One of the age old arguments in personal finance is the relative priority of earn more or save less. Since there are only two ways to increase your savings – earning more money or spending less of what you have – you do, unfortunately have to prioritize.
Let’s pick up the gauntlet: should you focus on spending less or earning more?
Spend Less or Earn More: The Order of Operations
Plenty of writers have weighed in on this question. Unfortunately, few have answered with the proper nuance. When trying to increase your net worth, you need to tackle both sides of the equation.
Of course, when you try to do multiple things simultaneously you optimize for neither. You do need to prioritize both; our advice avoids dividing your attention by adding a third variable to the equation: time.
Should you first spend less or try to earn more?
Our advice boils down to a single phrase:
First, spend less. Second, earn more.
Admittedly, there’s a ton encapsulated in there. We’ll expound on the most important points, but to preview our argument:
- Any time you spend less, there is an immediate return.
- Money saved today is worth more than money saved from future income.
- You save to invest, not for a rainy day.
- When cutting spending, you learn what you truly value.
- There is a limit to how far you can cut spending, but not on earning more.
- When you have a feel for expenses you’re better prepared to scale income.
Ready to see where we’re going with this?
Let’s address why we give the advice in this order.
Spend Less Before You Concentrate on Earning More
If you read other opinions on this topic, you’ll find people coming down strong on either side.
Income purists argue to accumulate a fortune you need to earn more. Frugality enthusiasts counter with examples of people living on absurdly low amounts annually.
They’re both missing the big picture.
Even with a top one percent income it’s entirely possible – simple, even – to outspend your cash flow. And the most frugal person still needs resources coming in to increase savings; there’s no way to cut spending into the negatives.
So: walk before you can run. You need to get a handle on your spending first.
Money You Don’t Spend Benefits You Immediately
A huge benefit of reduced spending is how quickly it helps you. If you make the conscious decision to not spend a dollar today, that’s a dollar in your pocket immediately.
Sometimes those immediate savings also translate to ongoing cash flow improvements. Cutting recurring bills (like overpriced services) saves you both in the current month and over time. Fixing habits (such as crutch meals) can do the same – if you can break them.
Tax Drag – A Penny Saved is Worth More than a Penny Earned
As we’ve pointed out, a penny saved isn’t a penny earned. Because of taxes, a penny saved is worth much more than a penny earned.
Add it up – depending on your income, a dollar saved might be worth earning $1.50, $2.00 or more. That’s because that extra dollar in income is taxed at your marginal rate – you’d have to earn more than a dollar to match what you save by cutting.
Save to Invest: Time in the Market is Most Important
If you’re working through the spend less vs. earn more debate right now, this is literally the youngest you’ll ever be while thinking through this. While you’re today-years-old, you’re in a better position than you’ll ever be to think through investing your new savings.
And you should be thinking about investing. The majority of money you save in this process needs to be earmarked for investing. Not future spending.
One secret of the stock market and other investments is they tend* to go up over time. So, by spending less today and investing the difference, that money is worth even more (on average) than investing future money.
* This isn’t always true, even for diversified investments. See our Nikkei Return Calculator. You’ll still be better off with investment declines than having nothing, though.
Cutting Spending Teaches You What You Value
We’re not sympathetic to full frugality here on DQYDJ. When you later switch focus to earning more, we expect you to spend more on some categories than you will when focusing on spending.
That’s not the point, though. In the beginning of your journey, you should cut spending as much as you can. Only until you go without – temporarily – will you realize what you truly value.
Maybe you’re like me and you really like your rib-eyes. Maybe you’ve got a coffee habit you truly enjoy. Perhaps you get better work outs in at the more expensive gym.
Whatever you value is personal – I couldn’t tell you. You’re not going to live 100% frugally forever (and if you do try, this isn’t the site for you). Concentrating on saving more first will help you know yourself and your family’s priorities.
Save More Before You Try to Earn More
Temporarily, your focus needs to be on saving more money.
Cut out spending wherever you can, and find how close to the edge you can take it. See how high you can raise your savings rate – we suggest a minimum savings rate of 20%, although an eventual target of 50% or more is ideal.
Over a lifetime, earning more dominates. Only by concentrating on spending now, at the beginning of your journey, will you have the experience you need while you accumulate a significant amount.
When you cut spending:
- Any expenses you cut are useful immediately without waiting.
- Saved money is worth more since you’ve already paid tax on it.
- It’s usually worth more to invest money today versus in the future.
- You learn what you truly value.
Use a service such as Personal Capital (our review here) or Mint.com to track your spending across all your accounts. Use what you learn in the next few months to figure out what you care about and start your investment pipeline.
