To achieve financial independence, everyone needs to boost savings and control spending. Once that’s done, it’s time to maximize earnings. The wider you grow this gap, the wealthier you will become over time.
The only problem when you boost savings so much is that it may begin to burn a hole in your pocket after it exceeds a certain threshold.
When I was a kid, I remember it was always hard to save a $20 bill my grandmother gave me, so I spent it instantly on candy and coin-op video games. Since then, I’ve built up a tolerance against spending any cash under $50,000. I’ve seen too many missed opportunities and financial tragedies to not have a decent financial cushion.
My tolerance against spending is being tested with a 4X accumulation of what I’m used to because I don’t see many good investment opportunities now that the markets are at record highs in 2019. At least cash nowadays is yielding a healthy 2.3% from an online savings account like CIT Bank.
I suspect many of you will be tempted to spend some of your extra money on wasteful things as well. It’s like going all day without eating and then denying yourself a freshly baked apple pie in order to continue starving yourself. Why punish yourself?!
Daydreaming Of How To Spend
I’ve thought of a number of things to do with my excess savings:
1) Pay down $180,000 of mortgage debt. Boring! But the responsible thing to do.
2) Buy a $195,000 Bentley Continental GT. Fun! But completely ludicrous for someone with only $200,000 saved. You’d need more like $2M in liquid cash to buy a $200,000 car.
3) Give $20,000 to my in-laws. Definitely a good thing to do, but I’m being met with resistance as they are too proud to accept financial help. I’ll figure out a way to give them some money through gift cards at places they shop.
4) Pay for a $20,000 – $30,000 around the world cruise for my parents who are happy with an inner cabin room after the pandemic is over. I want them to enjoy a room with a veranda so they can see and smell the ocean breeze. But my parents are also frugal and never seem to want any financial gifts from me. Maybe I should just give my editor dad a raise. Oh wait, that requires paying extra taxes. Forget that.
5) Build a 700 sqft extension to my house for $200,000, even though I’m perfectly happy living in ~1,910 sqft of space. The extension would add at least $400,000 in value, but it would be a stressful year long project. Always focus on expansion over remodeling if you want to create more value to your house.
How About Some Really Fun Things?
6) Buy a more reasonable mid-life crisis 2011 Porsche 911 GTS for ~$65,000. Sounds like a good deal compared to a $195,000 Bentley Continental GT.
7) Continue saving for the winter of 2020/201 when I anticipate the housing market will be the slowest so I can have the option of buying another property. Real estate agents and buyers are currently in denial, saying, “Only the $3M+ housing market is soft, everything else is strong.” Hello. A downturn always starts with the top and works its way down.
8) Invest $200,000 in Betterment, the leading digital wealth advisor for retirement so I don’t have to think about what to do with the money. Automatically paying and investing yourself first is what everybody should do. You can at least get a free portfolio construction tailored to your risk tolerance without having to fund the account.
9) Do a combination of wise and wasteful spending.
It’s actually fun to think about all the things to do with excess cash. But it’s the idea of spending that gets me excited rather than the actual spending. After being frugal for so long, spending money actually kind of hurts. Please tell me some of you feel the same way!
Paying down debt might not be very exciting, but it’s the responsible thing to do. Whenever I buy or invest in anything, I always fear feeling like an idiot because the only way to lose money is by actually deploying it. You may lose to inflation, but that would be different from my recent experience of losing part of my investment because of a 50% decline in Twitter stock.
Controlling The Urge To Splurge
Building wealth is all about exercising good money habits. Discipline is key. For those of you with excess cash or who want to boost savings, here are some easy tips.
1) Calculate how much in gross income is needed to buy.
To buy a $50,000 car takes about $75,000 in gross income at a 30% effective tax rate. At a 25% effective tax rate, it requires $2000 in gross income to purchase the newest $1,500 TV. Take whatever you want to buy and multiply it by 1.5X to see how much it really costs before tax. Suddenly, what you want to buy doesn’t seem as affordable.
