When looking for ways to get ahead, reducing expenses is often the quickest, easiest, and most effective way of making large strides.
Quick because it is easy to make immediate reductions. A few phone calls to different service providers, cancelling some automatic payments, or spending less on food. All can be done very quickly.
Easy because it is easier for most people to cut expenses than increase income.
Most effective because it is most bang for your buck. This last reason is what we will be expanding on a bit today.
Why is cutting expenses so effective?
Let’s say you earn $70,000 a year and spend $50,000 a year. If you get a pay rise of $3,000, then your pay increases to $73,000. But you don’t get to keep all of that increase. After income tax and ACC levies, you only get to keep $1,968 of that extra $3000.
What if instead of increasing income by $3,000, you decrease expenses by $3,000? You are $3,000 better off. Over $1,000 better off than if you increased your income by the same amount.
By cutting your expenses by $3,000 you are giving yourself the equivalent of a $4,500 pay rise.
Your expenses are now $47,000. Not only have you given yourself a $4,500 pay rise, you have decreased the amount you need to retire. Using the 4% rule as a guide, a decrease in annual expenses of $3,000 means you will need to save $75,000 less for your retirement.
This is no chump change and is what I mean when referring to a double pay rise. More money in the hand each year AND less needed to retire.
Final thoughts
There will always be debates over whether it is best to try and spend less or earn more as the most effective way to get ahead. I say do both.
Cut expenses as much as you can so that there is no waste, but you are not miserable.
Earn as much as you can without selling your soul and all your time.
You may tilt more towards one direction depending on your own personal circumstances, but it doesn’t have to be one or the other. For most people though, cutting expenses is the easiest and quickest first option. As we have shown, it also has the most initial impact on a per dollar basis.
Of course, there is a floor to how much you can decrease your expenses. We all have fixed costs and expenses that make our lives what they are, and we aren’t willing to go below that level. Once we reach that level it becomes hard to make further improvements. That is where help comes from increasing income. There is no ceiling there. The sky is the limit.
Just be aware that all the income in the world means nothing if you can’t keep your expenses in check. It may surprise you that someone earning $500,000 a year saving $10,000 a year is worse off than someone earning $50,000 a year saving $10,000 a year.
The $500K earner has expenses of $450K per year and will take 98 years to retire! The $50K earner has expenses of $40K per year and can retire in 40 years.
Income matters little if you can’t take care of expenses. Remember, the higher your savings rate, the faster you will reach financial independence.
The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here