Is It Better To Earn More or Spend Less?
When it comes to getting your financial house in order and freeing up money to invest or pursue your goals, you have two choices: reduce expenses or increase income.
Given those two options, you might be inclined more toward reducing your expenses than increasing your income. Most of us are instinctively aware that we sometimes spend money on things we don’t really need or could do without. If you think about your current situation, you can probably come up with a few expenses you could cut back on or eliminate like eating and drinking out or that gym membership you never use.
Then there’s the so-called “Latte Factor” you’ve probably heard about.
The Latte Factor
The Latte Factor is the idea that shelling out $5 a day on something small like a coffee seems insignificant, but if you invested that $5 every day instead, you’d amass a small fortune over time.
After all, if you quit buying your $5 latte every day, in 365 days you’d have $1,825. Every year, you could invest that $1,825 you recovered, earn a modest 5% rate of return, and come out with $244,331 after 40 years:
Screenshot of the AARP retirement planning calculator courtesy of the author.
You won’t get filthy rich or become a millionaire by quitting lattes, but that is a nice chunk of change. So spending less money seems like the obvious choice. But there is that second option to consider.
The Second Option
What if instead of sacrificing coffee and freeing up $1,825 annually, you went out and made an extra $1,825 a year instead?
If you make $60,000 a year and get a 3% raise, you’re pretty much there. Or maybe you make $40,000 a year from your job, don’t get a raise, and use your existing skills to freelance in your off hours, give music lessons for extra money, or start a low cost side hustle like earning money for reading books, which produces an extra $1,825 for the year.
The result is the same whether you scrimp or hustle. You have $1,825 you didn’t have before to invest and turn into $244,331 in 40 years.
Trying to make an extra $1,825 might sound like way more effort compared to just not going to Starbucks or cutting out similar small monthly expenses. So why do it?
Because it’s not just about the coffee or the other little expenses you cut out of your life. It’s about how the extra cash is generated.
Does the extra money come from sacrificing a $5 item you look forward to and thoroughly enjoy every day? Or does the money come through achieving something in your spare time that also has unlimited income potential?
Tracking your expenses, creating a budget, and cutting out an assortment of expenses that don’t help you reach your goals or improve your life are all financially sound decisions. But you’ll eventually arrive at a point where cutting expenses any further leads to a significantly lower quality of life.
The Turning Point
For example, suppose your current income is $50,000 per year. You blow through all of it every year and have zero savings. You decide it’s time to make some changes to your current lifestyle so you can put more money toward building wealth and reaching your financial goals.
You start tracking your expenses to see where all the money goes. You reduce your housing costs, lower your grocery budget, and opt for a more affordable car. You eat out less, choose lower cost entertainment options, stop buying things you don’t need, and find cheaper insurance.
As a result of the decisions you made, you reduce your yearly expenses from $50,000 to $30,000, which is significant. You’re building your emergency savings, you’ve started aggressively saving money, and your quality of life hasn’t declined in any noticeable way. You feel optimistic about achieving financial freedom.
But now, you’re at the point where the only way to lower your living expenses is to start cutting out things that make you happy.
Life Interferes with Your Plans
Suppose life happens. You need a new set of tires, your hot water heater dies, your property tax payment is due, your family gets bigger by one, and your dog needs expensive surgery all within a few months. All of that happened to my wife and I one right after the other not too long ago.
You tap your emergency fund, but you still might need to come up with more cash to avoid taking on any additional debt. Cutting out more spending to pay for it all and reseed your emergency fund means no more Netflix, fun hobbies, fancy coffee drinks, or occasional date nights out. Trimming these expenses frees up cash, but it also eliminates several little things that bring you happiness daily.
If you want to come up with additional money to invest, put toward your credit card debt, or deal with an unexpected bill, your first thought might be to focus on expenses and find new ways to slash those monthly expenses. If you’ve reached the point where cutting expenses any further requires giving up most or all of the little things that bring you joy, it’s time for a shift in mindset. It’s time to think about increasing income.
Cutting out the $5 lattes or other small everyday expenses and investing the money in the stock market could lead to a large sum of money over time. So could increasing your income. An extra $1,825 to put toward retirement or other goals is $1,825, whether it comes from avoiding the coffee shop or upping your income level.
Doesn’t it take more time, effort, and energy to make more money? Earning a raise or finding another source of income like getting a second job, or starting a side hustle while working full time require continued effort for sure. Maybe you make a healthy income now and don’t feel you should have to work more.
But there is no hard limit to how much additional income you can make.
On the other hand, there’s an inherent limit to how much you can lower your monthly expenses. You will always need food, shelter, clothing, health care, and transportation. There will always be bills to pay so you will never be able to lower your cost of living down to zero.
Reducing Expenses vs Increasing Income
Examining your spending habits then cutting expenses that don’t improve your quality of life is a good way to improve your financial situation. There’s no question that you’ll come out ahead by not buying a $5 cup of coffee every day and investing the money instead. That does not mean that buying coffee is a waste of money or a lost opportunity to build wealth, even though some personal finance gurus position it that way to sell more books or sound clever on TV.
Keep in mind that expense reduction isn’t the only way to get out of debt, build your emergency savings, or find additional money to put toward wealth creation. There is another solution. Increasing your income leads to the same result, has unlimited potential, and you don’t necessarily have to give up something that brings you joy every day.
Whether you make fifteen bucks an hour or you’re happy in your career and making a decent income, you can do both. You can come up with some ways to reduce your monthly expenses and brainstorm some new income ideas. Keeping your expenses low is important, but increasing your income could have greater long-term benefits.
Featured Image Credit: Unsplash
Jerry is a personal finance enthusiast, side hustler, and freelance web developer who began his career in financial services. He co-founded KindaFrugal.com, a personal finance and frugal living blog. His insights have appeared on MSN, Newsweek.com, HerCampus.com, Mashed.com, and many others.