The two ways to live within your means are spending less than you earn or earning more than you spend. While those two methods would have the same result, they come about from two different philosophies. Since we often look at things from the first point of view, I though it would be insightful to consider the opposing view.
The rationale behind earning more than you spend, rather than spending less than you earn, is two-fold. First, there is only a finite amount by which your current expenses can be reduced. The maximum amount is the total of all of your discretionary spending. While this could be a significant amount of money if you are a big spender, it still has an upper bound. If you want your net cash flow to improve by more than you can possibly cut expenses, increasing income is the only alternative. Second, reducing spending may lower your standard of living. Some cutbacks might not affect your standard of living, but many will. Higher income with the same expenses will allow you to maintain your standard of living and increase your savings or reduce your debt.
While spending less is certainly something I advocate, eventually earning more may be an easier solution. This point was discussed by Steve over at mywifequitherjob.com in his post Why You Should Worry About Your Topline More Than Your Bottom Line. He calculated that additional cuts to spending could save them at most $1,500 a month. Instead, he looked for ways to generate more money per month. If he could earn another $1,500, the net change to their cash flow would be the same, but without the work or sacrifices of cutting expenses.
Earning more is a viable solution, but it can also mask laziness and poor financial habits. A mixed approach may be best. Start by cutting back frivolous spending or purchases that you won’t miss. As further cuts become more painful, transition your focus towards earning more. While you can only lower your expenses so far, there’s no limit to the amount of money you can earn.
Is making additional cuts to your expenses more difficult than finding ways to earn more money?
One of the main reasons we spend money is to solve problems that we face. Even needs can be characterized in this way. The problem of being hungry can be solved by purchasing food. Trouble arises when we are persuaded to purchase solutions to problems that do not exist in our lives.
The example that always makes me laugh is the tissue commercial that describes how purchasing low quality tissues will leave you sneezing right through them, creating an undesirable and unsanitary mess. While I certainly wouldn’t want to have that situation occur, I have never had such an experience, regardless of the type of tissue I used. While the premium price of name brand tissues might be worth it to prevent the problem from occurring, since it isn’t a real problem for me, the premium is not worth it.
Many products are advertised in this way. The ads show how using a particular product will allow you to avoid an unpleasant situation. Before spending money on such a product, you should ask yourself if you are currently experiencing the problem. A recent episode of Saturday Night Live parodied this situation with a clip about a product for opening jars. The problem presented wasn’t just having a jar that was tough to open, but that in the process of opening a tough jar you might inadvertently kill a person and then have to deal with disposing of the body, avoiding capture, going to prison, etc. The product was advertised as a way to avoid all of those secondary, however unlikely, effects of the true problem at hand. While that example is clearly an extreme exaggeration, it does make a similar point.
You need to be careful not to pay extra for solutions to nonexistent problems. While advertisements may prey on your fear of undesirable events occurring, unless those events are likely to be experienced, paying for a solution is a waste of money.
Have advertisements persuaded you to buy solutions to problems you didn’t actually have?
We often hear risk versus reward discussions in the investment realm, but they can exist in our careers as well. Below are a few scenarios that may help to identify your tolerance to this type of risk.
The Short but Dangerous Job
Images of Sig Hansen and crew working their crab pots come to mind. These men often make significant amounts of money quickly, but the work can be grueling and loss of life is always a possibility.
The Far Away Job
Work assignments in distant locations often force the tradeoff between time away from family and higher potential earnings. What value do you place on seeing everyday life moments or tucking your kids into bed each night?
The Far Away Dangerous Job
A combination of the previous two types of jobs, an example of the far away dangerous job was covered in depth when myinvestingblog.com profiled a friend who was offered $290,000 per year to work in Iraq, performing the same job for which he was being paid $60,000 per year in the U.S.
The Startup Job
Working for a startup can get you in on the ground floor of a budding company. You may trade long hours and lower pay for company stock, which could potentially explode in value in the future. The downside is the possibility of failure for the business.
The Part-Time Job
Working part-time gives you more free time to spend with your children or to devote to other interests. For that freedom, you may have to give up more than just a portion of your potential earnings, as few part-timers are eligible for company benefits.
All of these examples present different tradeoffs. Depending on the value you place on money, time, and other intangibles, you might decide that any of these scenarios are worth it. A young, single worker would likely consider completely different jobs than an older married worker whose spouse’s job provided benefits.
Which of these scenarios would you consider?
According to The Wall Street Journal, one of the ways the economic crisis is affecting small business owners is that many customers are slow to pay. Receiving payments days or weeks late can be catastrophic to small businesses, which typically have much smaller cash buffers than their larger counterparts. It isn’t only other small businesses that are paying late; often, large business customers pay their smaller suppliers last. The rationale cited in the article is that customers want to keep their largest suppliers the happiest and are most likely to be pressured to pay by suppliers with the resources to hassle them about late payments.
What’s a small business owner to do when customers are behind in their payments and credit at banks continues to be tight? Those with good credit continue to turn to Lending Club for affordable financing. By taking out a 36-month P2P loan, business owners can effectively bridge the cash flow gap. Loan proceeds can cover everything from payroll to accounts payable until customers finally make their payments.
While small business owners may feel helpless when large customers pay late, there are a few things that can be done. As diminishing cash flow becomes a higher priority, so too may applying pressure to the customer. Cashing checks as soon as they arrive is also critical, given the wave of bankruptcies of late. CNBC recently showed a check that a small business owner had returned for insufficient funds from one of its customers: Lehman Brothers. Negotiating penalties for late payment is also helpful, though that is best done when new accounts are created and small businesses may be leery of scaring away potential customers.
As is often the case, those least able to survive late payments are often the ones most likely to experience them. What might be a minor nuisance to a larger business could end the existence of a smaller one. Using a P2P loan from Lending Club could keep a small business afloat long enough to survive the current financial crisis.
Have your customers been slow to pay you lately? What impact has that had on your business?
Saving for college through a state-sponsored 529 plan offers many advantages, not the least of which is a potential tax savings. Another significant advantage is that money can even be saved for children who haven’t been born yet.
If the plan you choose doesn’t specifically allow saving for an unborn child, the plan can be established with one of the parents as the beneficiary and then transferred to the child after birth. The provision to invest for future children is useful for many reasons. First, you may be more able to invest when you don’t have the accompanying costs of having children. Saving more when you are able to, to compensate for smaller contributions when you’re less able to make them, is one of the scenarios I described in Advantageous Times to Invest.
Another advantage of saving for future children is that your investments have more time to appreciate. All investors know that time is one of the most valuable assets. By saving before your children are born, you can extend the timeframe of your 529 investments from 18 years (birth to college age) to something longer. A couple that is married for 6 years before their first child is born has 33% longer for their investments to appreciate.
Since your intentions may change over time or physical circumstances may prevent you from having children, it’s also important to consider what will happen to a 529 account if the children for whom it is intended never come to be. Since the plan beneficiary can be changed, you can instead use the assets for qualified education expenses for a family member, including yourself. Other options are similar to those in the case where there is money left after a child’s expenses are complete.
If you plan to have children in the future, saving for their college education as soon as possible will help to make the expense more affordable. Giving yourself more time to save and contributing before the costs of having a child come into play make a strong case for starting a 529 plan before your children are born.