July 12, 2016

Build Wealth by Reducing Recurring Expenses

In our so-called modern but consumption oriented society, people get a kick out of shopping and buying stuff. Many spend too much and that may be the main reason they will never really get wealthy.

When it comes to saving, most people tend to get pessimistic very fast because they focus on the millions they would need to truly become financially independent. Some have completely given up and don’t even bother anymore.

Additional income sure wouldn’t hurt building up your fortune. But today, we will concentrate our efforts on the other side of the equation: expenses, and especially the quiet but nasty recurring ones!

The Illusion of Seamless Payments

To add to the misfortunes of compulsive shoppers and buyers, salespeople and marketers have found a new trick in this consumption driven era: they hide the real price of products and services behind easy-to-make payments.

That way, consumers don’t exactly know how much they are paying; they only know how little their payments seem to be.

Salesmen simply dismiss the actual price of their products and only focus your attention on attractive installments.

We experienced this trending scheme first hand last month as we seriously looked around to buy a new car. Car dealers never approached us about buying a 30-35K$ automobile. Instead, they presented bi-weekly payments under 200$ that appeared much more affordable. They carefully omitted the detailed fine print and some of them even offered incredible deals with ridiculous payments under 60$ per week. They were all very surprised when we insisted to talk about the bottom line.

In the same fashion, people don’t always grasp the impact of recurring expenses like their smart phone plan on their overall financial situation. They consider their beloved phone like a necessity and account for that monthly 50 bucks as trivial cost. The fact is that paying only 50$ a month can really add up over the years.

For instance, because he thinks he always needs the latest model,  a young man aged 32 with a life expectancy of 80 (over 48 years) will spend on average more than 28K$ for a basic 50$ monthly phone plan without considering interest or inflation. At 3%, the expense would climb over 64K$ and would be more than 166K$ at a very reasonable 6%.

You would still obtain astonishing amounts in you only considered his active life.

Just imagine for a moment paying as much as 166K$ simply for having a cool phone! The 50 bucks a month are not as trivial anymore!

Small Changes Can Go a Long Way

In all that spending mayhem, there can still be hope and the good news is that small spending habit changes can do wonders for your budget and lifetime savings.

As we often have suggested with the 12-Minute Approach, small repetitive steps may be the best and easiest way to get closer to your financial goals and to achieve wealth over time. 

If you had the opportunity to save 1000$ right now but only once or
10$ every month for the rest of your life, which option would you choose?

Many would not even hesitate to quickly grab the thousand bucks but as we will see later on, if you are not ill or on your deathbed, the recurring monthly saving would probably be a wiser decision, at least financially.

Furthermore, saving 1000$ can be a hassle but sparing 10$ looks much more attainable even if you have to repeat it every month. That’s why attacking recurring expenses can really do the trick once and for all.  

If you are not able to get rid of your phone altogether, at least shop around and try to reduce your monthly plan by 10$. This modest one time change could save you thousands of dollars over your lifetime.

So, as it is much easier than saving a big chunk, give it a try, find a couple recurring bucks here and there and save little by little.

Don’t get me wrong, you should not dismiss any chance to save even if it will only occur once. I’m just saying that these opportunities may be harder to come by and that reducing recurring expenses may have more of an impact.

Recurring Savings vs Lifetime Savings

As you can see from the following chart, sometimes it can be better to save 10$ for a lifetime than 1000$ only once.

The chart compares a repetitive monthly saving to a lump sum saving.
Note that you could multiply (or divide) values in the chart to quickly estimate the impact of different initial amounts.

For example, over 12 years at 6%, a 50$ monthly saving would build up to 10507.50$ (2101.50$ times 5). The same way, saving a smaller amount like 5$ a month would accumulate to 1050.75$ (2101.50$ divided by 2).

As with any financial value, these savings will be affected both by time and interest rate. Longer time periods will favor the recurring monthly saving but a larger rate of return will help the lump sum alternative.    

At all rates, the tipping point is grossly around 12 years. After that, the monthly option definitively gets in front of the lump sum one. Staying patient for a dozen years doesn’t seem that long to collect the fruits of your efforts. Yet it could pose a problem if you are not disciplined enough.

I will mention that most people should probably completely forget the 12% column as it may not be that realistic to obtain. I’m telling you this despite the fact we are personally able to sustain that sort of return in our DIY Portfolio.

Similar to Ever Recurring Dividends

To some extent, we analyse and treat recurring expenses like dividends. Both could potentially be sustained for a very long time and regularly influence your financial horizon but in fact, they are more like opposites.

Dividends provide regular income that can boost your wealth and ideally, you would love to always increase them. Over time they should at least follow the value of your portfolio and counteract inflation.  

On the other hand, recurring expenses hurt your wealth and you will always try to reduce them. Sadly, they should, in theory, increase with time following inflation.

Let’s hope this post provided you with interesting alternative avenues to build your wealth. Meanwhile, we will continue to work hard on both building a strong portfolio that provides healthy dividends and controlling our expenses.

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