Income – Spending = Savings and Investment
Rather than getting bogged down in the details of life’s wealth building tactics, methods, strategies, or mindsets, let’s keep things extremely simple for now. As simple as it may seem, the above equation truly sums up the key to building steady, long-term wealth over time.
Spend less than you earn, and save and/or invest the difference.
Unfortunately for many, this seemingly trite bit of advice is easier said than done. As typical American consumers, we can’t seem to save. Instead we look forward to taking that “hard earned” paycheck and plowing it right back into those goods and services we think make us happy. All this “stuff” we accumulate, financed fully by our paychecks and compounded by our credit cards, brings us a fleeting, drug-like high, tricking us into feeling happy…temporarily. As we all know, we’re never forever satisfied by buying stuff. We always need something more.
Our favorite excuse: “I’d save more if I earned more money!”
For most Americans, however, more money earned simply means more money spent. We live in a constant reality where Income – Spending is negative and we must go into debt just to fund our day to day purchases. Thus, Income – Spending = Credit Card Debt!
Instead of focusing on our level of income, we should be laser focused on our level of spending. For most salaried individuals, income earned is stable, with pay raises occurring (at best) once a year. So for simplicity sake, let’s assume that income is fixed. Now, in order to bring our Income – Spending equation into positive territory, we must focus on the variable side, or spending, as this is the area on which we have direct control.
So how can we best control our spending? Well, you’re probably thinking that the logical course of action would be to create a budget: list and itemize all expenditures (rent/housing, car payment, insurance, bills, food, entertainment, etc.). Compare and track this aggregated list against your income on a monthly basis, and adjust your discretionary expenses accordingly to bring our equation into the positive or black range.
I don’t like this strategy as the primary driver of expense control.
1.) Budgets are simply guidelines, and guidelines can be easily broken or ignored. We think to ourselves, “my budget for entertainment this month is $30, but I’m going to take this chick out for dinner and a movie anyway. I’ll make it up next month.” Meanwhile, we’ve just blown $60 on dinner and a movie for two.
2.) Budgets are a hassle. Personally, I don’t want to spend my free time recording by hand in excel, or browsing my transaction history online through my bank account. As a side point here, there are a number of excellent budget tools out there through www.mint.com, www.quicken.com, www.kiplinger.com if you’re truly itching to maintain a detailed budget, but these simply reduce the hassle, not eliminate it.
The easiest and most surefire way to limit your expenses and guaranty that you are constantly building a surplus of wealth is to
automatically pay yourself first.
Paying yourself first means that after your paycheck enters your bank account, money is automatically transferred to the savings or investment account of your choosing. In this fashion, you are forcing yourself to spend less than your income because the difference is automatically saved. As the month rolls on, you will have less money available in your immediate access spending account (typically your checking account), and those previously “fun” and frivolous purchases will be incrementally less plausible. The level of automatic saving will depend on your ability, and can be modified up or down depending on your absolute dedication to save.
I typically like to run my account pretty lean. In other words, I have boosted my automatic transfer amount to a level that brings my overall checking account balance near zero by the end of the month. I am saving as much as possible without tapping into my necessities (food, mortgage, bills, etc.). Start with a comfortable amount, such as 10% of your gross monthly income. If this is easily doable, slowly increase that percentage as you modify spending habits over time. This should be an ever evolving process until you find that saving “sweet spot” where you can buy what you need, and save the rest. All the while, you are watching your bank account grow.
This automatic savings method has allowed me to see steady progress toward my wealth generation goals, and can be easily modified or augmented should my financial situation improve (I get a raise, bonus) or worsen (e.g. a big one-time expenditure, loss of employment, spouse leaves workforce, etc.).
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