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A Dollar Saved is More Than a Dollar Earned

Why saving is more powerful than you think…

Photo by NeONBRAND on Unsplash

Here’s everything you need to know about personal finance in less than ten words:

Spend less than you earn and invest the difference

Now, obviously as you begin to apply it, things get more complicated than that, but that’s the main idea.

There’s obviously three separate pieces there:

  1. Spend Less
  2. Earn More
  3. Invest Wisely

Getting better at any one of the three will improve your finances, but sometimes you need to choose which of these levers you are focusing on. The first two work together to get you the money needed for the third. This means that it’s often hard to focus on both at once.

I’ll talk about my ideal strategy at the end, and I’ll make the case for earning more in a future piece. Right now I want to make the case for frugality and talk about how to do it well.

As far as I can tell, there are three main ways that frugality beats income generation:

Frugality is Faster

Getting paid can take a long time.

I’m all for you going out and trying to get a raise if you have a traditional 9–5 job, but it’s very unlikely that it’s going to happen overnight.

I’m all for you starting a side hustle and trying to make money online, but it can take a long time to get paid.

Here’s one example: In February I decided that I was going to publish a book on Amazon Kindle. I got the book out remarkably quickly, publishing it in June.

But obviously June is a long time after February. Plus you have to remember that you don’t get paid when you first start making sales. You have to wait for your royalty check. With Amazon that’s about two months, so I didn’t get paid until the end of August.

And of course, I paid some money along the way to get the book out there, so technically I haven’t even broken even yet nine months later (though hopefully I will soon). You can see this piece for more details:

Income generation can take a long time to get going, but you can start saving money today.

If you normally go out for lunch at a sit down restaurant and pay $10+ and instead scrounge together a brown bag lunch from what’s already in your fridge, that savings helps your bank account immediately.

When you stop and think about it, most people spend money far more often than they make money. For the majority of workers, money is going out every day, but only coming in once every two weeks.

There’s No Tax on Saving

As an American, I pay a lot of taxes. I have a job so I pay income tax, medicare, and social security. I have a house so I pay property taxes (renters pay this too, just indirectly), I live in Florida so I pay a sales tax.

I don’t mind the concept of taxes. It’s part of the social contract. The government protects the people and the citizens provide the government with the resources to do so. I would prefer a federal sales tax to an income tax, but that’s an issue for another day.

The presence of the income tax means that next time you go out and make an extra dollar, you aren’t really making a dollar.

If you make an extra dollar and are in the 20% marginal tax bracket, you really made 80 cents.

So I guess that means that if you want to make $1 you really need to earn $1.20, right?

Wrong.

In the 20% marginal bracket, you would have to pay 24 cents in taxes on $1.20 of income, so you would actually need to earn $1.25 to make $1 after taxes.

At the 20% tax bracket, you need to earn 25% more to make the same amount.

This is no reason to not try to make more money, but it does mean that in this case, a dollar saved is literally worth more to you than a dollar earned.

Saving Counts Twice

Let’s take a step back for a second and ask why we should even bother with this personal finance stuff in the first place.

The best answer I can come up with is because money represents choices and freedom. In our capitalist economy, you need money to get by, and so if you don’t already have enough to live off of, you’re forced to work, potentially in a soul-crushing job.

Money buys lots of things, but the most important thing it buys is freedom.

There’s a rule called the 4% rule (more accurately “the 4% rule of thumb”) that says that when you retire, you can safely withdraw 4% of your portfolio’s initial value each year and have an extremely low chance of running out of money. You can even give yourself a 3% raise each year.

This rule implies that if you can save up 25x your annual spending, you are retired.

This means that every dollar that you saved works to bring your retirement closer in two ways.

First of all each dollar save can be invested and grow over time, bringing you closer to the amount you need.

But also each time you lower your annual spending, you lower the amount that you need to have saved. Since you need to save 25x your annual spending, each time you save $1 off your annual budget it lowers the amount you need to have saved to retire by $25.

Where to Find Savings

When it comes to reducing your spending I recommend looking for BIG wins and EASY wins.

Big wins are anything that have a major impact on your budget. We’re not talking about driving 10 miles out of the way to save a few cents on gas, we’re talking about saving thousands or even tens of thousands of dollars a year.

The best place to find big wins is in the categories where people spend the most money: housing, transportation, and food.

Within each of these categories, there are many ways to save money, but there are a few that are most impactful. Here’s the biggest win you can get from each one:

  • Housing: Living below your means. This means finding a rent payment or a mortgage that is well within the limits of what you can afford. If you buy a house it should be with a 20% down payment. Instead of getting the nicest place you can afford, you should be looking for the cheapest place that meets your basic needs
  • Transportation: The biggest possible win here is finding a way to get by without a car. Since I know most people won’t do that (even I have a car), the big win here is buying a reliable model used car and driving it into the ground.
  • Food: The biggest win here is eating out less. Eating out is orders of magnitude more expensive than cooking for yourself. If you don’t know how to cook, your goal over the next year should be to learn how to make ten dishes out of simple ingredients that are tasty and relatively inexpensive.

The nice thing about these big wins is that two out of the three don’t require any ongoing effort on your part. Once you find an inexpensive housing arrangement, the savings just keep rolling in every month without you needing to do anything.

Cooking does require ongoing effort, but unless you have a personal chef and butler, finding something to eat always requires some degree of effort. Once you get into the habit of eating at home, it really isn’t that much work. You’ll get so good at cooking certain dishes that you’ll be able to do them on autopilot.

When we talk about EASY wins, we’re mostly talking about things that don’t take much effort to set up, but require no ongoing effort to maintain. Here are some examples:

  • Shopping around for cheaper car insurance
  • Switching to a lower cost phone/internet provider
  • Calling your cable/internet provider and asking for a discount
  • Cancelling services that have recurring payments which you rarely use

It’s often helpful to set aside a Saturday to listing all your recurring expenses and taking some time to research your alternatives.

Do you need the service in the first place?

Can you downgrade?

Can you switch providers to save money?

Can you call them and negotiate a better rate?

You might not be able to lower all your monthly expenses, but chances are you will be able to lower some of them.

The Final Verdict:

So there’s the case for frugality. Why a dollar saved is more than a dollar earned.

How convincing was it?

Well, one side always seems right until the other has spoken. My next piece is going to be the other side: the case for making more money.

I’ll give you this spoiler though, I’m not going to declare a final winner in this debate.

In my book Personal Finance That Works for You which I published earlier this year on Amazon Kindle, I made the argument that the strategy that makes sense for the most people is to start with frugality and then switch gears to figuring out how to make more money.

It’s important to go after the big wins and the easy wins, but at some point you’re going to run into diminishing returns and find yourself converting double-ply toilet paper into single-ply by hand. You don’t want to ever find yourself there.

Go after the big wins and the easy wins and stay tuned for next time where we’ll make the case for finding ways to earn more money.

Update: Here is that post: