The following is an excerpt from the book Set for Life.
I asked to run this piece because saving is the least glamorous step in the ESI scale but is also arguably the most important. I think this excerpt does a good job of detailing why it’s so vital.
Reason #1: Frugality Enables You to Seek Opportunity
Many finance experts and motivational speakers say things like, “Don’t limit yourself to a scarcity mindset,” and “Don’t sacrifice! Build your income!” They tell their audience things like “Expand your mind—money is unlimited.” They’ve, in effect, convinced their followers that they need to focus on income, not savings.
These big shot experts aren’t wrong! Income (and chasing higher and higher investment returns) is a necessary path forward, and two-thirds of this book is dedicated to these topics. Those seeking early financial freedom should build more and more income streams, and intend to scale them increasingly over time.
However, the intimidating big shot expert is forgetting something that is obvious to the wage earner who’s currently working a full-time job. The guru isn’t working a full-time salaried job at or near the median income level, and didn’t get wealthy while working a full-time job for someone else. She is likely an entrepreneur or executive at a large company, and plays by a different set of rules than regular employed folk.
How on god’s green earth are you going to build a business on the side when you have to be up at seven o’clock in the morning, out the door at eight, at work at nine, and don’t get home until 6:00 p.m.? You’re going to build a business from 6:00 to 10:00 in the evening, after a full day of work and any evening obligations? Yeah right. How could you possibly compete with all the people out there who are equally gifted, but with all day to build a business? Unless you are superman or superwoman, it is a tall order to outcompete other competent entrepreneurs, who can devote the best part of their energies toward building businesses.
Of course, those with an extremely long-term focus or who passionately pursue their side business as a hobby may find success or fulfillment with this approach. But, if you are a regular full-time employee working a typical job, the following statement might be painfully obvious to you. You can’t seek greater income opportunity right now because if you lose your nine to five, you’re screwed. In fact, because you aren’t frugal, you can’t even take a job that pays slightly less than the one you have now! Think about that.
Liz earns $50,000 per year. Assume someone offers her a job that paid 15 percent less than that—$42,500 per year—but that gives her a 50 percent shot at earning $100,000+ per year in two years. This job has the potential to drastically increase her income, allowing her to accumulate income-producing assets in pursuit of early financial freedom far earlier than her current job. However, Liz is unable to take that opportunity due to her spending constraints. She has bills to pay. She has a car payment, a hefty rent bill, the Internet and cable bill, bar tabs, and many other expenses she needs to cover with her salary. She can’t afford to risk earning less than $50,000 per year.
Suppose instead that Liz was very frugal. Suppose that she spent only $2000 per month and was able to save $1500 per month. All of a sudden, this job opportunity is something she can seriously consider. She probably has thousands or tens of thousands of dollars in the bank, and the new job’s base salary is still far higher than her spending. She can afford to take a chance on a new opportunity and pursue her dreams.
Most Americans probably can’t do this. They probably have no money saved up, and set aside just a fractional amount of their income in the form of savings per month. If that’s the case for you, you’re missing out on opportunities with every passing day. In fact, you can’t even see the opportunities you’re missing because it hasn’t even crossed your mind to look for lower paying work that offers commissions, equity, or other scalable financial rewards.
If you can easily get by on significantly less income than you currently earn, you open yourself up to an entire world of possibilities or opportunities. Some people call this luck—and only the financially prepared are in position to get lucky. Those possibilities absolutely include jobs and entrepreneurial pursuits that require short-term sacrifice for the opportunity to pursue huge long-term gains.
Reason #2: Frugality Opens Up Opportunities
It’s always fun when folks use those words discussed earlier—words like “sacrifice” and “money is unlimited.” One of the most absurd comments is, “Yeah, I wish I could save, but I’ve got a family and cutting back will prevent us from doing the things we love to do together. I need to focus on earning more money instead!”
This argument makes almost no sense. This person is claiming that both financial security and family/recreational time are priorities, yet somehow believes that being frugal will negatively impact their lifestyle more than attempting to earn more money.
Imagine this scenario: Adam currently works a forty to fifty hour per week job, and though it pays at or near the median US income of about $50,000 per year, he spends almost everything he earns and lives paycheck to paycheck. Adam’s employer doesn’t permit him to work on outside businesses or freelance work while he sits at his cubicle. So, Adam and the millions of Americans like him are forced to work on building outside income streams during other parts of the day.
