Spend or Save? The Importance of Living Below Your Means

Spend or Save? The Importance of Living Below Your Means

One question I often get is why do I worry so much about living below my means. The answer is simple:

Because most probably I’ll be alive in 10 years.

That’s it.

Oh, you need further explanation? Okay, let’s get to it.

The case

Let’s set the stage.

We will analyze two people, Mr. Spend and Mr. Save.

They’re quite similar in many ways, apart from the slight difference that’s apparent by their names. For example, they both:

• Save money
• Have stable jobs
• Have same income
• Live in the same area
• Invest in the same market
• Have the same starting position
• Are performing the same in their careers

The only thing where they diverge is their spending habits.

Before explaining their spending habits in more detail, these are the conditions:

• Inflation is 2% per year on average
• Their salaries will increase by 5% each year on average
• They both start their careers earning $30k net per year
• Their stock portfolio returns 7% per year on average, inflation adjusted
• They are able to save 10% of their salaries at the beginning of their careers

The difference

Mr. Spend spends 90% of his salary each month and puts the other 10% in the stock market.

Due to lifestyle inflation he will increase his spending to match his salary, thus spending 90% of his paycheck regardless of how much he earns.

Some may debate that he enjoys life more, but we’re discussing numbers here, not philosophy or lifestyle.

Mr. Save also spends 90% of his salary, but only in the first year. That was the maximum amount he could save on that income level.

With no lifestyle inflation, he keeps his expenses at this level going forward, regardless of salary increases.

That’s it.

So, in summary, the only difference is how we calculate their expenses:

• Mr. Spend’s expenses start at $27k and are always a proportion of salary, calculated as [current salary * 0.9]
• Mr. Save’s expenses start at $27k and are adjusted for inflation each year, calculated as [previous year’s expenses * 1.02] 

Results

I’m assuming that there is no question regarding the winner of the “who saved more money” contest. That was an assumption, not an observable.

However, what I want to portray is how big of a difference this can make over the years, especially when the effects of compounding start kicking in.

Let’s observe when certain events happen for the two gentlemen during a 30 year period.

Reaching $100k

Important milestone in every man’s life.

Both Mr. Spend and Mr. Save saved continuously and invested in a disciplined manner, so they both hit this target.

However:

• Mr. Spend’s net-worth crossed the $100k mark after 15 years of service
• Mr. Save’s net-worth crossed the $100k mark after 10 years of service

Breakpoints

At the beginning of the 6th year, Mr. Spend only saves half of what Mr. Save is able to save.

During the 10th year, Mr. Save’s portfolio is double the size of Mr. Spend’s portfolio.

• Mr. Spend’s yearly savings during year 6 are 3,828$, and portfolio value after a decade is 50,738$
• Mr. Save’s yearly savings during year 6 are 8,478$, and portfolio value after a decade is 103,380$

Half way results

Although certain trends are obvious from the 5th year onward (as shown in the breakpoints above), let’s see where they stand half way through our analysis. Right at the point where the snowball effect will start doing miracles.

They both earn 59,397$ per year. However:

• Mr. Spend’s annual expenses are 53,458$, annual savings are 5,939$, and portfolio value is 102,015$
• Mr. Save’s annual expenses are 35,625$, annual savings are 23,772$, and portfolio value is 257,046$

Saving $10k per year

Nice round magic numbers.

• Mr. Spend was able to save more than $10k per year after 26 years of service
• Mr. Save on the other hand, achieved this milestone during the 8th year

Becoming a millionaire

Now we’re talking big numbers. Although both their salaries are pretty average, let’s see how frugality and remaining consistent with an investment strategy can increase one’s net-worth:

• Mr. Save surpassed the $1m mark after 25 years
• Mr. Spend surpassed the $1m mark never

Ability to retire

Have you heard about the 4% rule? It’s the point in time when a person’s yearly expenses can be covered by a 4% annual withdrawal from his portfolio.

Historically, this is an amount that shows a high degree of success regarding funding one’s lifestyle for the next 30 years. Of course, it’s not a guarantee, but certainly a benchmark.

• Mr. Save can retire (early) after 26 years of service (with portfolio value of $1.14m)
• Mr. Spend can retire whenever the government decides

30y results

And here we go! After 30 years of hustle, salary increases, and compounding. Let’s observe the final results:

• Mr. Save spends 47,947$ per year with a portfolio of 1,802,986$
• Mr. Spend spends 111,135$ per year with a portfolio of only 493,546$

Commentary

We observed that Mr. Save’s portfolio value is 365% more than Mr. Spend’s portfolio.

Although significant, we can agree that it may not be worth it, if the price is 30 years of squeezing his wallet and never tasting the fruits of his labor.

However, I must add that this example was only for illustration purposes and is extremely conservative.

Maybe I’m not the best example, but just to put into perspective: I was able to save way more than $10k per year way earlier than the examples from this post and passed the $100k mark in the first few years of work experience, while investing way more aggressively. In contrast, they both achieved these milestones after more than a decade.

The salary increases assumed for the example are also too conservative and more characteristic of someone late in their career. During the early years, salary bumps of 10, 20, and even 30% are not uncommon. My significant increases were >500%, but leveraging geo-arbitrage, around 35% while changing jobs, and around 10% per promotion (which happen more often during the first decade).

