What’s the secret to wealth? It really isn’t much of a secret. You just need to save and invest as much as you can. Your investment will compound and your net worth will grow over the long haul. Last year, our net worth grew nearly $350,000. That’s incredible because we made much less than that from work. That kind of net worth gain is only possible once you have a significant amount of money invested. It wasn’t easy, though. We saved and invested diligently for over 20 years to achieve this result. It takes time to build wealth. In my 20s, most of our net worth growth came from new savings. When you’re young, you have to figure out how to save more. That’s the question today. Should you focus on making more or spending less?
Let’s go over the saving rate quickly first.
Saving Rate = How much you save ÷ How much you make
The saving rate is one of the essential metrics to track if you want to retire early. The higher the saving rate, the less time you need to work. Traditional financial advisors usually tell their clients to save 10-15% of their income. This is fine if you plan to retire in your 60s. However, you need to save much more if you want to retire earlier. I recommend saving at least 20% of your income and aim for 50% if you want to retire in your 30s or 40s.
Increasing your saving rate isn’t easy. If it was, we wouldn’t have this looming retirement saving crisis. The average American saves less than 5% of their income. It’s pretty dismal. There are only 2 ways to increase your saving rate. That’s making more or spending less.
Make More Money
Everybody wants to make more money. Most Americans are focused on this side of the equation. We all think life will be easier if we have a little more income. If I make more money, we could move to a bigger home, buy a nicer car, and save even more. It makes sense, right?
The great thing about focusing on earning more is the unlimited upside. If you work harder and smarter, you can make millions of dollars. Here are a few ways to make more money.
Focus on your career
For most people, the best way to increase their income is to focus on their career. You already know the work and the politics. The next step is to do it better and take on more responsibilities. This is much easier at the beginning of the career. When you’re at the bottom, the only way is up.
That’s what I did at the beginning of my engineering career. I learned on the job and attended classes to expand my knowledge. I worked long hours and took on a lot of additional responsibilities. My employer noticed and gave me raises and promotions which increased my income quickly. Unfortunately, I topped out on the technical side and got stuck. I could have taken some management courses or studied for an MBA. That would have enabled me to move on to the management track. I didn’t want to do that, though. I enjoyed the technical side of engineering and I am horrible at managing people. The lesson is to keep learning and make yourself more valuable to your employer. The more you learn, the more you earn.
What if you’re like me in the latter part of my career? I was stuck and wasn’t going to get a big raise unless I made a drastic change. My advice is to make a lateral move and find a new employer. A new company may energize you and help you break out of your rut. Don’t just stay in the same job because you’ll become disgruntled and your work quality will suffer. Alternatively, you can increase your income by working more on the side.
The easier path is to put in the hours on another job. There are so many side jobs now. Here are just a few that come to mind.
- Drive for Uber
- Seasonal retail work
- Rent out a room on Airbnb
- House and/or pet sitting
- Deliver pizza
Start a business
The more difficult path is to build your own side business. This takes a lot more time and energy, but the payoff can be exponentially higher. I started Retire by 40 when I was working full time and it was really tough. I used to stay up and work on this blog until 1 am almost every night. Life was like this for 2 years before I retired from my engineering career to become a stay-at-home-dad/blogger. Back then, Retire by 40 replaced 25% of my income and helped keep us afloat. Things have improved since 2012, though. Now, blogging generates almost as much income as my old job and I work much less. Today, I make more per hour than when I was an engineer. That’s damn amazing!
*Interested in starting a blog? Check out my tutorial – How to Start a Blog and Why You Should.
Here are some side businesses that worked out well.
- Accidental Fire has a graphic design side hustle.
- Brittany became a professional house and pet sitter.
- Lily made a nice income from her Airbnb rental. She sold it and made even more money from the appreciation.
- Ernie Zelinzki, my hero, makes over $250,000 every year from his books, How to Retire Early, Wild, and Free, The Joy of Not Working, and more. He also gets to travel all over the world and makes great income from public speaking. What a life!
