Can high expenses actually save you money ?

What is the utility value of your expenses ? How do you quantify what you get for your spending ?

Sometimes expenses are just that – spending on services that don’t typically have any major long term expectation of any financial return – for example: dinner out, netflix subscription, dry cleaning bill (etc).

Sometimes though spending can get you into opportunities you wouldn’t otherwise have had. For example, spending $5 on lattes everyday according to some is taking from your financial future with small daily luxuries that add up over time – leading you to ultimately miss out on huge amounts of compound interest on your investments. However maybe the down time away from daily life while you get your coffee, gives you enough thinking space to come up with your next great business idea. Arguably people can think without coffee (at least I’ve heard rumours of such people) – but maybe that’s what you personally need to be that organised in your thinking. So maybe that annual investment was 100 x $5 lattes = $500, but you thought about an eBook which ultimately generated $500 in sales – so that would be arguably break even on your coffee investment (apart from your time).

A more extreme example might be renting walking distance from work in an expensive city versus commuting. How can you justify spending thousands extra per year just for a lifestyle choice ? That is crazy money for a lot of people, but that is relatively easy to burn through in a high expense metro area, just renting a decent apartment in a nice neighborhood with the family and a couple of kids. For example rent can be conservatively $50k a year for a 2 bed apt in Manhattan. Rent outside the city would be say $30k a year, so you can save $20k a year on rent by commuting. But then you have pay for (maybe) a car to drive to the station, then battle the train and all those other people that seem to inhabit cities. So bottom line maybe you end up saving $15k, but you are spending say an extra 2 hours a day travelling, which is 10 hours a week or 12.5 work weeks per year commuting. For some people, commuting could increase your stress levels significantly, but it might not. Some people I know are very productive on their 7am commute, and clear all their inbox before they get in the office at 8am, and then leave early at 4pm to be back home for 5pm with the family. But that requires flexible employer working arrangements and personal discipline – i.e. no happy hour in the city after work.

If you work close to home, there are intangible benefits like being able to go home at lunch to quickly get some task done. Being able to use the time productively. You can walk everywhere, so arguably don’t need a gym membership. You have the mental and emotional energy to do the things that must be done at work. If you are in a job that has a significant annual bonus tied to performance, your competitive edge can be living and working close to work – you quantify the success of the strategy at the end of the year. Using the above example, if your after tax bonus makes more than the $15k savings difference, then you could consider your “excessive” rental spending for that year to be a win. If you are not in a job situation that has a bonus, then arguably it is just a lifestyle choice, maybe not a good financial choice – but that might be justifiable for your personal approach to life, but at least understand your trade offs.

Arguably in this situation you have “spent money to make money”, lowered your stress and improved your quality of life. There can also be a short term monetary value on reducing general life stress (like commuting) because it frees up your time and your mind to actually think about other opportunities. However also there can be long term benefits in terms of reduced future health care costs due to stress related issues, but that is obviously harder to quantify.

Its not what you make, its what you keep
In an earlier post we worked out your actual after tax savings rate, and decided this is way more important than just your salary or your actual expenses. It figures out “how much do you keep?” not the usual question of “how much do you make?”, so it is a much better measure of financial improvement. Importantly this number easily allows comparison between different peoples financial situation.

Without getting too technical, as a quick recap the calculation for after tax savings rate is:
your after tax hourly pay MINUS your actual living expenses DIVIDED by your hours worked per week.
If you haven’t previously, you can quickly work is out here using this calculator.

Individual salary and expenses alone doesn’t tell you much, but how much your Actual Savings Rate towards your personal target is much more important. A person that saves half of their earned money (after expenses) can have a better shot at early retirement, than someone who makes twice as much but only saves 10%.

Income Split between couples
It’s a good sound bite to say “oh they make tons of money”, or that couple “spends way too much”, but its usually too simplistic figure out to figure out if they are financially “successful”. Lets look at some different couples, where both people work and they have varying different income and expenses. But first some definitions so we can compare the couples together.

Couples – considered to be two people in a household, where either both or one person works. Click each link in the table below to see their projected early retirement date.
Income – Annual after tax pay on the first line. The person 1 and person 2 pay split is on the 2nd line in brackets, with the highest earner first.
Expenses – Annual actual living expenses
Savings – Annual savings (Income minus expenses)
Only One Person Working Savings – Annual savings if highest paid person in the couple stops working (either voluntary or involuntary)

The following tables gives some example numbers for well paid professional couples working in a large US metro area in 2016, but absolute numbers are not as important as the ideas behind each couple. The numbers can be adjusted up or down as appropriate for your situation.

Couples
Income
Expenses
Savings
Only One Person
Working Savings
Couple 1$200k
($100k/$100k)
$100k$100k$0
Couple 2$250k
($250k/$0k)
$100k$150k-$100k
Couple 3$150k
($120k/$30k)
$50k$100k-$20k

Couple 1 has high expenses, so most people would say they have a higher leveraged lifestyle. However if either person in couple 1 lost their job, they could still survive without cutting into savings.

Couple 2 makes the most money, but have high expenses and one point of failure being totally dependent on one salary – however they would stereo typically be seen as the “most successful” couple by many people.

Couple 3 have the lowest expenses, so they would probably be seen as the most financially prudent because their expenses are lower, but still have some employment risk because if either couple lost their job they’d have to use savings to live on.

So the way the income earned is split between the partners in a couple can also reduce risk, as well as just salary and expenses. In a couple, if either persons salary can cover total expenses, then there is a less risk that just relying on one salary. If one partner earns significantly more than the other, running side projects for income could be use to make up difference between the 2 salaries.

Summing Up
High expenses don’t necessarily mean that someone is saving inefficiently. Also the way income split is earned between couples can become a risk as well. Many financial blogs simply argue that if you have high expenses you are divorced from reality and the only solution is to reduce expenses. However for example high annual expenses could just the cost to able to live comfortably in an expensive city, that allows you to get a reduced stress opportunity at making the big bucks. High expenses can potentially disappear after leaving the city either for a career change or retirement. Assuming the expenses are not addictive “must have” lifestyle choices, they could easily be reduced long term – its not all going on day spas and massages (!) often just on basics like rent or daycare.

The point is not lecture on “this is right, this is wrong” approaches, but to actively understand why you are making active spending choices and if you can optimise them to improve what you keep in your take home pay.

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