Learn about forced scarcity and how it can help you manage your personal finances.
Humans have a tendency to consume. It's not our fault - we're just hard-wired that way. From an evolutionary perspective, more is better - it makes sense. However, when it comes to something like personal finance, that can quickly become problematic. Without some kind of restriction put into play, this sort of thing prevents you from saving anything, and even worse, would cause you to go into debt unnecessarily when emergencies come up.
Many people end up spending more as their means increase. Get a promotion, and now you're making more money? Great! It's time to buy that new TV, lease a better car, etc… It doesn't matter if you're making $30k a year or $300k a year, the behavior can be exactly the same, and at the end of the day, you're left with $0. This is where forced scarcity comes into play.
Forced scarcity is a term used for an artificial limitation you put on something to prevent things from getting out of control. In this case, we're talking about personal finance, but it doesn't have to be personal finance related. For example, you might have a "one in, one out" policy for yourself for clothing items to make sure you're not accumulating "stuff" unnecessarily. Buy something new? Then you have to get rid of something you already have (preferably donate or otherwise give away). In this case, the forced scarcity applies to the room you have available for clothing in your life.
In personal finance terms, forced scarcity applies to the money you have available for certain things. For example, say you're making $3,000 per month, and at the same time, you're saving $300 per month and putting it into a retirement account. That automatic transfer leaves you with $2,700 in your account - the $300 is never there.
Say, you now get a raise to $3,500 per month. Applying the principle of forced scarcity, you can always set aside a percentage of your income for retirement. In this case, you now make $500 more per month, but you're also putting $50 more per month into your retirement account (obviously there are limits here, and when you're making a small amount of income, you may need to tweak the allocations.) This leaves $3,150 in your account each month instead of the $3,500
The beauty of forced scarcity is that as your income grows, you're making sure your money is going into the right places first before spending it elsewhere (a big shoutout to Brian Preston and Bo Hanson of the Money Guy on this general concept.)
The first thing you need to do (and indeed the core principle here) is that you need to make sure money is taken out first before anything else so that you never miss it. There are many ways to set this up. For example, you could set up automatic transfers between bank accounts, use the envelope system (great if you're using cash), etc…
I typically set aside money in the following categories at the beginning of each month automatically:
- Current financial goal
- Charitable donations
- Regular expenses
The current financial goal might be whatever you're saving up for. It could be paying off debt, a vacation for your family, etc… This is just an example, but feel free to choose your own categories.
After this money is allocated, if there's anything left over, it can be spent on fun stuff. If not, maybe something unexpected came up. If you don't have any money left over after hitting your main categories, then you need to either figure out how to make more money or spend less to keep things in balance (that's another topic entirely on its own so I won't cover it here.) Most people tackle this the other way around where they end up spending a bunch of money on stuff they don't need early on in the month, and then bigger priorities are sadly left lagging at the end of the month.
You could take this strategy further if you wanted to and categorize things all the way down into specific details like groceries, gas, etc… but, at that point, you essentially have a full-blown budget. You also have to be mindful of how you're spending everything throughout the month because the money is readily available to you.
You can do this if you like, but I've found over many years of experimenting that budgets get too complicated. I try to strike a balance between effectiveness and simplicity (hence where the name of this blog comes from), and that's why a budget has never really worked for me.
I've found budgets to be:
- Too inflexible when things change (and they will)
- Too stressful worrying about every penny here and there
- A source of a lot of unnecessary work and headache with minimal payoff
I've found that if you focus on spending your money purposefully and on things that matter, it's not too difficult to live below your means. This allows you to be flexible as things come up, reduces stress and anxiety, and prevents you from tracking every single purchase down to the penny. Sure, you might spend a little more in each category, but at the end of the day, the tradeoff is well worth it.
Here are some steps you can take right away to get started:
- Think about how forced scarcity might be able to help you
- Determine the categories that you want your money to go to before anything else and how much goes to them
- Set up automatic transfers (or something like the envelope system if you like cash) so that the money isn't readily available
- Review how things are going each month and make tweaks as necessary.
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