When Brian started working with a promising young actor, he was very hopeful. Brian, an advisor friend of mine, learned from this actor (who shall remain unnamed) that he had just signed his first major contract on a TV show, meaning more than $1 million a year. The two of them put together a plan to take advantage of this sweet new deal and got to work. And the money started rolling in.
Then the money started rolling out. The huge mortgage payment for the huge house he bought was a huge percentage of his pay. It took a lot of new furniture to fill a big house. And that was just the start. “This was an unusual month,” he would say. The little cash saved up would disappear if he found an irresistible toy like a motorcycle (worth more than most people make in year).
Brian pleaded that delaying gratification for even a couple years could mean he’d never again have to take an acting job he didn’t like. But this fell on deaf ears. As a responsible advisor, Brian eventually dropped the actor as a client, saying there was no point in them working together.
Brian’s experience demonstrates a foundational truth to financial success: Wealth only comes by living within your means.
It’s easy to falsely equate wealth with a high income, but that simply isn’t true. That’s only one side of the wealth equation. The full equation looks like this:
It doesn’t matter if you have a $25,000/year salary or a $250,000/year salary, you will not stay afloat if you’re spending 110%. And whether you believe it or not, the hardest part of the equation is figuring out how to control expenses. Master that and you will build wealth, period.
Not a low income issue
When I look at every couple sitting across from me that has “made it” financially, they have this one thing in common. True, some of them have had crazy incomes or big inheritances. But I know lots of people with high incomes or inheritances who’ve blown it all. And I’ve worked with many clients who were average earners that became above average savers. In the words of Dave Ramsey, they lived like no one else, so they were later able to live like no one else.
The income side is not the differentiating factor. Those that are truly successful in building wealth have figured out the secret of controlling their expenses.
The scalability of lifestyle
Credit card debt is a sure sign that someone is not living within their means. And many affluent Americans suffer severely from large amounts of crippling debt.
People tend to think they will start building wealth once their income gets to the next level. The problem is that your lifestyle expectations also go up. Why do you think over 70% of lottery winners go bankrupt just a few years after winning? They obviously don’t have income issues. They have expense issues.
What do you do if you want to change your spending habits? Here are some principles that form the foundation:
1. Track all expenses: Budgeting is primarily about awareness & prioritization. So get a handle on everything you’re doing by connecting your accounts to a tool like www.mint.com or www.mvelopes.com to see where everything is going.
2. Build an emergency buffer: Unexpected expenses are one of the biggest reasons people get thrown off their game. Plan ahead for surprises by keeping at least $1,000 in a separated savings account. Eventually build this up to 6 months of living expenses.
3. Don’t borrow: Do whatever you can to avoid having balances on credit cards or taking out loans. Debt is one of the most obvious signals that someone is not living within their means. If you’re having trouble making ends meet, the three questions to ask are 1) how can I make more money, 2) how can I spend less, and 3) is there anything I can sell?
4. Live off one spouse’s income: Dual income earners can accelerate wealth by choosing to live off one income, while saving or investing the other. This may mean hard choices in the short-term, but it can be one of the fastest ways to start growing wealth.
5. Think differently: Don’t be afraid to shun “keeping up with the Joneses.” Avoid the trap of thinking too much about what others are doing and do what fits within your own finances. (Hint: many of them aren’t living within their means.)
6. Stay motivated: Desires will always outpace resources. So success will require prioritizing big payoffs down the road over immediate opportunities. Keep your big goals in front of you enough so you know not just what you’re saying “no” to, you also have a specific “yes” you’re choosing instead.
If you want to build wealth, you can certainly start by growing your income. But don’t forget that “money in” is only half the equation. You will never truly build wealth until you also solve the “money out” puzzle.