In the pursuit of financial independence it may be reasonable to work hard and make as much money as you can, however as I'll make a case for in this post, that's not the best course of action.
With a frugal mentality, you'll retire earlier. Earlier even, than someone with a harder work ethic; this is because of the two-fold effect of reducing expenses (which make it more important than increasing income).
- If you spend less, you can invest more.
More money opens doors to more options for investing, so not only can you invest more considerable capital but these alternative options may have better returns (think real estate), potentially making the race to financial independence a sprint instead of a marathon (but don't get burnt out!).
- If you spend less, you need to save less in total.
If your goal is to live under 4% of your net worth then, by living frugally you minimise that 4% which means the 100% is also small!
So to summarise:
your goal number is smaller and you get there faster!
Whereas, when your strategy is to increase your income, of course, you may get there faster, but your goal doesn't get any closer (it may even get further away (more on that later)).
"Always pay yourself 10%, right?"
The percentage savings rate is a great metric to know as you can use it to compare yourself to others easily. However, as an individual, it is essential to understand the false confidence it can give you. Sure if your family and another are at a 40% savings rate, technically you're 'even' (and will get to retirement at the same time), but if your household income is double theirs than from another perspective to be 'even' would be to have a 70% savings rate! Here's what I mean: If House A's income was $50,000 and House B's income $25,000 and they both have a savings rate of 40%, then A and B's total expenses come to $30,000 and $15,000 respectively. If House A were to focus on expenses as effectively as House B, House A would be able to save $35,000 which is a 70% savings rate! So, although both households are heading to retirement at the same speed, the lower income household can do so on a much tighter budget. They are representing a significant opportunity for the higher income household to improve, where, if they were only comparing savings rate, they otherwise might not have.
Of course, it's not all or nothing. Everyone has there 'right spot' between saving and spending. Perhaps in the above example, House A know that they are spending more than they need, but they find it's a middle ground that keeps them happy.
The biggest challenge of early retirement and financial freedom is, by far, living below your means (though dedicated FIREers would call it merely living within your budget).
Lifestyle inflation is a strange phenomenon in which, with an increasing income, people also feel the need to have a growing spending rate. Just knowing about it will help you identify it in your life and, hopefully, nip it in the bud before you become accustomed to the higher standard of living. For example, as university students enter employment, many may be lucky enough to get a doubling of their income. However, a few other things change as well; ramen and peanut butter become lunches with coworkers, and the fixie bike once used to get around campus becomes a car for commuting.
In other words, expenses can creep up on you. So before you know it, you're worse off (savings rate wise) than when you started.
By focusing on expenses, you can avoid this problem. You can learn ways to stay frugal, track your finances and so on (or carry the pain of knowing how much faster you could be reaching your goal).
On the pursuit of financial freedom, you may find yourself in command of a large sum of liquid cash. Frustratingly, however, sometimes freedom is self-control. Ask yourself: What has changed at the moment you read that bank statement? Nothing. Your needs, hopes, and goals are still the same.
Having money is not an excuse to spend money.
FOMO: Fear of Missing Out
Should you spend, or 'live life', while you're young and join your friends and colleagues in costly pastimes? These are difficult financial lines to walk, and as time goes on, with lifestyle inflation as the norm, the social pressure to spend can be overwhelming. How can you keep up? I say don't. Make relationships with people who understand your goals or find a middle ground (suggest dinner parties instead of restaurants).
As one gets older, we collect an extensive list of responsibilities. However, when it comes to focusing on expenses, it is important to distinguish 'life' versus 'lifestyle'. Many responsibilities are choices, and it's up to you to decide if they are worth the extra years of work; financial decisions add up, like mortgages and student loans, costs deferred to our parents become our own, and we become carers for our parents or children. Many increases to your expenses are a simple part of life, like healthcare, but when they become part of a certain standard of living that doesn't make you any happier perhaps it's time to reconsider.
As you earn more, there is a tendency to 'treat' yourself with a holiday, a new phone, and so on. After all, you have been working hard. This decision to reward oneself just boils down to the ability to defer gratification; keep that ultimate reward in mind. Can you imagine? Work becoming optional!
Have you fallen into these common pitfalls? Would you add any more to the list? Share in comments!