What to Spend Discretionary Money On.

Discretionary spending is spending you have choices about. You don't have much choice to pay the mortgage or the electric bill. But you do have choices about a significant portion of your annual spending. It's the coffee and doughnut you buy each morning, the music you download from iTunes, the greens fees for golf, or the extra purse in that color you didn't have.

What to Spend Discretionary Money On, 1-2-3.

1. Things you care about.

2. Experiences.

3. Things that rise in value.

1. Things You Care About.

Fundamental to the spending smart philosophy is reducing spending on things you don't care about so you can spend that money on things you do care about. This might seem elementary. "Isn't that what everybody does?" you might ask.

Not really.

When is the last time you shopped for new home phone service or insurance? Do you really care which company provides your dial tone or pays your survivors, as long as they provide high-quality service? Those two examples alone could be worth hundreds of dollars a year. That's money you could spend on something you need or want.

Think about work lunches. Many people would prefer to eat the delicious leftover meatloaf from last night's dinner rather than go out to eat. They truly don't care about eating out for lunch. Paying for that restaurant or cafeteria lunch would be money poorly spent. Yet, because they didn't get around to packing that meatloaf sandwich for work, lunch money trickled out of their lives.

That waste is replicated over and over again, dollar by dollar, day after day. Soon we're a walking, talking sieve of money leaks.

Everything has an opportunity cost. Opportunity cost is what you can't buy because you bought something else. You can't go on the Caribbean vacation because you refuse to bring lunch to work. It's a trade-off. It doesn't matter how much money you earn, there are always trade-offs and opportunity costs. I would rather trade money spent on stuff I don't care about and, instead, spend it on stuff I need and want. I bet you would, too. A sister concept is to measure the psychological value from a purchase, or how the purchase makes you feel. That might seem like an overly touchy-feely idea. But it's real, nonetheless.

Some people derive a psychological benefit from having a luxury wrist.w.a.tch, for example. It might make them feel a sense of accomplishment or superiority. If they can afford it, people who get that extra feeling might be spending smarter buying a brand closer to Rolex than Timex. Other people get no psychological boost from the brand of their wrist.w.a.tch. An expensive watch for them is money poorly spent.

2. Experiences.

Did you know you could buy happiness? It's true, if you believe a slew of recent academic research. That research has shown, time and again, that people are happier when spending money on positive life experiences, rather than on things.

The thrill of buying more stuff wears off in short order. By contrast, the longevity of a great memory improves over time. The other component to spending for happiness is including people. Solo experiences, it seems, don't generate near as much joy.

So spend discretionary money on summer vacations and weekend getaways, concerts, board games for the family, and special dinners out (not routine ones).

Experiences appreciate, a.s.sets depreciate. Save on the latter to get more of the former.

3. Things That Rise in Value.

This is a tough one, but many wealthy people swear by it. It's wiser to spend your money on things that have a chance to go up in value, rather than things that are sure to plummet in value. In other words, try to do more investing than consuming.

The most obvious examples are two of the biggest purchases for any household: a house and a car.

Homes almost always rise in value over the long term. The recent national housing crisis, which saw home prices decline, is an anomaly. So, give the nod to spending on education or sharpening job skills that will lead to a higher salary. Invest in your own business and buy mutual funds. All of those at least have a chance at being worth more in the future than you spent on them. That makes them worthy of consideration.

Of course, you'll have to weed out spending money on get-rich-quick schemes, from the state lottery to pyramid schemes to no-money-down real estate.

QUICK TIP.

If someone wants to sell you a program so you can make big money like they're making, pause a moment. Think about it. Why would they put money, time, and energy into developing a tape set or live presentation instead of doing that thing that makes them big money? It's illogical, unless they're truly being charitable. More likely, they make their big money on selling you the false hope of making big money.

By contrast, buying a new car or truck is a lousy investment. It is certain to lose a ton of value the moment you drive away from the car lot. A new car loses about 30 percent of its value in the first year. Most consumer purchases-from new electronic gadgets to m.u.f.fins in the morning to a new leather jacket-all lose value quickly.

QUICK TIP.

When buying something that will depreciate, imagine what you could sell it for at a garage sale the next day. A $15 music CD becomes 75 cents. An $80 cordless phone becomes $6. A $50 toaster oven becomes $5. That puts the purchase in perspective in a hurry.

Of course, we all must buy many things that deteriorate in value. But if you can shift some spending from consuming to investing, you'll be wealthier for it.

Now that we're on the same page philosophically, let's get down to the practical advice.

PART I.

Spending Smart Today.

