When we think of ways to improve our financial situation, we know we can earn more or spend less. But are both approaches equal? Although on the surface it would seem so; on closer examination it is clear there is a large disparity between the two.
Exiting the consumer rat race has a far bigger impact on your ability to achieve financial freedom than does increasing your earnings.
The reason for this is twofold:
1) Earnings are taxed; heavily.
2) Earning increases influence your wealth only while you are earning. Once you quit or retire the affect stops. Learning to be happily frugal has benefits that extend for the rest of your life.
Allan Roth’s article, Financial Wealth – It’s Time not Money explores this concept. Roth gives the following example of a 50 year old that can reduce spending by $10,000 for the rest of her life or increase earnings for the balance of her career.
A 50-year-old woman can make $10,000 a year more and will retire in 15 years, which translates to $150,000. But if a third goes to taxes, she is only left with an additional $100,000. On the other hand, if she spends $10,000 a year less and has a 33 year life expectancy, that translates to $330,000 in savings.
A dollar saved is $3.30 earned
So in the above example, lowering annual expenditures by $10,000 had about a 3.3 fold benefit over earning $10,000 more. That means a dollar saved is worth far more than a dollar earned – in the above example it equaled approximately $3.30.
Many of us try to out-earn our past or present spending habits. This seems particularly true of high earners. The problem is the more we earn the more we spend. If you are currently earning at least average wages, focus the majority of your early efforts on reducing your expenses in order to win.
Plugging the hole in your bucket before filling it with earnings is so much more effective than the alternative.