For example, Adam might pursue a side business in the early morning, or he might decide to moonlight and work a second job after regular business hours. Theoretically, he could also cut back on the time he spends sleeping, and work through the night. But, no matter how you slice it, pursuing additional income streams with no starting capital will involve a significant investment of time. That time investment will come at the cost of spending that time with Adam’s loved ones. Here are some examples of ways that Adam might earn some extra cash outside of work:
- Drive for Uber
- Take on after-work jobs like babysitting or tutoring
- Sell clothing or services to friends, family, and coworkers
- Start a business online
- Start a blog
The problem with these projects is that they are either unlikely to produce rapid benefits or they pay near the minimum wage. Adam will lose many nights and weekends to efforts like these and may have little to show for it. He will realize a far greater financial result with far less lifestyle impact by making some changes to the larger parts of his budget. For example, he might be able to live in a cheaper place that’s close to his work. This might allow him to save money on rent and time and money during his commute. Adam can now spend more time with his family and will have drastically increased his savings rate. As we will discuss in chapter 2, this simple decision can result in five-figure annual savings opportunities for millions of Americans.
This kind of thinking can free up time and money in Adam’s life. Think about how incredibly impactful this can be for most Americans. An hour per day of time regained and money back their pockets. We’ll go into the math behind other specific strategies to reduce expenses and increase time in a bit, but just contrast the effort and total lifestyle impact of moving to a cheaper place closer to work with that of starting a business. Or driving Uber after work. Or taking a second job on weekends.
Lifestyle design (frugality) can have a large impact for many full-time employed individuals seeking early financial freedom. It can be painlessly implemented, increase free time, and will definitely result in a large increase in monthly savings. And, while no one got rich through savings alone, efficient lifestyle design also enables the saver to start those other business and side-hustle ventures if that is how they choose to apply the savings and extra time they generate.
Reason #3: Our Tax System Favors the Saver, Not the Earner
Surprise! Income is taxed in the United States of America (and many other countries). That’s income, not wealth.
Those in the demographic most likely to benefit from reading this book are probably paying a marginal tax of 30 to 35 percent on any income earned, including both state and federal taxes. And more earnings mean more taxes. A single person earning $50,000 per year who gets a 10 percent raise (a really large raise!) might think they are $5000 per year richer. But they are wrong. This person is really only making about $3300 per year more, after taxes take their bite out of the new income.
Instead, if this person just moved closer to work and into a slightly less expensive apartment, he or she might spend $5000 less per year between the commute and the rent. That’s money they get to keep—they truly are $5000 per year richer. Furthermore, the move does not preclude this person from earning a raise—obviously it’s great to get a raise. Understand, however, the absurdity of attempting to move toward financial freedom by working fifty to sixty-hour weeks for small percentage increases in taxable income when thousands of dollars in after-tax wealth can be easily saved!
Another way of stating this concept is to say that it’s 33 percent more effective for someone in this tax bracket to save money than to attempt to earn it. A penny saved is 1.33 pennies earned!
In Summary
The preservation of capital should be the primary starting focus for financially ambitious nine-to-five employees for three main reasons:
- Frugality exposes the saver to opportunity.
- Frugality is noninvasive to one’s lifestyle relative to moonlighting or building businesses.
- A penny saved is better than a penny earned because it is after-tax wealth.
This is not to discredit the importance of scaling your income and increasing your investment returns. This is just to point out that it’s less effective to attempt to earn more money or invest efficiently when you can have far more impact by taking control of your spending. This does not mean that you should stop trying for that promotion at work! But it does mean that your focus starting out should be on saving more of your income, wherever and whenever practical.
Finance is more often than not a game of multiplication and exponential synergies. Folks that spend less can earn more. Investments that produce more cash flow can appreciate faster. You don’t have to spend less and earn less. Spend less to earn more instead.
Laurie@ThreeYear says
This is a great summation of the power of saving. I think the problem, for many people, is that they don’t know how. I believe that many people (including myself) grew up in families where they had no model for careful, frugal living. Learning how to save money is a difficult, multi-year process that a lot of people don’t have the self-discipline or perseverance to pursue. I think our family has succeeded by forced savings programs–we set up our mortgage payments to automatically pull out extra, max out retirement accounts, etc. It’s been extraordinarily difficult to voluntarily spend less on everyday expenses like groceries. My point is, for families like mine, saving is really hard. But there are ways to go about it-“tricking” yourself into saving more by funneling money into savings accounts, and buying cheaper “big” purchases like cars and houses. We’ve gradually upped our savings rate to about 45% in this way. But it’s taken years, and lots of work.
