There’s a lot of ongoing discussions/arguments and rules of thumb in personal finance across a wide variety of finance subjects like investing, saving, and taxes as far as what’s best. And I probably go against the grain in regards to a lot of them.
For instance, I invest solely in a taxable account, with no tax-advantaged retirement accounts to speak of. I have almost all of my worldly wealth invested in stocks, choosing to avoid fixed income. And I don’t compare my portfolio’s performance to the S&P 500 index.
And where has this divergence gotten me?
I’d say to a pretty good spot. I’ve built my Freedom Fund into a $170,000 powerhouse chock-full of equity in fantastic businesses that’s spitting out more than $5,500 in annual dividend income. And these numbers put me more or less on pace for my goal to become financially independent by 40 years old, so I’m happy.
Well, I’m here to possibly diverge once again.
There are basically two camps of people when it comes to living below your means and formulating a plan to save a large amount of your income: There are those that think you’re better off trying to earn more, and those that insist you’ll be better off if you save more.
I honestly don’t think it’s necessary to choose one or the other, as they’re not mutually exclusive. And I think most people on both sides of the line would generally agree with that. If you can simultaneously earn more and save more then that’s the absolute best way to go.
However, if you have to choose between one or the other for any particular reason I would always recommend to save more rather than try to earn more. And I’ll tell you why.
The Math Favors Saving
If you’re looking to maximize your savings rate, the math favors saving more over earning more. Simple as that.
And why wouldn’t you want to save more? I determined early on that I’d need to save at least half of my net income for 12 years straight in order to start from nothing at 28 years old and become financially independent at 40 years old. Mr. Money Mustache came to the conclusion that saving 50% of your net income would put you on pace for financial independence in 17 years, assuming 5% after-inflation returns and withdrawing 4% of your portfolio in (early) retirement. So we’re more or less on the same page in regards to how important saving is and the general timeline for someone to become financially independent.
I view saving at least half of your net income as mandatory if you’re looking to become financially independent at a young age.
But how does the math favor saving?
Let’s take a look!
Let’s say you net $40,000 per year. That’s a pretty strong income, and puts you in the top 1% of the world. So before you decide you need to make more money, keep that in perspective. And let’s say you currently spend $30,000 per year, which means you save $10,000/year – a 25% savings rate. But you’re hardcore! You want to double that and get to a 50% savings rate. You can do this either by saving more, earning more, or a combination of the two. But which of the two choices, if you only had one, is more effective?
Earn $10,000 More Or Save $10,000 More?
So we’ll compare two scenarios using the same amount of money both for income and savings.
- You nail a healthy raise at work, and your boss decides to reward you for your loyal servitude…ahem, work…and gives you a net $10,000/year raise.
Bam! You’ve now achieved a 50% saving rate, right? You just added $10,000 to the pile and since you were $10,000 short before you surely got to where you want to be.
Assuming expenses do not rise at all with the raise, you’re now netting $50,000 per year and saving $20,000 of it. That’s a savings rate of just 40% now. So you were on pace (using MMM’s numbers) for financial independence in ~32 years with your 25% savings rate before. You’re now on pace for financial bliss in just ~22 years now. That’s an improvement of 10 years. Not bad!
But how does that compare with saving more? Let’s check the second scenario.
- You decide to cut out a lot of fat that exists in your monthly budget and you’re able to save $10,000/year as a result. Expense categories in the Big Three like housing, transportation, and food are the first to get cut. These changes yield massive results.
Assuming income doesn’t change, you’re still netting $40,000/year in income but you’re now saving $20,000 of it after the changes. That’s now a 50% savings rate, which is exactly where you wanted to be. Congrats. You are now on pace for FI in just 17 years (again, using MMM’s numbers). That’s an improvement of 15 years!
Do you see how that worked?
Saving Is More Effective
Earning more is wonderful. But if you can’t also save more you’re not actually improving your results as much as if you’re able to save that same amount of money. And that’s because saving more is just more effective than earning more.
And the math works out in favor of the saver because less expenditures means you need less passive income to cover your bills. It should go without saying that the person with $20,000 in annual expenses needs much less investment income to cover their lifestyle than a person spending $30,000 per year.
Earning more may seem like the sexy way to go. And I’m not saying you shouldn’t look to maximize your income at every opportunity. In fact, much of my journey thus far involved not only working 50 hours per week at a car dealership, but also working for 20 hours or more per week here on the blog, eventually turning it into my primary source of income. However, while saving isn’t sexy it will definitely put you in a much better position to retire early and pursue your passions.
The Power Of Frugality
And not only does the math work out for the saver, but the skills learned in pursuit of frugality will serve one well if income is cut or eliminated. There’s no guarantee that your job will be around tomorrow or that the income you’re used to making will be around in the event of an economic downturn.
During the Great Recession, 6.8 million jobs were lost between 2008 and 2009. Relying on a high income to boost your savings rate can have an especially adverse effect on your ability to become financially independent if that income isn’t as secure as you might think it is. And as evidenced by the last decade or so, jobs aren’t all that secure at all. And that’s one big reason why I’m moving from the worker class to the investor class.
But living frugally and the skills gained can’t be taken away from you. They become a permanent part of you. I learned how to live without a car in a city without major public transportation infrastructure. I ate ramen noodles for lunch for a year straight. I rode a 49cc scooter through heavy Florida thunderstorms. I learned what’s possible. I know for sure I can live on less. I not only gained the skills and experience necessary to do so, but the confidence that I know no matter what I can get by. I can adapt. I can change. I can do what’s necessary.
Saving more is just plain more effective than making more. I’m not saying you should turn down more money, but I think due to the effectiveness of saving more and the power of frugality one’s efforts should naturally be more focused on saving.
Saving more creates control. You won’t rely on an employer’s good will or import numbers from China. You’ll instead be relying on your simple ability to live simply.
Not only will you actually decrease your timeline to financial independence much faster by saving more rather than earning more, but you’ll gain invaluable skills along the way that make you flexible and adept. And if you’re able to focus more on the saving side of the budget, any increases in income that come your way become that much more powerful. Cutting the budget down significantly and embracing frugality means additional income can drop right to your bottom line, amplifying your progress and increasing the likelihood of early retirement.
What do you think? Do you focus more on saving or earning?
Thanks for reading.
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