Should You Focus on Reducing Your Expenses or Increasing Your Income?
In order to save and invest for the purpose of increasing your net worth and building a secure financial future, you must spend less than you earn, and the bigger this gap is, the more that can be saved and invested. For a while now, there have been two somewhat competing 'camps' with regard to whether the optimal means of increasing this gap is by reducing expenses or by increasing income. In this post, I explore these courses of action and how an understanding of both can be helpful to the Christian steward.
Perhaps there is no better posterchild for the 'reducing expenses' camp than 'The Latte Factor', a book by David Bach and John David Mann. In this book, the authors illustrated a simple truth: making seemingly small reductions to one's spending and investing the savings can make a tremendous difference in one's finances. The book's title came from an example where one of the author's illustrated that a woman who spent $5 for a daily latte could have a sizable sum in 30-40 years by foregoing this expense and investing the funds. Many have criticized some of the calculations in the book, but the basic, metaphorical idea that reducing expenses can make a difference in one's finances over the long-term is mathematically sound. For instance, eliminating $5 of daily spending (i.e., $150 a month) and saving that amount at a 5% real (i.e., above inflation) rate of return for 30 years results in nearly $120,000; that might not sound like a huge sum, but considering that this was approximately the median net worth of Americans in 2020, it's a great step in the right direction.
On the other side of this debate are those who advocate that you should instead focus on increasing your income. They cite that there is no upper limit to your income. Also, they refer often to the strong link between one's income and net worth. For instance, in 2019, the net worth of American families with an income of $40,000 to $59,900 was $92,900. By comparison, those whose income was $60,000 to $79,900 had a net worth of $199,100, and those whose income was $80,000 to $89,900 had a net worth of $382,300.
It's rather obvious that both of these means of increasing one's net worth can work. But they both have drawbacks. Reducing one's expenses can only go so far. For instance, it's difficult, to say the very least, for most families with $40,000 of income to save 50% of that income. It might be very trying for such a family to save even 10% of their income. And no one should think that simply avoiding a daily stop at Starbucks or cancelling their Netflix subscription is going to enable them to build a financially viable future, for instance. (Dramatically downsizing an oversized house might be enough to do it though.)
While increasing one's income can certainly be highly beneficial to one's finances, it takes time, effort, and, usually, money to do so (e.g., starting a business, getting a college degree). Many families simply don't have the means to substantially increase their income, and most people's lifetime earnings are largely determined by the career choices they make in their 20s. And since the natural human tendency is to spend what we earn, earning a higher income does not necessarily mean that we will save any of the increased proceeds. There have been countless stories of lottery winners and professional athletes going broke.
In reality, we shouldn't put too much attention on either reducing our expenses or increasing our income. Many folks really do have an 'income problem' and need to find a way to significantly improve their earnings. And there really is no substitute for some level of frugality, that is, taking care with how we spend our money; no matter how high our income can be, we can spend it all and have little to show for it.
These aren't new ideas. Benjamin Franklin, in his book titled 'The Way to Wealth', written in 1758, cited both industry and frugality as being instrumental to building one's finances. We often have to be reminded of old truths.
And while accumulating enough assets to reasonably provide for your family's future needs is an admirable undertaking, we should always be careful not to crave becoming 'rich', one of the oldest bait-and-switch tactics known to humanity.
"But those who want to get rich fall into temptation and a snare and many foolish and harmful desires which plunge men into ruin and destruction. For the love of money is a root of all sorts of evil, and some by longing for it have wandered away from the faith and pierced themselves with many griefs."
1 Tim. 6:9-10