Becky says
Very good points. . . and math. You can only spend your money once, but wealth can be invested over and over. We’ve used net worth statements to assess if we’re “gaining ground” or on a “sinking ship”.
Lance @ My Strategic Dollar says
Love this. Living minimally and frugally just lowers the cost of living in general. Keeping your expenses low and growing your income is a surefire way to grow your net worth. Once you learn how to implement this style of life, you become happier. I’ve never been happier with my financial situation than I am now and I attribute that to spending less money.
WealthyDoc says
So true. We tend to think that we can build wealth either by increasing income or decreasing costs. While that is true, decreasing costs is more effective due to persistently lower income needs and the progressive tax system in the U.S.
Besides, frugality can actually be fun if you make a game of it.
OMMD says
Best financial advice I ever got was $1 saved is $1, $1 earned is 75 cents (or 85, 72, 67 depending on your tax bracket.
Mike H says
Totally agree that it’s the most important starting point, and thank you for sharing this ESI.
That is the first advice I give to people starting their career. Keep it as frugal as you can and focus on growing your career- and take that surplus into investments which only matter much much later- the first goal is to get the first $100,000 of capital saved up as the initial ‘seeds’ of future wealth.
-Mike
Kevin says
You are not going to get rich by saving and living frugally alone, but managing your money is salient to achieving financial independence. Investing is where the big money comes in via compounding. It just is. Saving or being smart about spending is crucial to allow this to occur. It is a foundation so that you have enough to invest. This comes back to managing or budgeting and paying yourself first so that you can invest.
Instead of keeping up with the Jones, which really doesnt make you happy, you need to figure out what makes you happy. You only live once. Life should be lived and experienced, otherwise do you know what makes you happy, what passions you have. Most of us have probably developed passions that we didnt have when we were 22 and beginning our first job out of college. So the sooner you find this out (and keep finding out), the better you can construct a budget that incorporates this so you can save/spend and allows you to invest to continue to maximize your passions and ultimately your happiness, and hopefully financial independence.
JayCeezy says
Savings is going to build your Net Worth.
The proof is in the actual numbers; do you know how much of your NW is due to Savings? If you don’t know, figure it out. If you are too lazy to do it, or don’t see the point of calculating it or knowing it, ask yourself why you feel this way. (Hint: you are protecting your ego, preferring to believe you are a superior Investor)
If you don’t know your Annualized Investment returns, and can compare them to a weighted benchmark to measure your success, you have another challenge ahead on the path to building NW.
In 17 years of measuring returns to a comparable weighted benchmark, my returns were better-than-average only two years; 15 years average, or below. In 30 years of Saving and Investing while Earning, my NW consists of 52% investment returns, and 48% savings.
Gozo says
PAY YOURSELF FIRST:
If I might slightly refine this point:
The most important element is to “pay yourself first.” Once you do that, it doesn’t matter quite so much how you dispose of what’s left (assuming, of course, that you can pay your bills).
What makes “pay yourself first” such a powerful force is that, as your savings/investments grow, you come to see that “buying” savings/investments is more-gratifying than buying “things.” It follows naturally, as “the night, the day.”
Regards,
(($; -)}™
Gozo!
George says
My wife and I have entered into that magical phase where saving is such a part of our behavior that we don’t think about it or actively measure it anymore. Still, a few months ago I compared our annual grocery / eating out budget to previous years. I was very surprised to see that although we are eating healthier and splurging on nicer groceries, our food spending only went up about 3% in 2016 compared to 2015 (2015 was about the same as 2014).
I couldn’t believe it, but I realized we were spending more on groceries and cut down eating out (especially sub-par bar food), as well as made more slow cooker / leftover heavy meals since we enjoyed the new healthier food. And we did this without ever discussing it… we just knew we needed to adjust.
I believe that is where frugality gets you, not just annual, short-term financial gains but long-term financial gains via behavior change.
Rick says
“Wealth” is relative. One son is a paramedic for a city/county system; the other is a high school teacher. Both are well-educated and intelligent, but have chosen paths that are not lucrative (but #1 is quickly being promoted and #2 wants to be a principal, so maybe?). However, I am helping both work on the “S” and “I” parts of their lives, building wealth relative to their income. Frugality is a part of that, as are saving and investing. I encourage “wealth” in the relative sense, since both already live well within their means. They have time on their side, and if they save a substantial portion of their incomes, their investments could soon grow faster than their deposits. #1 would have done better, financially, had he continued on to medical school, as would #2 in computer science, but I applaud their efforts knowing they can someday fund a lifestyle equal to or better than what they have while employed. They understand the sacrifices they make doing what they are doing and, frankly, we need them where they are.
