Spending Money and Saving Money Is Relative To Your Income and Net Worth
We’ve covered a lot of ground when it comes to saving money but what about spending money? It’s a topic equally as worthy of analysis when personalizing your quest to build wealth so let’s take a few minutes to put it into the context of the broader picture. Namely, I want to talk about an important point that sometimes seems to be forgotten: Frugality is relative.
Ultimately, the absolute amount of money you spend doesn’t matter nearly as much as the amount of money you spend relative to your income and net worth.
If you are 50 years old, have no debt, $2,000,000 in cash in the bank, earn $600,000 or more per year, own your home outright, and have multiple streams of income that aren’t at risk of disappearing at the same time, does it really matter if you want to spend money on things other people might consider ridiculous, such as a $150,000 car or $6,000 Brioni suits? Whether you prefer those things to a Ford and blue jean is entirely a matter of personal taste. There is no right or wrong answer. Your goal is not to die with the highest net worth possible, it’s to live a life that maximizes your own happiness, using money as a tool that serves you. As long as you are regularly adding to your net worth to the point your estate is generating more and more money with each passing year, you can spend large amounts and be fine. What counts is the surplus.
On the other hand, if you have no savings, $20,000 in credit card debt, $15,000 in student loan debt, a mortgage, a car payment, and your household relies on one or two jobs to cover your expenses, spending $70 going to dinner and a movie is far too expensive.
It is irresponsible. You are living on the edge of disaster and every excess penny should be going to reduce your liabilities, bolster your savings, and create passive sources of income that will still be there if you lose your job.
That may seem counterintuitive but sometimes it helps to examine extremes.
Consider two men, both of whom live in the same town.
John owns a small chain of paint stores. He’s successful and nearing retirement. He earns $250 per hour (roughly $500,000 per year). He has no debt. His portfolio is stuffed with millions of dollars in blue chip stocks, a collection of Series I savings bonds, and some good real estate investments. He likes nice things. After a long career of work, he now sits at home each night wearing $800 cashmere sweaters, writing with a $2,000 fountain pen, drinking out of a $400 gold-rimmed coffee cup, listening to music on a Steinway & Sons grand piano with a player system built into it, giving away thousands of dollars through his family’s charity, and reading $300 leather-bound, gold-edged books. Once a year, he spends $25,000 to take his grandchildren on vacation to the destination of their choice. He pays for violin lessons, dance lessons, private tutoring, and a host of other things that benefit his family. One night, he decides to take his adult children out to dinner, spending $700 on the ticket by the time all was said and done. To some people, that’s a mortgage payment.
Adam is a retail worker. He works hard. He earns $10 an hour ($20,000 per year).
He lives in a run-down apartment. He hasn’t bought new clothes in five years. His car barely runs. He keeps the heat off to save money. He’s responsible for making dinner. He decides to take the family to McDonald’s and spend $30 on cheeseburgers, fries, and Cokes.
John is behaving far more frugally than Adam when it comes to saving money. For dinner, he only had to trade only 2.8 hours of his time to pay for food, whereas Adam spent 3.0 hours of his time. That is, even though John’s family dinner was $700, it was cheaper on an economic basis than Adam’s family dinner at $30. As counterintuitive as it sounds, Adam paid more for his food than John did when you measure what counts – relative income and time traded to fund a purchase.
To put it bluntly, Adam can’t afford to eat at McDonald’s.
Whether that is fair or not is inconsequential right now, in this moment, as it pertains to his monetary situation. If Adam’s priority was achieving financial independence, he could have eaten far better, and paid 1/6th the amount, by staying at home and making something like Marcella Hazan’s classic butter and sage sauce or healthy, fresh, green vegetables by preparing a French recipe such as Leek and Potato Soup. As much as I, and others like me who own shares of McDonald’s, appreciate his contribution to the firm’s annual profits, he doesn’t have the ability to be funding our dividends. He should run his household far more efficiently and keep it all for himself during this stage in his life. He needs to be selfish and put his own needs, and self-interest, above ours. With proper time management, it’s entirely doable.
Yes, it can be a struggle to adapt this mindset but, looking at the data for the United States, many of the nation’s John’s began like Adam. You have to make sacrifices for what you want in life and if your objective is acquiring personal financial freedom. This is the cost if you weren’t lucky enough to be born into an affluent family. Sometimes, it sucks. Sometimes, it’s hard. Sometimes it feels patently unfair to the point it can make you angry, sad, or discouraged depending on your own psychology. You have to deal with it, anyway. Your feelings aren’t going to change reality only your actions will.
This doesn’t mean you can’t indulge in the occasional splurge if your willpower is weak, only that every penny counts if your objective is growing your nest egg and you are still at a point in your life when there isn’t a big margin of safety to get something wrong; be aware of it and accept the trade-off accordingly.
Focus On Your Savings Rate – The PSAVERT Ratio
A good way to measure your success at saving is your so-called savings rate. Look at the total cash you save each year, money parked in the bank, principal repaid on debt, and investments added to 401(k) plans, Roth IRA, or other retirement vehicles, and then compare that to your household income. Alternatively, you can use the PSAVERT ratio, the Personal Savings Rate, released by The Federal Reserve. You can view the historical savings rate of your fellow Americans by year.
I’m a big fan of savings rates over 20%, some of the reasons for which I touched on in an article called, How Much Money Should I Be Saving?. If you earn $1,000 a paycheck, I’d want to see at least $200 of that going to some sort of well-researched and chosen savings or investment account.
The big lesson is to stop spending out of someone else’s pocketbook, as my grandmother would say. The guy a few blocks over might be behaving far more frugally buying a $250,000 Bentley than you would be buying an $80 watch. Every year, you should be adding to your bottom line and your household income above and beyond the rate of inflation. If you aren’t, and you didn’t suffer some sort of preventable medical disaster or comparable catastrophe beyond your control, you are doing it wrong.
Spending Money and Saving Money Is Relative To Your Income and Net Worth Conclusion
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