“If you save $1,000 a year… that’s more than you’re going to earn on $10,000 in investing.”
I wish I had $1 for every time I’ve heard the term “budget cuts.” Most people cringe at the phrase because they know it usually doesn’t mean anything good. If you haven’t been impacted by a budget cut yet, you probably will be because, typically, they relate to businesses, schools, or government.
Now, budget cuts for the government and for schools are usually because there is a lack of funding. Businesses, however, are different. Cuts in a business are often used to increase profitability, even if the company is already doing well. The practice works well in the corporate world, but for some reason most people decide not to apply the same principle to their personal life. This article will show you how.
But first, we should try to understand why this strategy can be more effective than just plowing all of your extra cash into investments.
Cutting Expenses In The Corporate World
We’re going to use two examples and a little bit of basic accounting here. Both companies are going to print personal finance handbooks (fanny pack-sized!) to sell through Amazon. Optimist Printing Co. believes that in order to increase their profit, they simply need to increase their sales. Realist Printer Co. believes that they can increase profitability by reducing costs. Both have the goal to increase their monthly profit by $5,000.
Before taking action to increase profits, both companies’ monthly finances look like this:
For simplicity, we’ll say that expenses are 80% of the sales before our companies make any changes. So, for every $1 in sales, each company would spend $0.80 in materials, employee costs, and other expenses.
As you already know, both companies want to increase profits by $5,000, but they each have a different strategy to get there.
Let’s start with Optimist Printing Co.:
For an extra $5,000 in profit, Optimist Printing Co. had to increase sales by 25%. In one month! Hey, could be possible, who knows? I would bet that it’s not an easy feat, though.
Next, let’s look at Realist Printing Co.’s strategy:
Rather than increase sales by 25%, Realist Printing Co. only had to reduce expenses by 6.25%. Not to state the obvious, but that’s a huge difference. Plus, it’s a lot easier to control spending than to control sales. You could find ways to cut costs in production, but you can’t really force customers to buy more of your product.
Well, maybe you can, but I think that it’s generally frowned upon.
I hope you’re picking up what I’m putting down. The concepts may seem confusing at first, but I think that they get easier when an example is shown. But, if you’re just skimming for the good parts, to summarize:
A small change in something you can control can be as effective as a big change in something you can’t.
But, you aren’t a company, so how can this apply to you?
Budget Cuts At Home
Ew. I know. The title of this section sucks. Sorry.
Just like every other person out there who wants to help you manage your finances, I’m going to tell you to spend less. Blah blah blah, you’re not reading his to have me to tell you the obvious. Plus, I’ve already written an article about the basic ideas of budgeting.
Seriously though, every dollar you save is worth more than you think. Just like our book companies, a small decrease in expenses is worth the same as a much larger increase in income. The same goes for you.
It’s not totally apples to apples because your monthly expenses don’t increase with every pay raise (at least they shouldn’t!). However, we can look at it from the investment perspective.
Using the wise words of billionaire Mark Cuban, saving $1,000 is more than you’ll earn on $10,000 in investments. So, if you invested $10,000, and your investments earned 10% over the next year (good freakin’ luck), it will have been the same as saving $1,000 on expenses. Chances of earning 10% are pretty low, so I wouldn’t count on it.
Do you have $10,000 to invest? Can you guarantee you’ll earn 10% returns on it? I highly doubt it. Can you reduce your spending by $80 per month and take no risk? I’ll bet you can.
In no way am I saying to stop investing and rely on only saving. You should always be investing any money you can spare. The point is that saving a few bucks here and there can be just as powerful as investing. Plus, if you invest the extra money you now have, that will just add even more to your pot of gold. Harness the extra compound growth and let it make you a millionaire.
Look at ways that you can cut back, even if it’s only a small amount, each month. Get into the habit of being frugal. You don’t need to sacrifice fun for financial returns, but we all have a few ways we can save a few dollars.
You know the old saying: a penny saved is ten cents earning 5% annual growth over a two year period. Or a penny earned.
I always mess that one up.
What are some things that you’ve cut out in order to save some money? Is there anything you wouldn’t miss if you cut it out now? Comment below and share!