Budgeting Doesn't (Always) Matter
What's the first thing that comes to mind when you hear the phrase "good with money"? Often people equate being good with money to self-control. Does this sound familiar? Someone who is "good with money":
- Has a detailed budget and knows where every penny goes.
- Never makes an impulse purchase or buys something they don't need.
- Gets a good deal on everything, takes advantage of sales, coupons, etc.
Notice anything about those descriptions? Every line item is super negative. Don't lose track, don't buy anything dumb, don't overpay. It's like saying that being good with money means saying no to the part of yourself that wants to have fun. But there's a better way.
Income Minus Expenses
If you're trying to reach financial independence, you need to save money and invest it to harness the power of compounding growth. The faster you can add money to your pile, the faster you will reach your goals. The money that you save each month is determined by the following formula:
Income (Paychecks, etc) - Expenses (Rent, Car, Food, etc) = Money You Can Invest
Pretty simple. To be successful all you need to do is to make sure that your income exceeds your expenses so there's a surplus every month to invest. There's two ways to do that: decrease expenses or increase income. Taking a quick look at your current financial health will tell you which one to focus on. Do you have credit card debt? Are you not investing because you're afraid you will (or you already have) run out of money? If the answer to either of those questions is yes, you should probably focus on expenses, build a more detailed budget and get your spending organized. We're not going to be covering that in this two-part post, but stay tuned for future posts. Alternatively, maybe you already saving some money each month (hopefully invested in a low-cost index fund in a retirement account), but you feel like you should be doing more to reach your financial goals faster. In that case, this post is for you. Read on to discover why you should maximize your financial potential by focusing on income, not expenses.
Focus On Expenses
If you focus on decreasing expenses, there's a limit to what you can save. If you go too far down that path you'll end up living in a shack eating ramen noodles and beans. You can get so focused on saving for tomorrow that you can't enjoy today without feeling guilty. It's an easy trap to fall into. And you can't get back the missed opportunities: brunch with friends or a vacation with family. Even little things like buying nicer clothes for yourself or paying for a quality haircut so you feel good about how you look.
That's how I started out, trying to eliminate almost all spending. It took me a long time to learn to enjoy things, and I regret that. I don't regret that I started saving and investing early, but I shouldn't have been so fixated on cost for every decision that I made early on. Don't make the same mistake I did. It's a really limiting way to live. For me it had roots in a scarcity and fear mindset, being afraid of losing what I had and falling back into poverty. As a defence mechanism I became so focused on not spending money that I ended up forcing myself to basically live in poverty: exactly what I was afraid of in the first place. I guess in a twisted way it makes sense, you can't lose what you never let yourself have. But there's a better way to live: working towards abundance.
Focus On Income
Just to be clear, you shouldn't make it your life's goal to chase money for its own sake. That would be pretty shallow and unrewarding. Instead, you should pursue maximizing your personal potential by growing your confidence, your skills, your economic output, and your overall contribution to society. As a reward, you should expect an increase in your income.
A quick note, there's nothing wrong with making a modest living: just enough to provide the essentials. For example, people in the non-profit space may work super hard, challenge themselves, be the best they can be, and not see much of a financial reward. If they're good at what they do, they'll see rewards elsewhere. But there is something wrong with stagnating: deciding not to challenge yourself because you're comfortable, opting to stay where you are because you're scared of change. You owe it to yourself to see how far you can go, and you owe it to society.
So focus on income; focus on growth. Get promoted, learn a new skill, jump to a new company and get promoted again. In human history, there has never been a society with more opportunities to advance and learn and thrive than the one we're living in right now in the United States.
Self-Control Salem vs. Bold Brooklyn
We've laid out two high-level approaches: focus on expenses or focus on income. I've made my case that focusing on income is the better option to grow as a person. But how do the strategies stack up economically? As a thought experiment, let's compare two recent college grads with identical career starting points, and see where their decisions take them.
Self-Control Salem is smart, great with details, and doesn't like to take risks. That's why they got a degree in a safe major (computer science) and focused on getting good internships so they could land a good job. Now they're starting their first job making an above average salary for an entry level software engineer: $78,000 after taxes. Salem has a detailed budget and is careful with how they spend; they're able to limit their expenses to $4,500 a month even though they're living in a more expensive area. Salem works hard and gets a 3% raise every year, and always increases spending in proportion with their raise. They invest the rest in a low cost index fund ($2,000 a month to start).
Bold Brooklyn is also smart, but can be a bit impulsive and likes taking risks. They also got a degree in computer science so they could have enough money to pay for their sky-diving hobby and enough work life balance to actually enjoy it. Now they're starting their first job at the same company as Salem making the same salary: $78,000 after taxes. They are not as careful and spend an extra $500 a month on impulse buys, going out with friends, etc. In total they spend $5,000 each month. Brooklyn also works hard and gets a 3% raise every year. But, Brooklyn also likes to make bold moves. After two years on the job, Brooklyn is ready for something new and spends some time applying for jobs. After a year, Brooklyn finally gets an offer they're excited about and makes the switch, getting a 20% raise (which is actually on the low side for tech). They do this two more times (switch jobs every three years) before settling into a position that's too comfortable to leave. Brooklyn also increases their spending proportionally each time they get a raise, and invests the rest in a low cost index fund: $1,500 a month to start or $500 less than Salem.
After their working careers at age 65, who "won": Self-Control Salem or Bold Brooklyn? Trick question, the answer is both. But who accumulated more savings, and who enjoyed more spending? Because Salem was able to control their spending and invest consistently they now have a net worth of $9,553,350. Way to go Salem!
Brooklyn wasn't as careful. Remember they spent a full $500 extra every month starting out, and their spending increased from there. Were the three job hops enough to save them from poverty? At age 65, after 44 years of spending more than Salem, Brooklyn's net worth is $10,301,792. Wow. But here's the really interesting part, from age 21 to age 65, Brooklyn spent (or in other words enjoyed) $3,548,770 more than Salem. If you're interested in the details, here's the full spreadsheet.
Be More Brooklyn
Doesn't that sound more fun? Challenge yourself to find new opportunities, make more money in the process, and spend guilt free without worrying about where every dollar is going. "Okay", you might be thinking, "It's easy to say just make more money, but how do we actually do that?". I'm glad you asked. Join us for part two where we'll go through some concrete ways you can boost your career trajectory.