Before we get into the article, I want you do something for me.
Hold your hands one foot apart, palms facing each other.
Look at the gap – that’s how much you’ll save by cutting expenses.
Don’t move.
Erase that idea from your memory.
Look at your hands again – that’s how much you’ll earn with a raise.
Now, move your hands two feet apart.
Look at the gap – that’s how much you’ll save by cutting expenses AND earning a raise.
There’s financial hubbub on whether one should focus their attention on cutting expenses or earning more. Recently, two articles, David and Ramit, had me thinking about this idea.
When asked what’s best, people will point their thumb either to the left or right. When asked the same question, I point in both directions.
You’re probably thinking, “Oh what a cop-out taking the middle road”.
First, I have a personal preference towards earning more, which I’ll mention later on. More importantly, hopefully you will realize that the ONLY answer is BOTH after reading this article.
Why should this be considered: “the only answer you need to know”? Because your financial system does not move linearly in one direction, and we need to compensate by taking a systematic approach to optimize our finances.
I love analogies. Everyone who knows me will tell you I love nothing more than finding indirect comparisons to make relationships. So here goes.
Think of Michael Phelps. He consumes roughly 4x the recommended daily caloric intake, yet his abs are red carpet featurettes. Offsetting his immense consumption with vigorous Olympic training, he’ll be a great example. We’ll relate his eating to expenses and workouts to earning power.
WHY YOU NEED TO SAVE MORE. If he stops swimming, but keeps eating the same amount – it won’t be long before his speedo doesn’t fit so well. The real world example of this was everyone who thought that their income could never revert, and would continue to increase by leaps & bounds. Their spending was controllable only through their income, and once that buffer inverted…. they were screwed.
WHY YOU NEED TO EARN MORE. If his concern focuses instead on cutting supplemental meals, but keeps training at the same intensity – it won’t be long before his “as is” body gives out since it won’t be developing. The real world example of this are those who look more behind than forward. By focusing their attention on addressing the back-end components (i.e. saving more), they are missing out on opportunities to grow and develop themselves (i.e. earn more).
In order to appreciate that we need to focus on earning more AND spending less, we need to apply basic math principles. BOOOO! It won’t be boring or painful, I promise. I spent time preparing graphs, but scrapped them when I realized it was a lost cause.
Remember the hand exercise? Those are our bounds.
Your expenses will always be greater than zero and your salary cannot increase infinitesimally. When you understand there are constraints on both ends, you look within the limits and realize you can OPTIMIZE your system by pushing your variables (earning more and spending less) as close to those limits as possible.
Whether you cut 15% in expenses or receive a 15% raise, the results are more or less the same (more or less because there are long term differences). However, cutting your expenses AND earning a 15% raise results in TWICE the savings, or 30%.
That’s a pretty simplistic example, but consider the effects of variable rates. What if Friend A earns a 10% raise, while Friend B earns a 4% raise and cuts expenses by 7% – who got the better deal?
Once you get really good at cutting expenses, it’s much harder to extract more savings out of additional cuts. The reality is we have the most potential to increase our savings by increasing our earnings.
Although I think increasing your earning power is the “optimal” solution, there’s risk / reward with every decision we make in life. For right now, I’ll end the post here but will look at writing another highlighting the different risks/returns between each type of earning.
Photo by Jeremy M Piehler
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Good article, and good use of mental imagery to get your point across. I’m going to continue using the theme of running your personal finances like a business because I think it’s the only way to really get ahead financially. It’s not enough to just spend less, you owe it to yourself to try and make more, whether that’s at work, with a part-time job, or a side business.
Thanks for the mention!
@ David.
I hope people take the time to check out your site and articles. Like I said in my email, I think we’re going to start running parallel paths here.
Looking at your finances as a business is an incredible example. There’s too many examples to list in a single reply…
You’re absolutely right! The middle path is the key! While cutting expenses is one way to save, there’s a limit to how much you can cut. Life will get pretty dull and boring if you keep chipping at your expenses once the frivolous ones are gone.
@ Thirftygal.
You are right. We aren’t here to save and cut costs to a point where our existence is void of EVERYTHING. We should enjoy our lives and spend money in ways to make it richer. I simply want to advocate that there’s overlooked waste, and its the low-hanging fruit people can easily grasp.
Here’s analogy for you…If you want to lose weight, eat less and exercise more. People seem to want a more complicated explanation for the achievement of their goals, but I believe most of the things that improve lives and make people happy begin with a very simple strategy, like the one you point out in this post.
.-= Tracy´s last blog ..Another Measure of Wealth =-.
@ Tracy
Holy moly! So you’re telling me that eating healthier AND exercise will help me loss weight? I have friends who think their workouts give them licenses to gorge on whatever foods they want, and then wonder why they struggle with weight.
I really like your approach on simplicity. By making things more complicated, we also prevent ourselves from meeting our goals.
Great article – can easily tie in the decision to make more money to the Outsourcing article, too. Usually people who actively pursue making more money don’t have time to do alot of mundane household chores. But it’s definitely worth it to pay someone $15/hr to walk the dog while they are making beaucoup bucks elsewhere.
However, money that is “saved” is not usually taxed. Money that is earned is.
A wise man once said “It’s not how much you make, it’s how much you save.” Sometimes,one’s desires tend to increase when income does. There’s always the desire to treat oneself. Could be a candy bar or lottery ticket or could be a trip to Paris!
Keep up the good work in getting us to think about how we spend our money!
@ nextstage:
thanks for the compliment!
On the taxes, depending on how you save – it can be taxed. But hopefully its at a lesser rate than your income, or you’re at least getting tax advantages.
You bring up a GREAT point at the end – “one’s desires tend to increase when income does”. I’ve been thinking about this and even considering writing a post about our greater expectations. It’s not just what your OWN desire’s dictate, but what OTHER people expect from you.
Quick Example: If you are a doctor, and drive up to the hospital in an old, beat-up 10-yr car your patients are going to have cause for concern!
Hi Fin Engr,
A thoughtful post that proves time=money!
I concur with NextStage that desires often increase when income does–otherwise, we probably all would be able to be the janitor who leaves an endowment to his alma mater!
Keep up the insightful work!
Karen
Thanks Karen.
I’ll be working on the “Great Expectations” article next – so be on the look out!
Nice post here J. Doing both simultaneously is a great way to go. However, focusing on making more money is the easiest way. You can make way more money than save money.
Shorting a stock will give you 100% if it goes to zero (expenses). Going long a stock could go up 10000%, you never know.
.-= Financial Samurai´s last blog ..Is Becoming A Millionaire The Rule Rather Than The Exception? =-.
@ FS:
Definitely agree. There’s significantly more upside on the “earn more” side.
Once you either start plateauing or hit a long search before the next bump, there’s nothing to say you can’t squeeze an extra 5-15% out by “spending less”