The Foundation of Personal Finance: The Power of Spending Less Than You Earn

At the core of personal finance lies the principle of spending less than you earn. This principle forms the foundation for personal finance and long-term wealth building. Here’s why it’s important:

1. Financial stability: When you consistently spend less than you earn, you create a surplus or positive cash flow. This surplus can be used to build an emergency fund, pay off debts, and save for future goals. Having a financial cushion provides stability and protects you from unexpected expenses or financial setbacks.
2. Debt management: If you spend more than you earn, you may rely on credit cards or loans to cover the shortfall. This can lead to accumulating debt and paying high interest over time. By spending less than you earn, you have extra funds to allocate towards paying off debts faster, reducing interest payments, and ultimately becoming debt-free.
3. Saving and investing: Spending less than you earn allows you to allocate a portion of your income towards saving and investing. Saving money helps you build an emergency fund for unexpected expenses and provides a safety net. Investing your savings allows your money to grow over time through compound interest, potentially helping you achieve long-term financial goals such as buying a house, funding education, or retiring comfortably.
4. Financial freedom: Have you ever felt like you are a slave to the system? I know I have, I have to trade my time for money to live. Financial freedom is the state of having the resources and flexibility to make choices, pursue opportunities, and live a fulfilling life without being constrained by financial limitations or obligations. By consistently spending less than you earn, you gain control over your finances. You will be on your way to being able to be financial free and do what you chose to do.

Here are some ways to start ensuring you spend less than you earn:

1. Track your income and expenses: Keep a record of your income and monitor your spending habits. This helps you understand where your money is going and identify areas where you can cut back. You have to know what you have coming in to understand how much you can afford to let go out.
2. Create a budget: Establish a budget that outlines your income, fixed expenses (e.g., rent, utilities), variable expenses (e.g., groceries, entertainment), debt payments, and savings goals. Stick to this budget to ensure you’re spending less than you earn. In this post we talk more in depth about budgeting.
3. Prioritize needs over wants: This is important! We live in a consumeristic society where we feel like we need to keep up with the Joneses. We should distinguish between essential expenses (needs) and discretionary spending (wants). Prioritize your needs and allocate funds for wants after ensuring your necessities are covered.
4. Reduce unnecessary expenses: Identify areas where you can trim your spending. This might involve cutting back on eating out, entertainment expenses, or finding ways to save on utilities or subscriptions. Sometimes it will feel like a sacrifice now, but your future self will greatly appreciate it when you are truly free!
5. Increase your income: Explore opportunities to boost your income through career advancement, additional work, freelancing, or starting a side business. Increasing your income can create a larger gap between your earnings and expenses.

Remember, spending less than you earn is a fundamental principle that lays the groundwork for sound personal finance. It requires discipline, conscious decision-making, and ongoing evaluation of your financial habits. By adopting this principle, you can work towards financial stability, reduce debt, save for the future, and ultimately achieve your financial goals.

Let’s consider three people who each make $5,000/month. Each live different life styles and spend their income differently. John uses all his income and doesn’t save any money! Sara and Darrel are a bit more frugal, Sara spends 80% of her income while Darrel spends 60% of his income as shown in the graph below.

Lets calculate what could happen if these individuals invest their extra money over 25 years.

• John: Saving $0/month
  • Total savings over 25 years: $0
  • With no savings, John does not accumulate any investment funds or returns.
• Sara: Saving $1,000/month
  • Total savings over 25 years: $300,000 ($1,000/month * 12 months/year * 25 years)
  • Assuming a conservative 6% rate of return, the investment would grow to approximately $824,186.75.
• Darrel: Saving $2,000/month
  • Total savings over 25 years: $600,000 ($2,000/month * 12 months/year * 25 years)
  • Again assuming a 6% rate of return, the investment would grow to approximately $1,648,373.49.

These calculations are based on the assumption of a consistent monthly saving amount and a 6% rate of return, which is a simplified projection and doesn’t account for fluctuations in the market or other factors. The actual returns could vary to be better or worse, but 6% is typically considered conservative for market returns.

It is amazing to see the difference savings amount has on the total savings and potential returns over a 25-year period. This is due to the phenomenon of compounding interest which Albert Einstein said “is the most powerful force in the universe” This goes to show us that every extra dollar we can save can have a significant impact in the future. Take away from this post = Spending less than you earn is the key to financial freedom and building wealth over time.

Are there any other financial principles you’d like me to cover, let me know in the comments section.