Spend less, invest the surplus.
The math is simple
Most of us trade our time, which is a valuable and limited resource, in exchange for money that we then use to purchase goods and services. Many of these goods and services diminish in monetary value at a more rapid pace than the value of the money we exchanged.
It’s important to note that for many of us to spend less money than we earn sacrifice is required. We will be required to define our wants, and contrast these wants with what we define as needs. It can be tricky, because wants often masquerade as needs, ever heard someone say “I need my morning coffee.” I’ve written a short article on the subject of Want vs. Need, if you’re interested. Comfortability with what belongs in each category will vary depending on the individual. However, we’re working with a finite resource here (time) and it’s important to understand and acknowledge what we’re sacrificing on both sides. Acknowledge the want, acknowledge the sacrifice, and compare against the sacrifice of time.
It’s important to acknowledge the less money we spend the more money we have available to invest.
We should invest the surplus.
We trade time for money. For many of us, the amount of money we have will always correlate to the time we have to trade for it. Basic math can illustrate why this, by itself, is a losing proposition. Investing provides one of the few opportunities to decouple our time from our income. Imagine getting paid while you sleep. It’s an intriguing concept. It’s called passive income, and it may often be taxed at a lower tax rate than the income we work our butts off for. Additionally, due to an amazing formula called compound interest, the money you invest can increase greatly in value over long time horizons.
As I continue to learn, I’m noticing a couple of common recommendations before we can even begin to think about investing in any income surplus.
- The first is to use any surplus to pay down debt. The reason for this is that no investment return I have found will return anywhere near what credit cards and other creditors are getting in exchange for loaning us money. I’ve seen most rates anywhere between 13% and 22% for credit cards. This is insane. Get rid of this debt first.
- The second is to save an emergency fund. After you’ve paid off high-interest debt, an emergency fund provides a bit of a buffer in the case of unforeseen expenses, or a temporary loss of income. This is one of the few cases where a savings account makes sense (interest rates on savings accounts are so terrible that money in a savings account will lose value to inflation, the rising cost of our wants and needs, year after year).
After these two recommendations are satisfied, we can look at investing our surplus income.
Agree? Disagree? Have something to add? I’d love to hear your thoughts.
Disclaimer: The above is an opinion intended for information purposes only. Seek a licensed professional for financial advice.