You can spend money on some things you’re foregoing once you shift to income – what you can’t do is spend money on everything.
Work to Earn More Once You Understand Your Expenses
Hopefully that last section convinced you to concentrate on your spending first. The immediate rewards from spending cuts, the after-tax nature of savings, the time value of money, and the experience you’ll build are worth it.
But – let’s be frank – the income side houses the majority of potential gains. And if you’re still in your 20s or 30s, odds are your highest earning years are in your future.
Writers who tell you that cutting expenses to the bone is the optimal path to build wealth long-term are either lying or misinformed. Saving more of what you have is the prerequisite – the harsh medicine – you need before turning your eyes to focus on income. You want that system in place so you don’t need to watch as closely while you scale.
Once you’ve cut most of the excess from your expenses, you need to concentrate on scaling your earnings power.
There is a Limit To How Far You Can Cut Expenses
It’s extremely important you try to cut expenses first. Not to the bone, mind you – but to the point you realize what truly matters to you.
There is a genre of financial blogs which glorify frugality. Frugality for frugality’s sake is overrated. Better is to realize what you’re optimizing for: low impact on the planet, simplicity in life, self-sufficiency. If you like those things, those are noble goals – frugality for frugality’s sake isn’t.
The other issue with expenses is you can’t spend a negative amount. There is a limit to how far you can cut before you can’t go further. People have blazed this path – even at the extremes, growing all your food and making your own consumables costs either money or time!
Income doesn’t have that issue. In theory, there’s no limit (although in practice there are thresholds). Once you’ve cut 80-90% of your extraneous expenses, you’re better off concentrating on the income side of the ledger.
Cutting Expenses Taught You a Spending Model
It’s healthy to think of your cutting expenses phase as creating a spending template. When you go through the exercise for a few months, you get a feel for what your expenses look like in a good month.
At first, this is difficult – you get into the weeds and think through every purchase. However, like with all things you get better with practice.
After some months of spending reduction, you know what a good credit card bill looks like and you can sniff out the exceptions without losing tons of time. You’ve probably got automation in place tracking your spending through Personal Capital or Mint. You don’t need to dive into the details on every purchase anymore – by feel you know when your spending is running too hot or too cold.
Now you have a template. A template means leverage.
As your income increases you don’t need to sink as much time into evaluating your spending. Instead, you can concentrate on the more interesting things: investing more and earning more.
Income Begets Income: Experience Compounds
A helpful way of evaluating income is through the lens of your own time. In this paradigm, income is either passive or active: either it earns without your input, or you need to invest time to make money.
For example, a traditional job is active income. In exchange for a dedicated amount of time and your work product, your employer pays you money.
Contrarily, many investments are passive income. In exchange for a dedicated amount of money – capital at risk – investments (hopefully) pay you back in dividends or capital gains.
Of course, everything exists on a scale: being a landlord for property you own is passive until you get a midnight call to fix a toilet!
Everything you do to earn income compounds. Active income sources build experience, which leads to better jobs, consulting gigs, or business ideas. Passive income sources build cash flow or principal, which can be reinvested or tapped.
The name of the game – again – is leverage. You want to scale your experience, your cash flows, or your capital gains into even more income. Since you have a template in place, expenses mostly take care of themselves – leaving you to concentrate on earning more.
After Expenses, Spend Most of Your Time On Income
Again, knowing your expenses is a necessary step. However, once you’ve pivoted to an income focus you’re going to spend the majority of your time thinking about earning more.
Over a career, once expenses are in place scaling your income dominates in importance. To recap:
- There’s a limit to cut expenses… but not to increase income.
- Cutting expenses gives you a scalable template while you earn more.
- Active and passive income pay off with experience, cash flow, and capital gains.
That initial spending focus is important; it teaches you what you need while you grow. However, it’s fundamentally a scarcity focus. Income is the opposite; it’s an abundance focus.
It’s important to understand both, but after expenses are in place turn most of your attention to generating income. The lessons you learn from your early expense concentration will serve you well when you move to this stage.
Cut Expenses, then Earn More, then Enjoy!
Hopefully we’ve convinced you that you need to tackle this problem in stages.
When you’re first getting your personal finances under control, you need a laser-focus on expenses. See what you can cut, see where there are alternatives, and develop those healthy spending habits.
Once you have a spending template and understand the trade-offs, switch to earning more income. Your earlier experience will help you spot exceptions and outliers, and you’ll be able to scale your spending to newer and higher levels of earnings.
Over the long term, like a career, it’s a better use of your time to earn more. However, that’s not where the journey begins – first, you need to cut expenses.