A reader asks:
I just read Nick’s latest and I’m feeling a bit ashamed. Nick is awesome and Just Keep Buying is my investment motto. I’m 34, my wife is 28 and, not to brag, we make ~$590k a year with a net worth of ~$1.2 million. We max out our 401ks and take the employer match (~$55k / year) and we also save between $20k-$40k, if not more. Our savings rate in my monthly budget is about 24%. I also own one income producing rental in the Midwest. HOWEVER, we live in Los Angeles and spend….a lot! We take extravagant vacations, I drive a nice car, I like nice clothing, etc. After reading Nick’s piece, it made me feel like I should be saving more, even though I know we save adequately if not more than most. I didn’t feel that great after reading the rich vs. wealthy post….save me Ben!
My colleague Nick Maggiulli wrote a post last week about the difference between being rich and being wealthy.
I think this is the part of Nick’s post that has my reader worried:
Mr. Rich earns an impressive salary and loves to showcase his success with luxury cars, designer clothes, and extravagant vacations. He is the life of the party and appears to have it all. However, his high-income is matched by his high spending habits, leaving him with little savings or investments. Should his income suddenly disappear, Mr. Rich’s financial situation would quickly crumble, revealing the facade of his seemingly successful lifestyle.
Ms. Wealthy, on the other hand, earns a similar income to Mr. Rich but chooses to live a more modest lifestyle. She invests a significant portion of her earnings into a diverse portfolio of income producing assets that creates passive income streams, such as rental properties and dividend stocks. While she may not have the outward appearance of success, Ms. Wealthy enjoys true financial freedom, knowing that her assets and income will continue to support her lifestyle, regardless of whether she works.
Nick is using extreme examples here to make a point. If you live beyond your means, it doesn’t matter how much money you make, you’re not going to be wealthy.
Allow me to offer a third option to the Mr. Rich and Ms. Wealthy categories — Mr. and Mrs. Balance:
Mr. and Mrs. Balance save 20-30% of their income and prioritize all spending after that. They spend guilt-free on the areas of their life that matter the most to them and cut back on everything else. They drive new automobiles but don’t pay up for luxury cars. They enjoy spending money on experiences but don’t need to stay at 5-star resorts when they travel. They live in a nice house but spend less than one-third of their gross pay on housing-related expenses because they didn’t want their mortgage to control their lifestyle.
They utilize debt intelligently where it makes sense (they have a mortgage, a home equity line of credit and maybe a car loan or two) but always pay off their credit cards every month.
They automate their saving and investing every month, max out their retirement accounts and generally leave their portfolios alone.
Mr. and Mrs. Balance don’t feel guilty about spending money on the stuff that matters to them because they know they are saving and investing for the future.
They prefer to be selectively cheap in certain areas as opposed to frugal about everything because they choose to balance enjoyment today with delayed gratification for the future.
The problem with this stuff is there is rarely a happy medium between spending money now and saving for the future.
You can try to quantify it based on retirement calculators or financial planning software but I prefer a more qualitative approach.
The way I look at it is my savings rate should be just high enough that it feels a little painful at times.
Can you imagine the stuff we could buy if we weren’t saving so much money?!
But I should also be spending enough money that it feels a little painful at times.
Can you imagine how much that money would be worth in 20-30 years if we didn’t spend it?!
There are no hard and fast rules for these things but I don’t think you necessarily need to cut back your spending as long as you have a 20-30% savings rate and a net worth that make 90-95% of the population jealous.
This is a first-class problem to have but some people do reach a point where spending money becomes a psychological hurdle. You just need to do a better job of figuring out how to spend guilt-free on the things that make you happy and define those areas where you would be willing to cut back.
Want to go on extravagant vacations? Go for it but maybe that means you have to cut back on going out to eat all of the time.
Want to drive a luxury automobile? Go for it but maybe that means you don’t buy tickets to a bunch of concerts or sporting events.
Want to spend money on nice clothes? Go for it but maybe that means you have to cut back on expensive furniture in your house.
The spending categories themselves don’t matter as much as how you prioritize them.
Your priorities can and will change over time as well.
The stuff I prioritized in my 20s (going out all the time with friends) is not the stuff I prioritize in my 40s (spending time with my family and paying up for experiences) and the stuff I prioritize in my 60s will certainly look different than what I focus on now.
It can also be helpful to introduce trade-offs into the equation if you’re having a hard time striking the right balance between saving and spending.
In his book, Nick writes about his 2x spending rule where anytime he wants to buy something expensive, like a really nice pair of shoes, he has to match the cost by investing the same amount of money.
You want to buy $250 shoes? That’s fine but you’ll need $500 to do it because you’re also going to save and invest $250.
I’ve always been a frugal person but having kids completely changed my mindset when it comes to spending. We only have a certain amount of time with them until they turn into teenagers and never want to hang out with us ever again. So I’m fine pulling forward spending that otherwise could go towards more saving.
I would rather enjoy some of it now than put it off until my 70s.
But to get to that point I first needed to automate all of my savings. I treat savings like a monthly bill. It’s non-negotiable — max out the 401k, max out the IRA, put money into our brokerage accounts, contribute to the kids’ 529 plans, etc.
Once the savings are out of the way it’s much easier to spend whatever is leftover. It’s like paying for a vacation up-front versus putting it all on your credit card.
I understand that many personal finance experts assume frugality is the only way to get ahead. I would rather find some middle ground between saving for tomorrow and enjoying today.
I look at it as being selectively cheap and selectively extravagant.
We discussed this question on the latest edition of Portfolio Rescue:
Kevin Young joined me again this week to talk about questions on valuations, life insurance, saving for college and when to take Social Security.
Now & Then