I was reading through some personal-finance forums the other day when I came across a post that read something like this:
I have a $20,000 student loan, one car loan for $11,000, another car loan for $15,000, $150/month cable bill, $40/month gym membership, and tithe $600/month. I have an extra $200 bucks that I can put towards debt every month. Where should I put it? I have one two-year old and another on the way. I really want to be prepared when my second kid comes.
So let me get this straight. You are literally drowning in debt and you’re trying to figure out which debt to pay down with a measly $200/month? Response after response was advising this guy to cut out the cable bill, sell one of his expensive cars and buy a cheap one, or reduce how much he gives. Something. Anything. And the result? Excuse after excuse.
My wife really loves the new SUV so we can’t get rid of it.
We talked to our pastor and decided it would be best to keep up our $600/month tithing
What are you, high?!
This person shouldn’t have been asking which debt to put the extra $200/month towards. He should have been asking about good ways to increase cash flow because his was absolutely pitiful!
There are two ways to improve cash flow:
- Increase money coming in.
- Decrease money going out.
Out of the two options above, decreasing money going out is so much easier than increasing money coming in. Increasing money coming in usually means working a side hustle, asking the boss for a raise, or searching for a higher paying job. All of these are doable but tend to be a royal pain in the buns.
Decreasing the money going out, on the other hand, is a piece of cake.
Let’s take a look at a practical example of what making some sacrifices can do for your financial future. Person A has the following expenses:
- Mortgage: $1,200/month
- Student Loan: $180/month
- Car Loan: $413/month – 2015 Honda Accord currently with 17k miles.
- Original loan amount: $23k
- Original term: 60 months
- Remaining term: 45 months
- Rate: 3%
- Remaining balance: $17,568.89
- KBB Value of Car: $23,000
- Cable & Internet: $120/month
- Groceries: $700/month
- Restaurants: $200/month
- Other (insurance, utilities, etc.): $450/month
Total cash going out the door: $3,263/month. There are some pretty gaping holes in this person’s cash flow picture. There is plenty of low-hanging fruit here: the grocery bill, restaurant bill, cable/internet bill, and car loan.
After reading this blog and smacking themselves in the face for being such a dummy-head, Person A becomes awesome and does the following:
- Sell their Honda Accord and have $5,432 to buy a new car with cash (KBB Value of $23,000 – Loan Balance of $17,568 = $5,432). They go out and buy a 2009 Honda Civic for $5,400. Since they still have $32 left after switching cars, they buy some sweet fuzzy dice to hang from the mirror as a celebration of their awesomeness. No more $413/month car loan.
- Cancel cable TV in favor of Netflix. This cuts their cable/internet bill to $65/month and saves $55/month.
- Eat out only once per month and save $150/month.
- Realize that it’s totally doable to feed one person for $4/meal and drop their monthly grocery bill to $450/month, saving $250/month.
Total cash flow improvement: $868/month
That is a ton of dough. In fact, $868/month is equivalent to over a $10k/year raise! If this person now invests that $868/month in a low-cost index fund earning an annualized 6% interest, in 7-1/2 years they’ll end up with…drumroll… $100,000. This kind of makes you question, “did I really sacrifice anything?” You ended up with a ton of money. Your “sacrifice” turned into a great opportunity to build wealth. In fact, if you’re not sacrificing short term luxuries, then you’re really sacrificing long-term riches.
That $100k you just earned by making a short-term sacrifice is no measly sum. If anything, I hoped this exercise showed that in order to become wealthy, you must improve cash flow and then do something productive with the extra cash.
But I work hard for my money and deserve to enjoy some luxuries
I’m not disputing this one bit, but I think most American’s idea of what level of luxury they need is a little out of touch with reality. Let’s look at house size, for example. In 1970, the average size of a new, single-family home was 1,500 square-feet. In 2004, that number grew to 2,349 square-feet. House size increased 156% over a time period that the number of births per woman decreased from 2.48 to 2.05 and the number of single-person households increased from approximately 17% to 27%. In other words, we’re “needing” more space for fewer people*. We’re buying into this idea at the expense of working away our entire lives. Do we really need this extra space which is mostly used to just store more stuff? Do we really need to go into debt to buy a more expensive car when you could pay cash for one that does the same thing?
Let’s take the previous example we walked through. Take away the preconceived notions you have about new cars versus old cars and examine what the difference between these two cars is:
They’re both cars with four doors. Hondas, in fact. Black in color, with a little touch of chrome. The Accord looks a little bigger, but what reason do you have for not being able to use a Civic? I might give you “car seats”, but if that’s the case then you’re in luck: Honda made Accords in 2009 too!
The Oracle of Omaha himself, Warren Buffett, said “Your standard of living is not equal to your cost of living.” I couldn’t have said it any better. If Warren Buffett was able to drive his ’06 Cadillac for almost 7 years before getting a new ride, then what’s your excuse? Sure, it’s a Cadillac which is a nice car, but others with a similar net worth are driving Bentleys. Mr. B. is a prime example of how to live below your means.
If you want to be wealthy, you’ve got to make some sacrifices. Sacrifice the size of your McMansion for a house that meets your needs without exceeding them. Sacrifice your premium car for a regular, ol’ car. Sacrifice the $70/month you pay for cable TV–it is 20% commercials anyways!
A sacrifice isn’t really a sacrifice for that long. After a few weeks it just becomes… normal. I remember going from my parents house to a college dorm room. My god. It was so tiny. And I had to share it with a hobbit-looking fellow that would wear my clothes and let his friends sleep in my bed. The next year some friends and I got an apartment. My own room?! What a luxury! Who cares if I had to share a small apartment with three other dudes–I had my own room. My point is this: you’ll adjust. You won’t shrivel up and die.
The bottom line
It is impossible to become wealthy without making sacrifices. Whether it’s in the form of delayed income like nearly all doctors go through or putting off a nicer house so that you can still save for retirement. There must be sacrifices and you’re the only person that can decide to make them. I’ll end with a fitting little joke that I read in the same forum as the example mentioned at the beginning of this post:
Q: How many psychiatrists does it take to change a light bulb?
A: One. But the light bulb has to want to change.
You’re the light bulb!
- List out your expenses. All of them.
- A free tool like Personal Capital can help you with this big time.
- Pick some to eliminate. Completely. Car payments should be the first to die.
- Keep a record of the expenses you cut and immediately shift those funds elsewhere.
- If you’re trying to figure out where to put them, revisit What Should I Do With My Money
*A family member commented that maybe that the amount of square-footage each person needs is correlated to Americans’ waist-size. In other words, we need the extra space so we can find a place to park our larger hindquarters. It would be interesting to see a graph that showed sq-ft of housing per pound of person as a function of time.