Starting a business takes a lot of time and energy. There is no guarantee that you’ll succeed, but the payoff could be much better than working a side job.
Lastly, I want to give a quick plug to passive income. Investing is another way to make more money. We generate income from our dividend stocks, rental properties, and real estate crowdfunding. Passive income is my favorite way to make more money. If you invest right, your passive income should grow every year without having to work more. That’s the best way to make money. It takes a long time to build passive income, though. You need to keep at it and invest as much as you can.
Now, we’ll take a look at the other side of the equation. Most Americans are obsessed about making more money, but that’s not enough. Making more doesn’t automatically increase your saving rate. When people make more, they tend to spend more too. Unless you have a good handle on your spending, it will be very difficult to increase your saving rate. Here is an example.
John makes $50,000/year. He invests $5,000 in his 401k and spends the rest. His saving rate is 10%.
Saving rate: $5,000 / $50,000 = 10%
Three promotions later, John now makes $100,000 per year. He needs to save $10,000 per year to maintain the 10% saving rate. To increase his saving rate to 20%, he’d need to save $20,000 per year. You see the problem? John needs to save 4 times more to double his saving rate to 20%. Also, saving more is the last priority for most people. They’d rather spend the money on a bigger home, a nicer car, and exotic vacations now that they can afford it. It’s not easy to increase your saving rate even if you make more money.
Saving rate: $20,000 / $100,000 = 20%
Prioritize spending less
This is why I think it’s better to figure out how to live modestly first. Once you have a good handle on the spending side, then it will much easier to save. Spending has a way to getting out of control. If you’re like most Americans, you’ll wonder where all the money went at the end of the month. Many people live paycheck to paycheck. To combat mindless spending, you need to track it.
We track our expenses in detail every month. This helped me figure out what’s important to us and what to cut back on. The gym membership, traveling, and RB40Jr’s activities are important to us so we don’t mind spending money on them. Having a nice car isn’t a priority and we cut back to just one modest vehicle. You need to cut back on things that don’t add happiness to your life.
Which should you focus on?
Should you focus on making more or spending less? This is a trick question. You need to work on making more AND spending less. Everyone should focus on increasing their saving rate instead of picking one side over the other. Working on just one thing isn’t enough. Here is what I recommend.
- Work on spending less first. This is a short term project. You can figure out how to cut spending in just a few months. Track your spending and get rid of unnecessary spending. The hardest part is to sticking to it and keeping lifestyle inflation at bay.
- Work on making more next. Making more money is much more difficult. This is a lifelong project for most of us. It’s easy to say “make more money,” but the execution is very difficult. If it was easy to make more, you’d already have done it. You need to put a lot of work into it. Those successful businesses I mentioned weren’t overnight successes. All those entrepreneurs spent a lot of time and energy on their projects. Success is never easy.
Finally, work on your weakness
If we were robots, my recommendation above would work perfectly. However, humans are unpredictable. I’m sure some investment bankers would scoff at living moderately, especially if they are convinced that making more would solve their money problems. On the other hand, a frugal van dweller would champion spending less. It’s almost impossible to convince people to change their mind.
Recently, I had a revelation. You need to work on your weakness. If you’re good at making money, you need to work on living more frugally. If you’re already frugal and can’t cut back anymore, then you need to work on making more money. That way you’ll grow your saving rate. Just take a good look at your finance and see which side is weaker. Try focusing on that for a while and see if it improves your saving rate.
At the RB40 household, we’re pretty good at living modestly so we need to work on making more money. Cutting back more at this point wouldn’t help much. On the other hand, any extra income we make will go straight into our investment and build wealth.
Well, what do you think? Are you better at making more or spending less? What’s your weak point?
*Sign up for a free account at Personal Capital to help manage your net worth and investment accounts. I log in almost every day to check on my accounts and cash flow. It’s a great site for DIY investors.
Image by Brendan Church
Passive income is the key to early retirement. This year, Joe is investing in commercial real estate with CrowdStreet. They have many projects across the USA so check them out!
Joe also highly recommends Personal Capital for DIY investors. They have many useful tools that will help you reach financial independence.