Chapter 2.

First Things First.

Getting Started.

You can take a number of supereasy steps to get your financial life in order. For some tasks, it's a matter of actually doing them and crossing them off your list. Others require periodic maintenance.

Often, these fundamentals alone will put you on a path to money success. It's like learning to golf. If you don't have a proper grip and stance, your swing is doomed. Children can't read until they know the alphabet and what sounds letters make. You'll be an unsuccessful driver until you learn about the accelerator, the brake, and the rules of the road.

These fundamentals are always taught-and learned-the same way, step-by-step, in a process as easy as 1-2-3.

Taking Stock.

n.o.body is starting this minute with a clean financial slate. We already have a lot going on. We're spending and saving every day. So, it's time to take stock.

Taking Stock, 1-2-3.

1. Take a snapshot. Find out where you stand now.

2. Look back. Track previous spending to see where your money goes.

3. Look ahead. Set specific goals for where money will go in the future.

Imagine your money life is moving along a timeline. All you own and all you owe is constantly changing, with every swipe of your debit card and every deposit in your retirement plan.

It's important occasionally to take a snapshot of where you are now, a freeze-frame in the motion picture that is your money life.

In the introduction, I wrote about how receiving financial advice is like taking driving directions from a GPS navigation device in your car. No matter how good the machine is, it can't give you directions to where you're going until it knows where you are now. It pinpoints your location by searching for and locking in satellites as it boots up.

Well, it's time to boot up with your finances and find out where you are. It's the first step in getting to where you want to go.

1. Take a Snapshot.

There are two simple exercises to hone in on where you are.

First, add up all the money you ever earned in your life. I first saw this task in the book Your Money or Your Life by Joe Dominguez and Vicki Robin. The book is great, but the authors go into excruciating detail with this exercise. I think you can get close with just a little effort.

If you have worked for employers your whole career, you can total your lifetime earnings fairly accurately from your annual Social Security statement, which details how much you earned each year. The statement comes a few months before your birthday. If you need a copy, go online to www.socialsecurity.gov/statement to have one mailed to you, or call 1-800-772-1213.

Also, refer to federal income-tax returns. If you've worked at the same employer for a long time, the human resources department probably has a record of your earnings. Estimate other income, such as gifts of money, family loans that were forgiven, money earned as a teenager, even significant gambling winnings.

This trip through your earnings history should be illuminating. It lets you know you have earned significant money over your lifetime. This counters any notion that you don't have enough money to save or enough money to manage.

The second step is to figure out what you're worth today, specifically your net worth. If you liquidated everything in your life-sold everything and paid off all your debts-what would you have to show for it? Create two columns on paper: all you own (a.s.sets) and all you owe (liabilities).

For example, money in your retirement plan is an a.s.set. Furniture and jewelry are a.s.sets. Don't stress yourself out trying to get superaccurate values. Just give items ballpark estimates. Meanwhile, credit card debt is a liability, as are student loans and family loans.

If you're making installment payments on something you own, it might be both an a.s.set and a liability. For example, if you own a home with a market value of $300,000, that goes in the a.s.sets column. If your mortgage is $225,000, that goes in the liability column. The result? A net $75,000 is added to your net worth. It's similar if you're making car payments, although some people actually owe more than the vehicle is worth. If so, the vehicle actually subtracts from total net worth.

So, now you have two numbers: your total lifetime earnings and your net worth.

The big question to ask yourself is, "With all the working and earning I've done over the years, what do I have to show for it?" A lot, or too little?

Of course, much of that earned money went to necessities that added little or nothing directly to your net worth-food, clothing, vacations. Meanwhile, some of your a.s.sets have appreciated, such as your retirement plan or the value of your house.

If you're still in your working years and your net worth roughly equals your lifetime earnings, you're doing really well. Even if your net worth is a quarter to a half of your lifetime earnings, you're not in bad shape. The ratio should improve to one-to-one or better as you approach retirement, says Liz Pulliam Weston in Easy Money: How to Simplify Your Finances and Get What You Want Out of Life.

But if your net worth is zero or negative, you might honestly ask and answer, "With all I've earned, what do I have to show for it? Nothing."

The big question is, "Now that you have a snapshot of where you are with money, what will you do from here?" Will you do things to add to your net worth, such as save and invest? Or, will you buy more consumer goods and services, which subtracts from your net worth? After 10 more years of earning money, will you have more to show for it than during the past 10?

A wealth formula from the best-selling book The Millionaire Next Door provides an interesting exercise. It offers a measuring stick for how well you are acc.u.mulating wealth.