Several years ago, my wife and I sat down to work on a budget. Our goal wasn’t to reduce spending so much as it was to plan our spending. We had recently purchased a house in a pricey in-town neighborhood and that purchase happened just over a year after the birth of our daughter. Between those two things, our spending had risen substantially and felt a bit out of control. Although we were able to cover our expenses, we had to be more deliberate about our finances and an essential step in that process was defining when “enough is enough.”

Budgeting

For us, “enough” meant determining a level of spending we could sustain both now and a few decades from now when I retire. It also meant choosing to spend on things that added the most to our lives. Trying to define what that was in and of itself proved very helpful. Finally, defining enough also required calculating just how much cushion we needed to protect against unexpected income loss or increased expenses.

In identifying a current, sustainable level of spending, we didn’t reduce our current spending since it was financially viable. Instead, we built a specific budget using our current spend and set a few ground rules as follows:

  • We wanted to focus on experiences and not things. One example of this was that we allocated a good bit more to vacation and less to general shopping.
  • We set a hard limit on spending – a specific dollar amount that would force us to have to make choices on where to allocate our spending.
  • We avoided doing things that would lead to an ongoing increase in expenditures — things that involved taking out more debt or expensive subscriptions or memberships. Between this rule and the hard limit on spending, we would be able to avoid the lifestyle creep that leads people to spend more when they make more.

Having a stable, predictable budget over the last three years has also allowed us to set aside reserves that we could use if either income or expenses headed in the wrong direction. Calculating exactly how much we needed in reserves was key since I set aside reserves in either cash or very safe investments. Reserves earn much less over time than funds invested in more aggressive investments – and the funds aren’t available to pay down debt – so it doesn’t make financial sense to set aside more than needed.

I split reserves into two categories – an amount to cover an unexpected loss in income and a separate amount for specific expenses that I knew would vary. Calculating an amount to set aside to cover unexpected income loss was a bit complicated since, as a business owner, my income has varied a good bit. Fortunately, I have a long track record with the business, so I used the worst revenue downturn over the last 15 years – the financial crisis – to determine how much I might need to cover due to decreased income. As part of your “enough is enough” decision-making, if you work for someone else and your salary is fixed, the rule of thumb of 3 to 6 months worth of expenses should be sufficient if your job is stable. The more stable your job is, the closer to 3 months of reserves you can be and vice-versa.

The process for setting aside reserves for unexpected expenses was a good bit simpler. There were three areas we wanted to cover – real estate, car, and health. We have two rental homes plus our primary residence, and in each case, the goal is to set aside a percentage of the home’s replacement cost — typically 3% to 5%1. A quick back-of-the-envelope calculation can confirm if this percentage is enough to cover any of the pricier maintenance items like replacing a roof or HVAC system or to cover the homeowner’s deductible.

As part of determining when enough is enough, how much to set aside for a car depends upon the specific car you have and what the dealer covers in terms of maintenance. We took a look at the maintenance schedule for our car and the costs of the various maintenance periods and also took into account big-ticket items like tires. As the cars got older, we budgeted more towards them, both because the chance of unexpected maintenance and repairs increased and because we needed to begin to save for a new car. Finally, for healthcare, we worked to fund our HSA so that we would have the out-of-pocket maximum for a year set aside in cash. Any funding for the HSA beyond that is slated to be invested in relatively conservative investments.

It has been several years since we worked to define what “enough is enough” meant, and our financial situation is markedly improved because we did. Our reserves are funded, we agree on what we spend, and we know our long-term financial picture is very healthy. Settling on precisely what was enough for us is one of the best financial moves we have made.

  1. If we purchase more rental property, we will decrease this percentage since the pooled amount should be enough to cover repairs and maintenance over a given timeframe.