Myfinancekits says
If one is frugal, he will not only have money set aside for emergency, he will be able to live a debt free life. Also instead of squandering money, he will be able to divert his savings into investment
Paper Tiger says
These really are words to live by, especially if you are just starting out or early in your earning career. I am a boomer and I came up in a generation where it seemed like the expectation was that as your income rose, so should your standard of living. When you could only afford to live in a certain neighborhood, you worked hard to be able to afford to live in a better neighborhood. When you could afford a better car, you bought a better car. The goal to strive for working hard to be your best was correct but the reasoning behind it was completely flawed.
In spite of my flawed thinking, I managed to achieve financial independence but it never dawned on me to set an objective of retiring early because of this generational ingrained pattern I had established. How much more net worth would I have accumulated if I had only adopted a more frugal lifestyle and how many better options in life would have come with it?
I don’t believe in living with regrets. My life is my life and I made these choices and in spite of my mistakes, I’m still happy with where I am. However, when good advice comes along, you should listen and you should adjust accordingly. I only wish someone had pointed this out and helped me realize the positive impact of frugality 40 years sooner!
Dave says
Like always, great content. I truly believe that everyone should put in the effort to grow in their career. However, there are limits. Everyone is not cut out for a C-title nor wants that job. Even if they do want it, those positions are limited. The trick is to do your best to earn and save until it hurts. That model will provide almost anyone the freedom to invest 15% or more. If you do that for a few years, the opportunities will pop-up like magic.
getagrip says
Savings is more than just a thing you do, it is a mind set you have to make a habit of in order to succeed. Like most habits that are exercised you saving percentage and amounts grow over time, and folks often miss that point. Those folks I know who have poor money habits, and thus are typically living paycheck to paycheck, all seem to share a similar attitude towards savings. It’s the last thing they think about when they get a raise, a bonus, a windfall, since the first thing they generally think of is how to spend the money and what they can get with it. Investing the money, building the money over time, just doesn’t register or is considered an afterthought with any monies “left over”. When you tell these folks to pay yourself first, they happily agree, because in their minds paying yourself first doesn’t equal saving and investing, it means spending money on yourself before bills. It’s hard to tell such folks who figure they’re living fine if they can pay their bills the importance of saving, especially if they think saving small sums really doesn’t get them anything especially in near term.
So I appreciate these solid examples of how treating savings that way hurts your opportunities for the near future, to include earning more money and missing opportunities. I’ll add the lost opportunity point to any discussions on why savings, even smaller amounts, is a good thing.
Cody @ Dollar Habits says
Love this! I especially love that the author calls out the “gurus” on their advice which doesn’t apply to the general public. Even if someone is working to grow their career, it can be a lengthy process (speaking from experience), whereas shifting to a more frugal lifestyle can be started today. Additionally, there are many factors beyond our control (though we do have control over the decisions we make and effort we expend) in working to grow our careers, but we have total control of our spending habits. Frugality has made all the difference in getting us to where we are while living on one-income in an expensive COL location. With that being said, I am looking forward to being able to be frugal by choice, rather than out of necessity.
Justin | An Intentional Lifestyle says
Wow this is powerful stuff. I like your blog’s approach to balance the Earn, Save, and Invest portions of the equation but there’s no substitute for frugality. You could make $1M a year but spend $1M a year and still have nothing left to show for it at the end of the year.
Earning more money is wonderful but frugality is the key to freedom!
Terry Pratt says
Frugality is great, IF you have an income at least within shouting distance of the median, but frugality on a minimum wage income won’t get you very far.
Jeff B. says
that is the ultimate time to be frugal is when you have no money.
Joe says
Good excerpt. However, I think this takes it too far on the other spectrum. Being frugal is good, but you can only do it once. Probably not enough context here so maybe I should read the book.
Of course, you need both side. Being frugal is the first step and increasing income is second. They are both equally important.
Gozo says
“Pay yourself first,” and the frugality will take care of itself…
Regards,
(($; -)}™
Gozo!
Mrs.Wow says
Once you figure out what and how to start decreasing costs, I’ve found that there is a snow-ball effect that begins to permeate through your whole life. You start with a few things, then realize that this other thing isn’t important to spend money on and so on. I think all too often people get consumed by earning more and neglect cutting their expenses, which can be just as powerful.