Most everybody wants to be rich but only so few actually attain that goal. Wealth seems like such an elusive thing for most of us. In reality, we can actually boil it down to three simple ingredients. Revenue, expenses and investments.
The salary, business earnings or professional fees you make constitute your revenue. Those things that you spend on make up your expenses. Expenses consist of either spending for needs like food and shelter or for wants like vacations and movies or a whole cabinet of shoes. When you take what’s left of your revenues after deducting your expenses, you come up with your savings. Placing that amount of savings into anything that creates additional revenues – such as interest, dividends or gains on sale- that’s investment.
Most people work nine to five jobs all their lives but never get to save anything substantial. Without any savings, they also have nothing to invest. Even more staggering, some people would earn huge sums of money, people like professional athletes or stock brokers, but they still get to spend everything they earn or even more and end up bankrupt or in debt. At rare times, however, you run into someone with a simple job, like a janitor or a postman, leaving a huge estate to his children.
From this we can conclude that revenue alone does not determine wealth. Large revenue can still lead to bankruptcy. Small revenue can still lead to wealth. The critical factor that determines the outcome is expense – the amount one spends out of his revenue.
Benjamin Franklin was a famous proponent of frugality and is often quoted as saying “a penny saved is a penny earned.” Actually, if we consider the effect of income tax on revenues, cutting down on a penny of expense is actually a more effective way of increasing savings than earning an extra penny of revenue.
For example, assume that Bob wants to increase his savings by $100 a month. He has the option of (1) taking on a part time job that would pay him the hundred dollars, or (2) reducing his consumption of five-dollar coffee lattes, by 20 cups per month. If Bob took the first option, taking the part time job which paid a hundred dollars, he would still have to pay the government a 25% tax on the income he received. Hence, he would actually just be left with $75 in real savings. If he, however, took the second option, he would be left with a hundred dollars in savings. One hundred dollars net of tax (because the money he didn’t spend isn’t subject to tax).
One area where people tend to spend unnecessarily is with respect to small priced items that they buy daily or periodically, thinking that the small amount is insignificant and will not actually affect their wealth or lack thereof.
For instance, examining your eating habits can reveal areas where costs can be cut and savings generated. One person may find comfort in dropping by a Starbucks before he heads out to work. It’s not really because of the coffee. He has a coffee maker at home and there’s free coffee in the office. But, it’s just a habit that he has formed. He is conditioned to feel better or happier or smarter every time he steps into a Starbucks to buy brewed coffee.
Assuming the coffee costs $3 and he gets stuck with his habit for 20 years, he will have spent a total of $21,888 during the whole time. On the other hand, assuming that he instead saved the coffee money and invested it at an average interest rate of 7%, he would have also earned interest income of $25,620 over those 20 years. He would then have a total of $47,508 (the $21,888 he saved plus the $25,620 interest he earned). Just by breaking that one habit, that person can actually save a small fortune over the next 20 years of his life, saving the money that he was supposed to be buying coffee with every day.
It can be coffee or soda or mints. If a person is really serious about generating additional savings, there are a lot of food items that are not necessary for one’s well-being. Cutting those food items out are likely to even improve health.
In addition to food, one can also look into transportation costs, rental costs or utilities. They initially appear to be necessities and yet savings can still be made in these areas. For example, rental rates and transportation costs to and from work should be added up when deciding where to live. A place might seem to cost more in rent, but the transportation costs saved going to work from there might make up for the higher rent. On the other hand, a place may seem to have low rental rates but the related transportation costs are higher. If money saved on coffee can yield a small fortune, how much more any possible savings that can be made on these periodic, big ticket items.
Considering these things, even a person with just a reasonable income can grow wealthy if he is able to purposely identify unnecessary, seemingly insignificant expenses and eliminate them in order to create savings.