2) Calculate how many hours of work it takes for you to buy.
This is where being a freelancer is advantageous because we are generally more cognizant about the relationship between our time and income. To buy a $65,000 second-hand Porsche 911 GTS will take me 2,600 hours driving for Uber at $25/hour after operating expenses.
Let’s say I drive for 40 hours a week, it would take me one year and three months. But wait, I still need to pay taxes on my $25/hour, so it will really take me more like 1.8 years of driving to just purchase the car. Calculating required labor is one of the best ways to restrain spending and boost savings.
3) Automatically pay yourself first.
So long as you are maxing out your 401k and saving a certain percentage of your after tax income before spending a penny, you’ve basically got carte blanche to spend however you like with your remaining money. Automate your way to boost savings.
One goal I had for 13 years was to max out my 401k and then save 100% of every other pay check and 100% of my year end bonus. Since I was paid twice a month, I ensured an easy way to save at least 50% of my after tax income every year. After the first year, living off one paycheck became just a way of life. Given it became easy, I pushed myself to save even more.
4) Compare yourself to different people.
Appreciate what you have and recognize how fortunate you are compared to the billions of people who weren’t born in a developed country. Making more than $35,000 a year puts you in the top 1% of global income earners.
According to the United Nations world food program, some 795 million people in the world do not have enough food to lead a healthy active life. As soon as I moved to a less expensive neighborhood in 2014, I felt much happier because there was less ostentatious wealth.
Alternatively, you can try and really motivate yourself by comparing your career or wealth to other people your age who are doing better and have more. Tell yourself, “Only until I get that promotion or reach a certain amount of net worth will I buy XYZ.” Here’s a good net worth guideline by age to shoot for.
5) Establish a goal that must be achieved before spending a penny.
I’ve always told people who object to my 1/10th rule for car buying, “If you want to buy a $30,000 car, why not just try and make $300,000 first?” Then they get pissed off for some reason. By tethering your desires, you force yourself to achieve certain financial goals before wasting money.
You might just find that after spending all that time earning or pursuing a goal, you’ll lose your desire to splurge! I’ve already created a mid-life crisis investment fund for a fancy car that I doubt I’ll buy. You can create other goals like losing a certain amount of weight or finding a life partner before splurging. Boost savings to meet your urges.
6) Visualize the opportunity cost of your purchase.
If the total return (principal appreciation + dividends) of the S&P 500 averages 7.2% a year for the next 10 years, you will have doubled any money you invest today in the index. Therefore, the $10,000 vacation or $65,000 luxury car you buy today might be worth $20,000 and $130,000, respectively in the future.
Thinking about opportunity cost is the hardest way to prevent spending, because what you give up is so far in the future. Therefore, you should run your finances through a retirement calculator so you can visualize whether you are on track or have a ways to go. You should input different future expense and income variables to see what works.
It’s easier to boost savings when you use a free tool like Personal Capital.
Boost Savings And Invest Wisely
The reason I love simple financial guidelines is because it cuts through all the noise and gives people targets to shoot for. If you can amass a net worth equal to 20X your average gross income, I’m pretty sure you will experience financial freedom and never have to work again.
If you’re finding it hard to resist spending your excess cash, couple your good money decisions with your bad money decisions. Always be mindful of Financial Yin Yang.
In case you’re wondering what I did with my excess cash, I ended up investing $550,000 of it in real estate crowdfunding to take advantage of the lower valuations and higher net rental yields in the heartland of America. Fundrise is the best real estate crowdfunding platform with a variety of highly vetted offerings.
I think there’s going to be a multi-decade demographic trend away from expensive coastal cities due to technology and the rise of remote work. With higher yields and no work involved, I’m a big fan of real estate crowdfunding. Fundrise is free to sign up and explore.
Updated for 2020 and beyond.