I’ve been dealing a lot lately with individuals who are struggling trying to save and invest for retirement. By and large they all tell me a very similar story; that the basic costs that they insist that they need simply do not allow for any remaining funds left over to invest. It’s an all too common story.
What I find interesting is that the more questions I ask in order to understand if there’s anything that can be done to fix the problem, the more I start to see the underlying common theme.
Usually this common theme is that most people have an incredibly difficult time discerning between things that are ‘needs’ and those things that are ‘wants’.
Needs based spending versus wants based spending
What’s crazy about this is that at its very core THIS is about the only thing you need to know about building wealth.
The more ‘wants’ you have to service, the less money you’re going to have available. The less money you have available after the bills are paid, the less chance you’re going to have to build wealth. Period. That really IS it! That IS the magic formula!
In its most basic form, a base ‘needs’ lifestyle for the most part is pretty consistent amongst most individuals who share that same economic demographic profile.
More specifically, what it takes a 25-year old to live in one urban area in the United States is roughly the same as it takes another 25-year old to live in a completely different urban area in the US, with some adjustments.
Same goes for the basic costs of a family of four with very a similar profile living in another rural area somewhere else and so on and so forth.
Basic needs based life expenditures
As an example, let’s look into what a basic needs lifestyle would cost for a 25-year male living in small city, say 25,000 people, in the United States. Let’s assume that our subject lives alone in a single bed apartment that costs roughly $850 a month that includes heat/cooling, sewer and water included.
Let’s add to that $50 dollars a month for electricity, $100 a month for cable and internet bundle and another $100 a month for cellular phone.
Add to this a $350 a month car payment, $100 a month in car insurance and another $200 a month in gas.
In addition, our subject spends $400 a month in groceries and another $200 a month in take out meals and restaurant tabs.
Our subject also spends $100 a month in entertainment costs, $20 a month on a gym membership and another $100 a month on miscellaneous items.
No one would accuse our subject (except for our FI followers!), who is currently spending $2,570 a month or $30,840 net dollars a year, of living a particularly extravagant life. In fact, this level of need based living reflects what would be reasonably considered basic for a 25-year old living in a small US city.
Optimize your needs based spending
That said, some of the more frugal folks amongst us might be able to optimize this gentleman’s life by cutting some of their basic costs, or could suggest a house hacking strategy to reduce their housing costs, but it would be reasonable to considerable these costs fall somewhat in line with what an average needs based life for a 25-year old single person living in a small US city would look like.
Again, I know that some of you will argue that our subject should get on a much more affordable phone plan, knock that bill down to $20 a month, take advantage of a house hack by living with others, stop going out so much to restaurants, buy groceries in bulk at the large discount food stores and cut back on their entertainment and miscellaneous spending.
Yes! This is EXACTLY what is needed for our young subject to do in order to be able to build wealth over time.
In fact, it would be very reasonable in this situation for our subject to easily shave off $300 a month and take off $3,600 of net annual spending and only spend a total of $2,270 a month or an annual total of $27,240.
With some additional frugality our subject could even comfortably reduce their spending down to $25,000 net annually and still be able to live an ‘American style’ life.
Reduce ALL costs so as to optimize wealth building
Now here’s the point of this post; notwithstanding our ‘wants’ to spend money each month, we do have base ‘needs’ and those to some degree ‘are what they are’. I’m not necessarily saying that they’re fixed but they are at some point when you cut them as low as possible.
However, it is our job as wealth builders to either reduce these costs as much as we can or significantly mitigate them if possible if we want to build wealth.
For example, let’s talk about base ‘needs’ as we know them. I suspect most would agree with me, for better or worse, that in our US created lifestyle the following are base ‘needs’; housing, associated utilities, transportation, gasoline, food, medical and communications.
These are essentially the ONLY costs that any of us need to have in our life. That said, every other cost in our budget is a ‘want’.
Cutting needs based costs to the bone
Now, in order to become a wealth building machine we should look at these basic ‘needs’ and optimize every last dollar being spent on them so that we can reduce them as much as possible. For starters, what is the most affordable way to get housing?
One extreme would be to find free housing. Really? Free housing? Yes.
One of my younger colleagues and her partner have chosen to be ‘dorm parents’ at a nearby college. For staying in the dorm and acting as chaperones, they live there for free. Any other opportunities?
Sure. I have other acquaintances who have chosen to work in certain industries, such as at resort properties, or do certain things, such as become groundskeepers, and get free housing as a result.
Any less extremes to get housing affordably? Perhaps.
If you were able to purchase a multi-unit building and could rent another unit out within that property whereby it covered your rent then that certainly would fit the bill.
That is happening all over the place as a tenet of the Financial Independence (FI) way of life.
My point is when you look at even a ‘need’ you still MUST try to look at it from the standpoint of “how can I get this for free or as affordably as possible”.
That must be the litmus test for EVERY expense if we are going to be in a position to build wealth.
Transportation: The biggest wants based expense
The example that always gets me is transportation. What exactly do any of us really ‘need’ in the way of a vehicle? Frankly, something that reliably can get us from point A to point B. That’s it. It doesn’t need big shiny wheels, a honking V8 engine an amazing paint job or anything else.
Yet, I’m sure that every day hundreds of thousands of people are jumping into their Suburbans, Explorers and Jeeps to make the trip alone into their place of work.
I even have written a post about how this seemingly innocent purchase of a brand new car is literally robbing you from building future wealth A 2019 BMW 3-Series for $380,730.57?! The Real Cost of Buying a New Car – Wealth Builders Forum
The bigger question perhaps is can we use public transportation, carpool or use alternative forms of transportation so as to either eliminate having to have a car to begin with or at least to reduce it down to only having one.
Sure we CAN. We just CHOOSE not to and that’s when a harmless ‘need’ turns into a very expensive ‘want’.
Other wants based costs that are robbing you
The other ‘want’ based expenses that I love to talk about with my clients are jewelry, vacations, personal care, subscriptions and the list goes on and on.
Our biggest mistake is that we justify our ‘wants’ by proclaiming that “we deserve them” now.
The unfortunate part of ‘wants’ based spending is that every $100 we spend today would otherwise be worth $332 to us in just 20 years (6% annual rate of return).
Think about it. For every $100 dollars we spend now we are missing the enjoyment of over THREE times that amount in just 20 years!
Conclusion
I ask my clients every time they spend something whether they really believe it is going to be worth three times of something else in just 20 years?
Because THAT is the ultimate litmus test when spending money today…not whether “I deserve it” or not.
Remember, a truly ‘needs’ based lifestyle is essential in order for us to build wealth. It is the structural foundation for it. Unfortunately, it is our ‘wants’ based spending that is denying us from creating a life of wealth.
