It Isn’t Frugality That Builds Wealth

I am frugal to a fault, and Mrs. C. will never let me hear the end of it. Cutting back on eating out, cutting my own hair, switching off all the lights constantly, wearing clothes til they fall apart, etc, has saved me maybe $3,000 a year that I can happily invest, but in the grand scheme of your life, these savings are small potatoes.  Mrs C. and I are on track to save over 45% of our income this year, and whether we skip McDonalds or not will be a rounding error in the equation. The vast majority of wealth is not built by concentrating on the little things, but on the big things; Income, Housing, Cars, and Taxes.  Virtually everything else becomes a much smaller portion of your wealth building stream.

Income:

We’ve strived to increase our income and our 2017 income is 67% higher than our 2014 income.  I’ve increased my total hours worked by over 40%, Mrs. C. increased her hours by 30%, I’ve negotiated a couple raises,  and we gained around $10,000 per year in Social Security benefits for taking in our two nephews.  Obviously the vast majority of that income goes towards direct expenses in raising them.  Oh, and I started making a couple grand a year from this blog.  Increasing your income is the number one thing you can do to build wealth.

Housing:

As a percent of income, our housing cost, including mortgage, property taxes, and insurance is right at 10%.  This gives us a 23% advantage over the average American. When we bought our house it was around 18% of our income.

Vehicles:

My 1K carWe paid around $10,000 for Mrs. C.’s van last summer, and I have been driving the same $1,000 beater for almost 4 years.  No vehicle payments. $0. Adding in registration tags, insurance, repairs and standard maintenance (oil changes, brakes, tires etc) puts our cost at around 4%.  Add in fuel, which is the biggest vehicle expense we have and we are pushing 7% of income on transportation.

Housing and transportation combined in our budget adds up to 17% of our income.  The average US household spends 48% of its income on these two categories.  For our family the efficiencies we gain in these 2 categories alone account for us being able to save a full third of our income. 

Taxes: 

Once you have your income, housing expenses, and vehicle expenses firing on all cylinders, it becomes much easier to save money on taxes.  You can throw more money into tax advantaged accounts, reducing your taxable income, and potentially qualifying for the retirement savers tax credit.  Because we can save so much money from housing and vehicles we can save even more on taxes.  Our retirement contributions for 2017 allowed us to save about 4% of our income on our federal income taxes and 1% of our income on our state income taxes. This adds up to another 5% of our total gross income.

Because we reduced our AGI substantially, our health insurance premiums are reduced from $522 per month to $275 per month due to where we fall on the Federal Poverty Level based on AGI and family size.  That’s $3,000 per year.  What’s more is that it puts us into the range where we receive cost sharing with a silver plan, dropping our deductible from $4,000 to $1,200 and our out of pocket max from $11,000 to $3,000.  All in all this savings adds up to another roughly 5% of total gross income.

Housing, Transportation, and Taxes alone allow us to save 43% of our income.    Since we saved 47% of our income last year, this leaves only 4% of our income that is saved in other areas of our budget, under 10% of our total savings comes from everyday frugality.  “Live like no one else” in your housing and vehicle decisions and you can super charge your wealth building. 

 

When Frugality Does Matter:

If your net worth is the paycheck you received today, then frugality matters a whole lot, because as a percentage, those small things add up to a lot.  Going from saving $0 a year, or $500 a year to $2,000 a year makes a world of difference.  If you are in this scenario, by all means, frugality on the little stuff is highly important, but you can’t spend the majority of your time analyzing this stuff.  Your time is much better spent on getting your income up and attacking your housing and vehicle costs.

John C. started Action Economics in 2013 as a way to gain more knowledge on personal financial planning and to share that knowledge with others. Action Economics focuses on paying off the house, reducing taxes, and building wealth. John uses the free tool Personal Capital to track his net worth and posts quarterly updates on his finances. Check out the Action Economics archives section for all past posts.

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