When I first started out in personal finance, I didn’t understand why everyone kept emphasizing to cut back on daily expenses as the #1 rule to building wealth.
I mean, isn’t having a large salary and making pots of money being wealthy?
Look at all of these people with high incomes — they’re all considered rich!
There must be something to this salary thing.
Oh young grasshopper!
It wasn’t until I really started tracking my expenses that I realized there was a second part to “cut back on daily expenses”, and it was:
Cut back on daily expenses, because wealth doesn’t exist without savings.
Now we’re getting somewhere!
Wealth doesn’t exist without savings
Jane makes $45,000 after taxes, and saves $20,000 of it, living on a very frugal lifestyle.
Every year, she banks $20,000.
John makes $130,000 after taxes, and saves $10,000 of it.
Every year, he banks $10,000.
There. Example finished.
Even on an income 2.8 times higher than Jane’s, John saves less, and therefore flashier than Jane but is much less wealthy.
This becomes even more significant when you take compounding interest into consideration.
Spending should be in line with your lifestyle, not income
This sounds a bit like “Umm.. what are you smokin’, because most people spend based on their lifestyle anyway, not their income..”
From my experience, not so much.
Spending in line with your income
If you make $30,000, you spend it, but the majority goes to basic expenses and such.
If you make double that, you have it in your head that you make $60,000, and therefore, spend accordingly to what you know to be your income.
At higher and higher incomes, your spending for basic expenses increases by small increments, and you start to spend a higher percentage towards more “frivolous” categories to have what you feel is a better quality of life, such as on eating out, shopping, taking flashier vacations, and so on.
We spend what we know we make.
Spending in line with your lifestyle
It took me a while to learn the distinction between income & lifestyle, because the two do NOT have to mean one and the same.
You could make a lot of money or a little bit of money, but if your lifestyle stays the same, your expenses will follow suit.
For us, if we make extra income in a year? Fabulous. We bank it, and use some of it to go traveling when the two of us are free to do so.
If we make $0 income in a year? No problem. We have our banked savings and we don’t sweat it.
We are still living the same lifestyle, no matter our income.
The best example of spending according to income
…is my brother (Mr. Jones).
When he first started out, he was pulling in $35,000 a year. He lived with two roommates, ate beans out of a can, and cleared his $15,000 student loans within a year or two.
As his career progressed, his income increased to $100,000 a year, and so did his lifestyle.
He started driving a sports car, going out to eat nightly, drinking on weekends, flying away on impromptu vacations — the whole lot.
Now that he and his wife make almost half a million a year, it has gotten out of control.
- Upgrading to a $750,000 home from their starter $250,000 home
- Two new cars because the old ones looked old
- New furniture for this new home
- A huge pool to use 2-3 months a year because we live in Siberia Canada.
- For the kids: toys, toys toys!!!
Sure, they save about 4% or $20,000 a year.
But whatever he saves, they end up spending, on the premise that they can always make it all back, and they’d rather have the fun now, rather than later.
Note: To be fair, my brother is the type of workaholic who only needs an office, a bed, his telephone & his computer. Other than that, he could work/live anywhere and under any conditions.
He just simply doesn’t care about his surroundings — it seems to be more my sister-in-law who is into the image of “hearth & home”, and who pressures him into loosening up the purse strings so they can “live a little”, but then complains when he works too much to make all this money to pay for their fabulous lifestyle.
Not so fabulous, I say.
To put it into perspective, they need to make $150,000 a year (together) at a minimum to pay for the mortgage and utilities.
That’s it. My entire sister-in-law’s income goes towards just paying for their bloated McMansion.
Food, gas, cars, clothes, vacations, furniture, medicine, books, tuition, toys and whatever else they want? They need more than $150,000 to cover that, not to mention savings & retirement!!
The good news is that such excessive spending in my family, makes me feel the urge to really tighten the reins on my own spending.
What you spend is a greater contribution to your financial independence than what you make
You shouldn’t base your lifestyle on how much you make, because as illustrated above, you’re just spending for the sake of spending.
Basing your lifestyle on how much you spend, is much more important to ensuring financial independence.
In the example above, if you make a boatload of money like John at $150,000, but only save $10,000 of it after taxes, you are a slave to your job, because your lifestyle demands it.
You feel trapped, as if you cannot quit your job because you need the money.
I definitely felt like that at one point.
I had so much debt, I felt trapped in my job, unhappy but making a good salary to put chunks of money to clear it each month.
It seemed like it would never end.
Then I realized: I am treating myself for being employed & throwing a pity party for being in debt!!!
I had created my own financial prison and I had to engineer a jail break, and once I did:
- I was able to live on much less than I thought possible (never in a million years…)
- .. and I felt comfortable with spending less than 50% of what I spent before! (*gasp*)
- I saved more money & finally saw the light at the end of the debt tunnel
- My lifestyle became my own again, rather than a monster I couldn’t control
This was of course, all possible because I started tracking my expenses & creating a budget.
