“Work a lot, spend a little, save the difference, invest it wisely, leave it alone. It’s not that hard. We just make it harder than it needs to be. Paying too much attention to the details of markets is a chief culprit.”
— Morgan Housel in Motley Fool
It is amazing that most people just do not seem to accumulate enough wealth despite making a comfortable living. Many live from paycheck to paycheck, even with steadily rising incomes. Borrowers often fall behind on their mortgage payments. Credit card and consumer debt is growing at an alarming pace. Employees in the prime of their lives are not setting aside anything significant for retirement. As a result, many baby boomers cannot stop working at the usual retirement age because they are not ready to fund the rest of their lives.
Every Dollar You Make Equals LESS than a Dollar for You to Spend
Are you sometimes disappointed at not realizing your dreams of building wealth or becoming financially secure? The overwhelming odds are that at the root of your feeling of financial insufficiency is how you tend to spend.
A common folly is to assume that every dollar you make equates to a dollar you can spend. In reality, you need to make much more than a dollar to spend each dollar. Apply the following some simple arithmetic to calculate the true purchasing power of your income.
- Suppose that you are employed in the United States and you are in the 28% tax bracket. If you pay 6.2% in Social Security deductions, 1.45% in Medicare deductions, and your state income tax rate is 4%, then your total deductions are 39.65% of your income. On every $1 you earn, you pay $0.3965 in deductions. Therefore, for every $1 you make, your purchasing power is just $0.6035. In other words, you have to earn $1.65 (1.65 = 1/0.6035) to spend every $1. For instance, you would have to earn $3,811 to buy a 47″ flat screen TV that costs $2,300.
- When you invest your money, you do not pay Social Security or Medicare deductions on dividends and capital gains. If the tax rate on long-term gains and dividends is 15% and your state income tax rate is 4%, you will retain $0.81 of every $1 you make in long-term gains and dividends. Even then, you have to earn $1.23 in dividends and capital gains to spend $1.
Harness Your Purchasing Power
“Anything you do to make yourself more valuable will pay off in real purchasing power.”
There are only two ways to get rich: make more money and spend less. The first method is relatively difficult: it is never easy to get a significant raise or a better job at a better place, win the lottery, take a second job, sustain a secondary source of income, or consistently make sizeable gains in the capital markets. It is easier to build some discipline in your spending habits.
- Track all your expenses for a month. At the end of the month, analyze your cash flow. Scrutinize your expenses in terms of ‘wants’ and ‘needs.’ Happiness comes from matching your wants to your needs. Consider ideas for cutting costs and their consequences. Examine your discretionary spending. Scale down or dispose of unnecessary services or subscriptions, irrelevant utilities and features. Consider reprioritizing your expenditures with a medium- and long-term perspective.
- Examine your spending instincts. Be mindful of the perils of consumerism and materialism. Do not let your rising income fuel increased spending. Simplify your life.
- A one-time windfall, bonus, or tax refund is no excuse for indulgent spending. Be selective in your purchases without abandoning your plans for paying off debt, saving money or funding your retirement account.
- Seek to be disciplined and prudent, not necessarily thrifty or frugal. Cultivate an appropriate financial discipline without hurting the quality of your life. Reward and treat yourself for your achievements. Invest in anything that makes you feel good, happy, or helps you realize your goals.