Let’s go crazy and pigeon hole people into one of four categories, based on their earning and their spending.
*Before you gasp in horror, spit out your tea in fury and head butt your laptop in rage at the definitions of a ‘High Earner’ or a ‘Low Earner’, the whole post should be taken with a pinch of salt and a sprinkling of the surreal*
Financially, this is the most destructive group to be part of. With bad personal finance knowledge and a desire to have everything right now this group shun the first law of personal finance. They spend more than they earn. I hear you howl in frustration, face lit up spookily by the light of your laptop, as you read this. Good for you.
This group want to live and spend like ballers, believing that spending will bring them happiness and somehow make them successful.
In reality, high earners can do this as well, it’s just spending more that you earn, be the earning high or low.
Low earners, low spenders – Frugal by nature
Despite their wizard-like skills of frugality they will never be particularly financially stable as they don’t earn enough to be able to build up a financial war chest for the rough times.
This group just love the high life that spending a substantial wage seems to offer them.
A big house, new cars, fancy clothes, buckets of latte and shiny things are the norm. Thing is, this leaves little room for saving.
Whilst they appear rich, they are asset and time poor. Nearly every minute is spent working to pay off their lifestyle, rushing about in the intervening periods between work. To stop working would mean their lifestyle grinds to a halt.
High earners, low spenders – Goldilocks zone
In the Solar System of personal finance, there exists a ‘Goldilocks Zone’. With a perfect combination of income and savings, this group are right within the zone for a Financially Independent life. Life that is happy and self supporting (within a relatively few short years of work).
With a well paying career (although not necessarily ludicrous) and by living well below their means mean they can save in excess of 50% of their income.
The might be viewed as cheap by other groups, or perhaps hiding some sinister secret that is a black hole for money, but it is their habits that are helping to build a powerful collection of assets that will soon support Financially Independent life.
Thankfully we can see the world famous Mr-Zombie’s-Spendy-Matrix without the need for a blue or red pill, it handily shows the above in a single chart;
Most of us hover around the middle, bouncing randomly a small amount into each quarter from month to month, like some cruel Brownian Motion that’s unable to settle.
Let’s have a quick look at the impact on your finances of being in each quadrant of Mr-Zombie’s-Spendy-Matrix.
Over the course of 10 years consider an individual from each of the areas with the following attributes;
The credit generation is living on credit cards so a 20% interest rate seems about right. For the others, a 5% real growth rate is pretty standard, so I’ll roll with that. I’ve actually used an after tax number in the example to keep things a bit more realistic, but other than that, that’s it. Nice and simple.
The result is perhaps not that surprising, but it is staggering.
After a few short years anyone in the Goldilocks Zone (High Earner, Low Spender) has streaked ahead of all other parties, thanks to their consistently high savings rate. With about £350k in the bank after 10 years they are nearly Financially independent using the old 4% rule as a basis. 4% of their assets is £13,776 and 35% of their after tax income is £14,744 (what they are actually living off).
It would take less than another year to become financially independent at this rate and under these conditions, i.e. for the theoretical ability of their assets to produce income/growth that exceeds their living expenses.
On the other hand the High Earner, High Spender (The Jones’) and the Low Earner, Low Spender (Frugal by nature) aren’t worlds apart, with £26k and £11k in assets respectively. The Jones’s…all that money, with it’s savings & earning potential energy, frittered away over the years along side depreciating assets. If you look at the above in isolation it seems madness to spend so frivolously, yet this is how many choose to live their lives. And it is a choice.
The Low Earner, High Spender (The credit generation) at the bottom is heading towards the middle of a complete financial black hole, a seemingly never ending downwards spiral. It doesn’t have to be a Low Earner of course, it’s just anyone spending more than they earn, breaking that all important first law of personal finance.
Just looking at the first year, and the differences in the approaches should be enough to convince anyone that upping your savings rate is what all the cool kids are doing. And while you’re at it, try and increase your earnings. At least for a few years to build up some helpful assets that earn income or can be drawndown as they grow. Not everyone will earn a ridiculous income, nor is a large income everything, but steps towards improving their financial position and edging towards the upper left of the matrix is surely a good thing.
What, right now?
These things don’t follow a step function, a sudden violent wrenching and all-changing shift in your life.
You don’t transpose from one day earning a normal wage and saving 5% of your income to the next day earning £100k and saving 75% of your income, leaving some poor bastard in your old position. It’s not like that, it’s a gradual shift, or a series of smaller step changes.
These things happen over a number of years. It can be too easy to look at the likes of MMM, see a huge gulf between their lifestyle and yours, then conclude it’s impossible for you.
Around 3 and a half years ago I took the decision to retrain, at the age of 30. It meant a substantial drop in salary and a lot more work to be done, with exams along side work. I’m nearly at the end of this now, it’s been hard work but worth it.
It was far from an instant change. It forced me to rebase my expenses, with a substantial decrease in salary it’s incredible how you can cut back on spending when you have to. Luckily, as I was retraining, I found the world of Financial Independence and used this as an opportunity to stamp on the head of lifestyle inflation and up my savings rate as I went along.
Slowly getting there, it’s been a near four year journey to get myself towards the upper left hand side of the matrix rather than meaninglessly hanging around the middle. There’s still a bit of work to be done to get my savings rate up to 65%
So yeah, you can make changes right now, but the impact might be a gradual shift, rather than an instant one. Even if you are killing it on the earning side, habits can take a while to change, your lifestyle can take a while to adjust. Increasing your earning probably isn’t going to be an instant thing either, it’ll take time and some hard work.
Time passes quicker than you think. For me, this means getting into that top left hand corner and staying there for a few years. Then, with Financial Independence in my tool belt, I can slow down, regain some headspace and stop time from zipping by so quickly.
[January Challenge update: I have sacked off both alcohol and caffeine for January, in an attempt to be more healthy. Blimey, this along side cycling everywhere is going to have me looking ripped.
It’s been just over a week. The alcohol has been pretty easy, especially after the excesses of Christmas. The only real challenge was going out for a curry with Mrs Z. Something about a curry and a beer, it’s just such a good combination. And it’s healthy too, right?
The caffeine was harder. A headache clattered around my cranium throughout the second and third of January. I found myself so tired by about 6pm, it was like I had been up at 5am each day and done 100 miles on the bike.
Surprisingly, the first week at work was actually fine, the main thing was getting out of the habit of drinking coffee or tea. Getting up from a couple of minutes to make a hot drink is a (tiny) chance to recharge. Replacing this with a cup of hot water seemed to help. And as an added bonus, confused colleagues.]