What is the best approach to building wealth: cutting costs to free up money for saving and investment or increasing income to create an excess of money that is saved or invested? Let’s examine the pro’s and con’s of each approach and see if we can come to a conclusion.
The advantages of cutting spending:
- Available to everyone. Unless a person has implemented every cost cutting measure in existence and exploited them fully, there is an opportunity to reduce spending and free up money for saving. It is simply a matter of making saving a priority. Once that is done, the money for saving can be found.
- Immediate results. Cost cutting can begin literally from one minute to the next: adjust the thermostat by a degree or two, up in the summer and down in the winter, and/or unplug all electric appliances not in use that have an LED on when turned off or that have an “instant on” feature. Both of these actions will reduce the cost of energy immediately.
- Clearly defined spending priorities. Cutting costs forces a person to prioritize spending to discover what can be cut and by how much. Prioritizing spending helps a person get the most value out of the money that is spent. Increased value leads to increased satisfaction.
- Control over spending. Clearly defined spending priorities make it possible to create an effective budget that produces money for saving without making a person feel deprived, because money is still being spent on the most important things in that person’s life. The use of a budget gives a person control over spending.
- Efficient: No taxes and no cost. Cutting spending produces after-tax money for saving: one hundred percent of the money freed up by reducing costs is available for saving. Cutting spending does not incur any monetary costs; it takes time, not money.
The disadvantages of cutting spending:
- Limited effect. Only so much can be achieved through a reduction in spending. Cost cutting is limited by the amount available for spending. If a person has $3,000 a month available for spending, the most that can be achieved through a reduction of spending is to free up $3,000 for saving and only if 100% of spending is eliminated. A reduction in spending of 30% to 50% is more realistic and would result in $900 to $1500 to add to savings per our example. If the person in this example needs to accumulate more than that amount per month to achieve a financial goal, cutting spending will not produce enough savings.
- Deprivation. For some people, any reduction in spending is perceived as a sacrifice and leads to a feeling of deprivation that can undermine the will to cut costs. Establishing clearly defined spending priorities can mitigate or even eliminate the feeling of deprivation for many people. However, some will feel deprived it they have to give up anything.
- Exclusion from mainstream culture. Mainstream culture is all about consumption and conformity. Reducing spending makes a person different and excludes him or her from the mainstream culture. If subscriptions to cable television, Netflix, and other similar services are canceled to achieve a reduction in spending, a person will be essentially ostracized from discussions of mainstream entertainment. If cellular plans are downsized to reduce spending, a person may not be able to participate in the 24/7 connectivity that has come to dominate mainstream culture. Eating out less frequently, avoiding coffee shops, bars, the golf course, the gym, and the nail salon can also leave a person feeling left out of the mainstream culture. Being different can make a person feel uncomfortable.
The advantages of increasing income:
- Potentially unlimited effect. There is no limit to the amount of additional income a person can earn if the right knowledge and skills are developed and then marketed effectively.
- Enhanced status and power. Increased income avoids feelings of deprivation or alienation from the mainstream culture and thus preserves the status that a person has already accrued. Even if it is saved, increased income also adds to a person’s status: in our culture, more income equals more status. If the increase in income is attributable to advancement, then additional power is also accrued as a result of increased responsibilities.
- Accelerated achievement of financial goals. With its unlimited potential, increasing income can reduce the time it takes to realize financial goals. It may also cause a person to expand those goals as the possibility of achieving more becomes evident.
The disadvantages of increasing income:
- Doesn’t address control over spending. If spending isn’t controlled, an increase in income will probably result in an increase in spending, as well. If that increased income is leveraged to maximize an increase in spending, then debt will be accumulated instead of wealth.
- Takes time to realize results. Whatever approach a person takes to increase income, it takes time before any additional income is realized: the development of new skills, a promotion, finding a better paying position, changing employers, starting a business, finding a second job all take time. In some instances, such as the completion of a degree or certification or starting a business, it may take years before significant increases in income are realized.
- Not available to everyone. Not everyone is capable of increasing their income substantially. Some may not have the aptitude to handle additional responsibilities. Others may have physical or mental impairments that keep them from taking a second job or seeking additional training while holding down a job. Still others may be unable to cope with the risks involved in starting a business.
- Requires investment of time and/or money. Increasing income often involves an investment of time and money: time to acquire additional skills, job hunt, complete a degree or certification, work a second job; money to pay for training, schooling, transportation, childcare, tools, working capital for a business, relocation expenses. Time and money are costs that negatively affect the net amount of additional income that is available for saving.
- Taxes. Increases in income are subject to taxes which reduce the net amount of additional income. Depending on a person’s tax situation and other circumstances, it may take $1.30 to $1.50 of increased income to net $1.00 for saving.
Now that I’ve itemized the pro’s and con’s of each approach to building wealth, what do you think? Which one is the best approach? If you prefer certainty, you might choose to cut spending; you are sure to free up money that can be saved by using that approach. If you are one who takes risks and thinks big, you might choose to increase income; you like the idea of unlimited potential.
Fortunately, you don’t have to choose between them; cutting spending and increasing income are not mutually exclusive. In fact, they complement each other. You should do both to enjoy the benefits of each approach while minimizing their downsides.
Cutting spending is the easiest thing to do, and it produces immediate results. You can be adding to savings by the end of the month. The big advantage to cutting spending is the control over spending that is acquired. You must have control over spending if you are to benefit from an increase in income. Otherwise, any additional income will just be spent. Isn’t that what has happened in the past? If you spend everything you make, you will be broke at the end of the month whether you make $1,500 per month or $15,000 per month. You must gain control over spending.
Once you have a budget and control over your spending, you are ready to pursue additional income. Save any increases in income along with the money you are already freeing up as a result of cost cutting and you have the best approach for accomplishing your financial goals.
K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages