The notion of financial success is slippery because it’s subjective. For the sake of discussion, let’s define it as living debt free and having some sort of savings for future goals. The average American reportedly has $9,300 of credit card debt so we’re setting the bar relatively high.
How might one live debt free and accumulate savings?
By living according to a relatively straightforward equation. Consistently earn more than you spend. The hard part for people is doing that three, four weeks a month; ten, eleven, twelve months a year; eight, nine, ten years a decade.
Let’s think about the equation more deeply. Earning is almost always thought of as one’s salary, and of course, that’s an important part of it. However, earning can take other forms such as investing one’s savings wisely which generates investment income. Obviously, the more one saves, the more they generate in investment income. If I have $1,000 saved and earn 5% and you have $1m saved and earn 5%, you earn $49,950 more than me a year. For the vast majority of people, investment income is a small fraction of their annual salary-based earnings.
On the surface, spending is a straightforward concept, but there’s several types including relatively fixed recurring expenses (insurance premiums, mortgage payments, property tax payments), relatively fluctuating recurring expenses (utility bills, groceries/restaurants, clothing), discretionary expenses (entertainment, travel), and unanticipated expenses (root canal, counseling).
This most simple of conceptual frameworks gives rise to two fundamental questions. How does one increase their earnings and how does one reduce their expenses?
But here’s the amazing thing, the personal finance conversation in this country focuses almost exclusively on an altogether different question–what’s the best way to invest?
This exasperating disconnect isn’t unique to the personal finance industry. Education reformers focus on a whole host of things–technological bells and whistles, standards, standardized tests–that have little positive effect on the teacher-student relationship.
So, let’s return to the example of being debt free with $1,000 of savings. Imagine we’ve assembled a focus group of fee-based certified financial planners to advise me. I suspect, even though they’re fee based, at least nine out of ten would spend all of their limited time debating the relative merit of different investment tools including indexed mutual funds, ETFs (exchange traded funds), TIPS (treasury inflation-protected securities), gold, bonds, whatever.
How to invest savings is a legit question, but at best the third most important.
For the life of me, I can’t figure out why even fee-based planners focus almost exclusively on investment strategies when what people really need help with is how to increase earnings and reduce expenses.