s a tendency known as lifestyle inflation. Every month you witness the same battle. Your salary fights against the all-mighty marketing industry. Who has the upper hand depends on you — and only you.
Let’s be frank. You don’t need a new car. Nor do you need that Louis Vuitton bag. Here are some tips to deal with your expenses.
Withdrawal: avoid ads as much as possible. Google knows you better than yourself, and marketers can exploit this weakness. You can’t fully avoid ads unless you live in North Korea. But you can minimise their effect. Stop using social media or pay for ad-free subscriptions if they’re meaningful to you.
Delay: last week I wanted to buy a new Vespa so bad. I pictured myself with a vintage helmet, riding around Lisbon. After some days, the idea didn’t seem as good as I thought. Had I bought it on the spot, I would have regretted it. In short, wait for some weeks or months before making a significant purchase.
Convert to time: time is money. When you work your 9-5, you’re selling your time for a fixed hourly rate. Next time you want to buy something, convert the price to time invested. Say you make $25 per hour, and something costs $1000. The price for you would be 1 week worth of work. Does it make sense now?
Expenses are decisions
And decisions are hard. Placing your expenses into different buckets helps in making decisions. Here’s a diagram I like to use, inspired by Maslow’s pyramid.
Fixed expenses. Avoiding them results in legal consequences or extremely undesirable outcomes. They’re usually bound by a long-term contract. Examples include debt, bills, taxes, or fines.
Essential expenses. Food, transportation to work, healthcare. It’s an essential expense if avoiding it leads to severely negative consequences: losing your job, health problems, or not having anywhere to sleep.
Smart expenses, or life enhancers. Expenses that help you save money, time, or improve your health. For example, buying an ebike to commute or a gym membership.
Meaningful expenses: things or experiences that make your life worth living without breaking the bank. Eating out, new clothes, travelling. Or, in my case, art supplies.
Avoidable expenses: expensive or unhealthy things that don’t add value to your life. Especially if they are recurring. Smoking, drinking, buying a new car when you have a functional one. A yacht, a private jet. Avoid, even if you’re worth billions.
You should look at this pyramid with a long-term perspective.
If you minimise your fixed expenses, you have a greater margin of error. Sh*t happens, so ensure you can cover your essential expenses.. Don’t get into long-term contracts. Only if it’s strictly necessary.
If you minimise your essential expenses, you have more money left for smart expenses.
The more you spend on smart expenses, the more efficient you become. You have more money, time, and are more healthy.
This leaves more room for meaningful expenses. The 3 previous categories are means to spend however much you want on this one. Why live if there’s no inherent reason to do so? If it’s meaningful to you, don’t be frugal.
Don’t fall into the trap of considering everything meaningful though. Would you still spend money on something if you couldn’t tell anyone about it? If the answer is yes, chances are it’s truly meaningful to you.
How do you deal with your expenses?
Photo of the week
I bought a new padel racket. This is a great example of a meaningful expense for me.
Alejandro Lopez — The Psychology of Wealth
Very good stuff. I like the pyramid graphic in particular and would like to borrow it for an article that I am working on for Seeking Alpha. Would that be ok with you?
I have to ask, what is a padel racket exactly?