The Path to Prosperity: Cutting Costs vs. Boosting Income

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 instinctively know 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:

Whether You Increase Income or Reduce Expenses, the Outcome is the Same

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 made an extra $1,825 yearly instead?

You’re pretty much there if you make $60,000 a year and get a 3% raise. 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 additional $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, turning into $244,331 in 40 years.

Trying to make an extra $1,825 might sound like way more effort than 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 with unlimited income potential?

Tracking your expenses, creating a budget, and cutting out various costs 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 further cutting expenses 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 reduced 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 noticeably. 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 water heater dies, your property tax payment is due, your family gets bigger by one, and your dog needs expensive surgery within a few months. That happened to my wife and me, 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 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 over time. So it could increase your income. An extra $1,825 toward retirement or other goals is $1,825, whether from avoiding the coffee shop or upping your income level.

Doesn’t making more money take more time, effort, and energy? Earning a raise or finding another source of income, like getting a second job or starting a side hustle while working full-time, requires continued effort. Maybe you make a healthy income now and don’t feel you should have to work more.

But there is no 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 and then cutting expenses that don’t improve your quality of life is an excellent way to improve your financial situation. There’s no question that you’ll come out ahead by not buying a $5 cup of coffee daily and investing the money instead. That does not mean buying coffee is a waste of money or a lost opportunity to build wealth, even though some personal finance gurus position it to sell more books or sound clever on TV.

Remember that expense reduction isn’t the only way to get out of debt, build your emergency savings, or find additional money for 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 are 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.

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