There are two ways to achieve your financial goals. One way is to make more money. Get a raise, promotion, bonus or side hustle and put that extra money towards your financial goals. Earning extra money isn’t always easy but it’s an effective way to achieve your goals.
The second way is even more powerful.
To achieve your financial goals, reducing your expenses and saving more money actually has 2x the benefit of making more money.
Every $1 saved is worth $2 earned!
There are a few reasons why saving has twice the impact of earning. So, if you want to hit your financial goals, spend extra time on finding ways to reduce your current spending.
To show you exactly how powerful saving more money can be, let’s set up an example. Meet John. He’s 35 years old and wants to retire early at age 60, an ambitious goal. He has another 25 years to save for his early retirement.
John, a life-long bachelor, has recently learned how to cook. He can now make delicious meals at home. He figures this will save him at least $30 per month by avoiding one take-out meal every other week. This is a small change in John’s spending, but will have a strong effect on his savings
There are three ways that reducing his monthly expenses by $30 will help John achieve his goal.
1. Small Monthly Savings Turn Into Big Rewards!
John has made a commitment to cook at home more. This is a small change which will have a major benefit on both his health and savings! Let’s see how:
The obvious benefit of reducing your expenses is that you’re able to save more money. This has a one-to-one impact on your current net worth. Every $1 you save increases your net worth by $1 immediately.
That immediate boost to your net worth is a great incentive to save but over time, when invested properly, your extra savings also benefit from compounding.
Compounding multiplies the effort you put into saving money. Over 25 years, $1 saved today is worth $3.39 in the future*.
That is the power of compounding! By saving $30 each month over 25 years John will have an additional $17,572.
2. Less Retirement Money Required
By reducing your expenses, you also reduce the amount of savings you need for retirement. In our example, John has permanently reduced his expenses by $30 per month. This means that each year in retirement John needs to take $360 less from his retirement investments to support his spending.
John is planning to retire at 60 and hopes to live well into his 90’s. That is 35+ years of reduced spending!
John doesn’t need to spend this money in retirement which means he also doesn’t need to save that much either.
At retirement, John actually needs $6,029 less because he’s been able to permanently reduce his expenses. This allows John to reduce the amount he puts into his retirement savings by $10 per month.
This frees up money for John’s other savings goals, like maybe a wedding in the near future 😉
3. Smaller Emergency Fund Required
The third benefit of saving more money is that you can reduce the size of your emergency fund.
John keeps 6 months of expenses in an emergency fund. Reducing his expenses by $30/month means he can reduce his emergency fund by $180. This is because his overall monthly budget is now lower as he does not need to have money put aside for bi-weekly takeout.
John can now put that money to work in a better way. Emergency funds are usually held in safe places like high interest savings accounts. These accounts provide minimal returns. Usually less than inflation. But by reducing his expenses John can take $180 out of his emergency fund and put it to work. Investing this amount will let this money grow much faster.
Through the power of compounding his original $180 will grow to $610 over 25 years.
Bonus: More Flexibility
The bonus benefit of saving more money is that you’re more flexible. If you ever face a financial emergency you’ll have a bit more breathing room thanks to the effort you put into saving more money.
Flexibility is a ‘soft’ benefit of reducing your expenses. Having additional flexibility doesn’t provide any financial benefit but it does provide a huge psychological benefit.
Saving more money makes you more flexible and lets you feel better about your finances.
Lower expenses means you’re able to get by on less in the event of layoff or disability. You also have additional savings that can be re-directed to more immediate needs should they arise, like a new roof or an expensive car repair.
That feeling of flexibility in the face of hardship can be very beneficial. This makes John happy!
Reducing Expenses vs Making More Money
Of course, making more money is the other way to achieve your financial goals. This is definitely an important strategy, especially for those just starting out in their careers, but it’s definitely not the only way to achieve your goals.
The reason why saving more money is twice as effective as making more money, is because the extra money you earn is taxed at your marginal tax rate. You lose a big chunk of every dollar you earn right off the bat. But when you save more money every dollar is yours to keep.
Making an extra $1 is actually just $0.70 after-tax**.
After tax a pay raise of $30/month is worth $12,300 when invested every month for 25 years.
Compare this with saving $30/month which is worth $17,572 + $6,029 + $610 = $24,210!
That is why a penny saved is actually worth TWO pennies earned.
*Assuming a 5% real return. All values are in today’s dollars.
**Assuming a 30% marginal tax rate.
Founder of PlanEasy Inc.
An avid traveler, father and personal finance expert. Owen's goal is to make financial planning easy. He believes that objective and straightforward financial planning is something that every Canadian should have access to. Find out why.