A reader asks:
I’m 38 years old and for most of my adult life I didn’t make much money. I made just enough to survive with nothing left to invest. Everything changed a few years ago. I went from making $35k per year to around $140k in about 4 years. At first I spent everything, but in the last two years I’ve started doing the opposite. I save everything. My monthly expenses including my mortgage are less than $1,000. My after-tax saving rate is somewhere in the neighborhood of 80-90%. In the last two years I’ve saved about $150k not including maxing my 401k and Roth. My job isn’t going anywhere but I have a constant fear that something is going to happen and everything will be ripped away. Key thing is I have no real skills but happened to hit the lottery at a company that has rewarded me for a decade of hard work. My question is: most financial experts would probably say I’m saving too much but I’m wondering if my situation justifies the high savings rate?
I love this question because it shows how money is more about your mind than math.
A lot of the questions I receive can be similar from a financial perspective but we all have our own forms of money trauma depending on our circumstances.
First off, while I like it when people remain humble but don’t sell yourself short. Hard work is a skillset and if your company has given you a 4x raise in four years you’re obviously doing something right.
I understand the trepidation to spend money in a situation like this.
The lottery mindset can cause some conflicting money emotions.
Most people spend their entire careers methodically increasing the amount they make over time and slowly building wealth through regular savings.
One of the reasons so many actual lottery winners end up broke is because it’s not normal to experience such an abrupt increase in your wealth.
I wrote about this in Don’t Fall For It:
According to the Certified Financial Planner Board of Standards, almost one-third of lottery winners declare bankruptcy. These winners ended up in a worse place than they were in before winning gobs of money. Lottery winners have also been shown to be more susceptible to drug and alcohol abuse, depression, divorce, suicide, or estrangement from their family.
Even the neighbors of lottery winners are more likely to go bankrupt than the average household. Researchers at the Federal Reserve discovered close neighbors of lottery winners in Canada were more likely to increase their spending, take on more debt, put more money into speculative investments, and eventually file for bankruptcy. And the larger the winnings, the more likely it was others in that neighborhood would go bankrupt.
Wealth is simply the difference between what you make and what you spend, so the secret sauce to building wealth over time is avoiding lifestyle creep as your income rises. This is one of the reasons so many lottery winners go broke. Their lifestyle grows exponentially larger than their pile of money.
Your first reaction to spend everything from your newfound higher income level makes sense. It’s the lottery mentality.
It’s also understandable why you’ve now gone to the opposite extreme from spending everything to saving everything. You know what it’s like to live on a much lower income because it’s so fresh in your memory.
The good news is you already have the ability to cut back and live an extremely frugal lifestyle. An after-tax savings rate of 80-90% is good enough to make even the most ardent FIRE supporters blush but I’m even more impressed you’re able to live on less than $12,000 a year in expenses.
Even if your biggest fears are realized and your new six-figure income gets ripped away, you’ve given yourself the biggest margin of safety in all of finance — a high savings rate combined with a low burn rate.
Most people can barely handle one, let alone both of these.
If you’ve got $150k sitting in taxable accounts that’s roughly 13 years of your current lifestyle expenses in savings.
If we include your max contributions to a 401k and Roth IRA over the past two years we’re looking at more like 17-18 years of living expenses.
You are in fantastic shape financially. You know how to cut back, you know how to save, you have a high income and you’re not even 40 years old.
If you decided to give yourself a raise by spending double or even triple what you do now you would still be well on your way to financial freedom.
The problem here is not one that can be solved through numbers or spreadsheets. You already get all that.
The only way you’ll ever feel comfortable spending more is by tapping into your feelings and emotions about money.
Every financial and investment decision comes down to trade-offs and regret. The biggest regret you’re concerned about right now is what happens if your new higher income somehow goes away.
But you also have to think about the regret you may feel someday if extreme frugality makes you miss out on life.
Ramit shared a comment from Reddit this week about someone who took the FIRE movement too far:
Some people have an unhealthy fixation with money when it comes to over-spending.
This person has an unhealthy fixation with money when it comes to over-saving.
We all have our own issues when it comes to money. No one is perfect and basically everyone worries about something when it comes to their finances.
Instead of going cold turkey and immediately dropping from an after-tax savings rate of 80-90% down to 30-40% (or whatever a reasonable number is) I would consider increasing your spending in a stair-step fashion.
Decrease your savings rate, and thus increase your spending rate, a little bit each month.
Try something like decreasing the amount you save by 5% or so per month and slowly but surely give yourself a raise until you get to a more steady state.
But you also have to figure out what makes you happy by prioritizing your spending in areas of life that matter to you.
Pick one or two things — it can be anything really — going out to eat, clothes, shoes, concerts, a nicer car, whatever brings you joy — and spend on those things without worry.
Studies show that things like experiences or building relationships give you the biggest bang for your buck but I’m fine with spending on material goods if that’s what makes you happy. Or pay up for time (laundry, lawn care, etc.) or convenience.
Feel free to continue cutting back on the other stuff that doesn’t matter all that much but be sure to pull some money levers that will make an impact.
If spending on yourself doesn’t bring fulfillment, buy a round of drinks for your friends. Take your family out to dinner and pick up the tab once a month.
You can even budget a set amount every month to spend worry-free if that makes you feel better.
But don’t live your life in a constant state of the financial fetal position.
At a certain point you have to actually enjoy the money you’re working for.
A good financial life is all about striking a balance between saving for the future with enjoying the moment.
We discussed this question on this week’s Ask the Compound:
Michael Batnick, Bill Sweet and Bill Artzerounian joined me on the show this week to go over questions about content creation, investing money for your fantasy football league, Roth vs. traditional 401ks, financial planning with a pension and how to plan for early retirement.
