Don’t Focus on Saving Money

Sep 7, 2015 by

No one ever got rich by saving money. That being said, a number of people have lost their wealth by overspending (see 50 Cent, Mike Tyson, and Mickey Rooney). Bill Gates, Warren Buffet, and Mark Zuckerberg did not build their billions by clipping coupons or contributing more to their 401(k)s. Ultimately, saving is self-limiting.

Imagine you decided to live as a monk but work an average American job. Given that you are provided food, clothing, and shelter by the monastery, you could save your entire income.  As a single person (you are a monk, after all), earning the American median household income, $51,939 in 2013, you actually have more to spend on yourself than a typical household containing multiple people. That being said, it’s only $1,000 per week. Nonetheless, you decide to diligently save all of it. Let’s see what happens.

As a thrifty monk, you pick a portfolio of stocks and bonds that delivers 6% per year. Thanks to the miracles of compounding, you manage to save $1 million shortly after 13 years, and $4.1 million in 30 years. So, being a thrifty monk won’t give the average American household 8-digit wealth. $4.1 million in 30 years only has the purchasing power of $1.7 million today if there is 3% inflation.

While it would be nice to save 100% of income, it simply is not possible. Even a thrifty monk must pay taxes. After paying for health insurance, food, clothing, and shelter, it is very hard to save anywhere near 100% of income. In fact, the average American only saved about 5% in 2015, and people under 45 saved an average of 3.5%. Assuming the average saver earns an average income, 5% savings means just $2,600 per year; $206,000 after 30 years at 6% growth. With effort, the rate might be doubled, or even tripled or quintupled. Nonetheless, it is still isn’t much money. Saving 25% of income would mean saving just $13,000 per year – not enough to max out a 401(k), and a sum that would ultimately lead to $1 million in 30 years – the equivalent of $436,000 today. Given that retirees should only draw 4% of their savings per year, $436,000 today would not be an adequate nest egg, as it would yield just $17,400 per year on which to live.

So, even a household with a typical income ($52,000) and a high savings rate (25%) falls short. The solution is to focus less on the savings lever and more on the income lever. Imagine that the household had been spending 95% of its income, or $49,400 per year. If one person took a part time job paying $26,000 per year (boosting income by 50%), and then managed to save 75% of the additional income, savings would grow to $22,100 per year and the household would avoid skimping. The higher savings rate would yield $1.75 million in 30 years; the equivalent of $741,000 today. This in turn could generate about $30,000 per year in income during retirement.

In summary, a household that sets out to boost its income by an attainable but significant amount may be better off than one that tries to radically reduce its expenditures. As Tom Peters said, you can’t shrink your way to greatness. While controlling spending is a key aspect of building wealth, its upside is limited. The upside on earnings has no limit.

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