Build up an immunity to your salary by cutting back on expenses
Think of cutting back in your expenses as inoculating yourself & your life against a potential income-destroying disease.
By gradually cutting back in your spending, you are preparing yourself for the worst situation possible (which in many cases does happen), and you won’t feel the pinch when push comes to shove because the less money you spend, the less you worry about having to keep your job just to keep up with your lifestyle.
I know more than a few people who are trapped in jobs they hate, but are helpless to leave because the only thing they can tell me is :
I NEED $80,000 a year to live. I just need it. It’s my bare minimum.
When pushed about why the “need” that money, the truth comes out: they bought a house they couldn’t afford, they have car payments, they need to go out every weekend…
Bla bla bla.
They just think they need that money, but it sounds more to me like financial slavery than freedom.
How can anyone enjoy that house, that car & those fun activities if you dread waking up on Monday morning to start another work week, in a job you absolutely hate?
If your expenses are as low as you can go, it won’t matter if you have to (or want to?) take a job with a lower salary.
But if you make $150,000 and then drop to making $40,000, while living an $80,000 lifestyle, you are going to feel that crash & come out bruised & bleeding, crying about your bad lifestyle choices & lack of knowledge about how to even begin to lower your expenses.
IN SUMMARY:
- Wealth doesn’t exist without saving.
- Cutting back on expenses helps you save that money you’re making.
- Track your expenses to find out where you need to cut back in your budget.
- Your spending should be in relation to your true lifestyle, not your income.
- Spend less money & you will need less money, but be grateful for anything above & beyond.
- Prepare yourself for a possible drop in income at any time, by learning to trim expenses.
- Save. Save. Save. And never feel like a slave to your job again.
Something about cutting back feels like giving up instead of building the ambition to just make more money to afford what you want.
I’m trying not to live an inflated lifestyle. I just got a raise and it’s so easy to think, “Oh, now I can afford that housekeeper I wanted!” But before I got the raise, I had planned to put all the new money into my Roth IRA. I’m trying to stick to plan #2 as difficult as it is.
Well, yes and now. John might ended up landing a very good job – is he is going out, socializing and making fun.
New company, new pension scheme, new salary. The other point – John lives in his prime! It is only once when we are 20, 30, 40….
Certain things are only good than…
I don’t want to go back to the lifestyle we were living back when we were poor graduate students. There’s a level of income where we have enough… but it isn’t where we started out.
I just wrote this exact response to the SAHM post by that other blogger. That my neighbors both work and I know the wife makes about what I would make to working. So assume we make the same DHs and same DWs right? They pay $2500/month daycare, pay to have food delivered at more than $100/delivery (premade meals that need to be heated), eat out more, drive more, drive nicer cars, order everything online because they “don’t have time to shop”, and basically spend more than we do.
I would probably guess that we save just as much as them, perhaps even more (30% of our income), have no debt, but we make about half what they make…
So perspective? If you cut back you have not live that hectic lifestyle and stay at home with their 2 year old (our kids are 3 months apart), versus the life they are choosing now. But if the wife wants to work for sanity great. BUT working for STUFF???BUYING a water fountain for their house? Dog daycare? New cars? Delivered food? Geez, I’d rather have the memory of time with my kid over that crap and I can guarantee that my DH values it more too. We have tons of time together and not much stuff.
Great Post! It really puts into perspective the difference between having a lot of money and wealth. Like you said you can’t be wealthy without saving. If you make a lot of money and all you do is spend it then you will never be wealthy.
This is so true. I should be following in the footsteps of my parents. They’ve lived on two incomes in the past, but always had a LIFESTYLE that would allow them to live on just one. My husband and I are falling prey to living based on our income, and I know it’s time to reevaluate our true NEEDS expenses.
“Treating myself for being employed & throwing a pity party for being in debt” is a great line. I’m due to finish paying off approx $65 in debt (student loans mainly, credit card, car loan) in May. I make about $50K USD/year live in a small apartment, walk to work, and avoid lifestyle inflation. This blog continues to be an inspiration.
I have been following your blog for over a year now and this is by far my favourite post. This is what I strive to do in life!
I completely agree and hope that this helps some of the people I sent this particular link to in my contacts.
I personally feel great when I go under budget per 6 months. It feels great knowing that I can save even $100 or whatever but it is usually a lot more than that and half always goes for my daughters future.
Absolutely agreed, that’s been my biggest problem to this point. For every raise I got, I took on another “expense” to account for that extra cash.
Regular lurker, first time commentor. This post really resonated with me! Ive recently gotten into personal finance and this entry did a really good job of explaining WHY I need to track my spending and keep it in check. I’ve been tracking my expenses and starting to start budgeting… This entry was motivating. Great!