Blue Haven

Replacement spending vs excess savings?

By January 20, 2025 No Comments

One of the best feelings financially is when you finish paying off a debt. Whether it’s a car loan, mortgage, or student loans, these large monthly expenses can hold back spending and savings. In this article I’m going to address the concept of replacement spending versus excess savings. How you think about this concept can dictate personal happiness and your household net worth in meaningful ways.

What is replacement spending?

Replacement spending is when you replace one spending item with a new one. For example, I’m currently paying $600 per month in childcare expenses for my 4 year old. He’ll turn five this year and will enter Kindergarten at a public school in fall, 2025. So that $600 per month expense is going to go away.

What will I replace it with? Well, let’s see, I’d love to get new windows on the house, maybe take a nicer than usual vacation, perhaps complete a small home project…

Do you see what’s happening here? Even though I’m going to “save” $600 per month once my son goes into kindergarten, I wouldn’t actually save that money if it’s just going to be replaced with new spending. That is what replacement spending looks like.

Two things to keep in mind with replacement spending

I’m not going to say that replacement spending is a bad thing, but it should be done with two things in mind:

First, purpose: replacement spending should be done in a way that will you bring you joy or utility.

Examples of purpose driven replacement spending:

  • An awesome experience, like a vacation or venue event (concert, sports, etc)
  • Charitable giving or philanthropy
  • Self improvement: gym membership, therapy, online courses
  • Home improvement: something that is creating a better space for your family… more energy efficient appliances, etc

Here’s a good example I just heard a client discussing: they have a gym membership but also want to hire a personal trainer. They asked if I thought that was poor budgeting? My advice was I would not hire the personal trainer unless the expense was replacing an existing expense. So they are waiting until their student loans are fully paid off later this year and then they plan to hire the personal trainer.

The second thing you must have when it comes to replacement spending is awareness. Do you even know if you’re doing it? The best way to avoid potential replacement spending pitfalls is to be aware of your current spending to begin with. I recommend doing a quick housekeeping of current cash flow using a fillable sheet like this one. From there, you should map out expenses that qualify as potential replacement spending categories.

I already outlined my own example above with my childcare expense but I’ll share one more. When we bought our new house in 2023, we had to install a new HVAC system. The new system cost about $15,000, which we financed with a 0%, 18-month loan. I’ve been paying $834 per month towards the HVAC loan and my final payment is due in June 2025. This is a big expense that will soon be off the books, and I’m actively planning for what I’m going to do with the excess savings.

What about excess savings?

Thus far, I talked about replacement spending and what that looks like in my own life. But there’s an alternative, you don’t have to replace the spending! In a concept I debate with my wife regularly, you could save or invest the savings instead of replacing the spending.

Here’s a few questions you can ask yourself when determining if you build excess savings or invest instead of replacement spending:

Did you max IRA contributions?Max them out before replacing spending
Are credit cards paid off?Pay bad debts before replacing spending
Are larger expenses on the horizon, like gifts for the holidays or saving for a car/house?Build excess savings

You can take any unique situation you may find yourself in and have this discussion with yourself and/or your partner.

The bottom line is that most sources of new spending or excess savings present a trade off. You might be keeping a lid on your overall net worth by spending extra money on a luxury vacation. Or you might be skipping that same vacation in order to plow as much money as possible into your investments. I’m not here to tell you which is right or wrong. Everyone views the utility value of money differently. My only recommendation is to make sure you’re making your choice with a purpose and are fully aware of the financial choices you are making.

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