Lastly, although he’s saving less than Mr. Save, note that Mr. Spend is not doing a bad job! Saving 10% consistently is an amazing feat that not many people achieve.

A real case of consumerism will be associated with debt, negative net-worth, and working a lifetime for governments and banks, potentially never being worth even 0$. But we observed two intelligent investors – both living below their means, started early, and utilizing an investment strategy to build long-term wealth.

Mr. Save just gives extra effort… And most probably pursues FIRE.

After retirement

Building a long-term portfolio doesn’t only yield convenience, piece of mind, and financial freedom during the working years.

It also continues after a person retires.

Before retirement, living below one’s means allows a person to build more wealth, accumulate it faster, and boost the benefits of compounding.

After retirement, smaller withdrawals from one’s portfolio makes it last longer, potentially remove the risk of depletion, and allow a person to leave generational wealth behind.

And these are only the monetary benefits. Not to mention that consumerism, wasteful behavior, need to impress other people, and comparing our daily life to our colleagues’ and neighbors’ highlight reels is, for lack of better term, insane.

Focus on sustainable growth.

The point of making money is to save it. Not to spend it.

And for those that need help with starting to invest, Become an Investor can be a great resource – probably the only one you’ll need.

Results breakdown

If you’re interested to see how each of their portfolios performed over time, here’s a breakdown of the numbers:

Mr. Spend – 5% annual raise, 10% savings rate, 2% inflation, 7% portfolio performance

Mr. Spend
Year	Income	Expenses	Savings	Portfolio
1	30000.0	27000.0	3000.0	3000.0
2	31500.0	28350.0	3150.0	6360.0
3	33075.0	29767.5	3307.5	10112.7
4	34728.8	31255.9	3472.9	14293.5
5	36465.2	32818.7	3646.5	18940.5
6	38288.4	34459.6	3828.8	24095.2
7	40202.9	36182.6	4020.3	29802.2
8	42213.0	37991.7	4221.3	36109.6
9	44323.7	39891.3	4432.4	43069.6
10	46539.8	41885.9	4654.0	50738.5
11	48866.8	43980.2	4886.7	59176.9
12	51310.2	46179.2	5131.0	68450.3
13	53875.7	48488.1	5387.6	78629.4
14	56569.5	50912.5	5656.9	89790.4
15	59397.9	53458.2	5939.8	102015.5
16	62367.8	56131.1	6236.8	115393.4
17	65486.2	58937.6	6548.6	130019.5
18	68760.5	61884.5	6876.1	145997.0
19	72198.6	64978.7	7219.9	163436.6
20	75808.5	68227.7	7580.9	182458.0
21	79598.9	71639.0	7959.9	203190.0
22	83578.9	75221.0	8357.9	225771.2
23	87757.8	78982.0	8775.8	250350.9
24	92145.7	82931.1	9214.6	277090.1
25	96753.0	87077.7	9675.3	306161.7
26	101590.6	91431.6	10159.1	337752.0
27	106670.2	96003.2	10667.0	372061.7
28	112003.7	100803.3	11200.4	409306.4
29	117603.9	105843.5	11760.4	449718.2
30	123484.1	111135.7	12348.4	493546.9

Mr. Save – 5% annual raise, constant inflation adjusted annual expense, 2% inflation, 7% portfolio performance

Mr. Save
Year	Income	Expenses	Savings	Portfolio
1	30000.0	27000.0	3000.0	3000.0
2	31500.0	27540.0	3960.0	7170.0
3	33075.0	28090.8	4984.2	12656.1
4	34728.8	28652.6	6076.1	19618.2
5	36465.2	29225.7	7239.5	28231.0
6	38288.4	29810.2	8478.3	38685.4
7	40202.9	30406.4	9796.5	51189.8
8	42213.0	31014.5	11198.5	65971.6
9	44323.7	31634.8	12688.9	83278.5
10	46539.8	32267.5	14272.3	103380.3
11	48866.8	32912.8	15954.0	126571.0
12	51310.2	33571.1	17739.1	153170.0
13	53875.7	34242.5	19633.2	183525.1
14	56569.5	34927.4	21642.1	218013.9
15	59397.9	35625.9	23772.0	257046.9
16	62367.8	36338.4	26029.4	301069.6
17	65486.2	37065.2	28421.0	350565.5
18	68760.5	37806.5	30954.0	406059.1
19	72198.6	38562.6	33635.9	468119.2
20	75808.5	39333.9	36474.6	537362.1
21	79598.9	40120.6	39478.4	614455.8
22	83578.9	40923.0	42655.9	700123.6
23	87757.8	41741.5	46016.4	795148.6
24	92145.7	42576.3	49569.4	900378.5
25	96753.0	43427.8	53325.2	1016730.2
26	101590.6	44296.4	57294.3	1145195.6
27	106670.2	45182.3	61487.9	1286847.1
28	112003.7	46085.9	65917.8	1442844.2
29	117603.9	47007.7	70596.2	1614439.5
30	123484.1	47947.8	75536.3	1802986.5