We've covered a lot of ground when it comes to saving money. But what about spending money? Ultimately, the absolute amount of money you spend doesn't matter nearly as much as the amount of money you spend relative to your income and net worth. If you are 50 years old, have no debt, $2,000,000 in cash in the bank, earning $600,000 per year, own your home outright, and have multiple streams of income that aren't at risk of disappearing at the same time, it really doesn't matter if you want to spend money on things other people would consider ridiculous, such as a $30,000 set of sterling silver flatware or $6,000 Brioni suits. Why? Every year, you should be adding to your net worth to generate even more money next year, despite the large sums you spend because you are still living far below your means, generating a surplus.
On the other hand, if you have no savings, $20,000 in credit card debt, $15,000 in student loan debt, a mortgage, a car payment, and your household relies on one or two jobs to cover you expenses, spending $70 going to dinner and a movie is far too expensive. It is irresponsible. You are living on the edge of disaster and every excess penny should be going to reduce your liabilities, bolster your savings, and create passive sources of income that will still be there if you lose your job.
That may seem counterintuitive but sometimes it helps to examine extremes. Consider two men, both of whom live in the same town.
John owns a couple of paint stores. He's successful, nearing retirement. He earns $250 per hour (roughly $500,000 per year). He has no debt. His portfolio is stuffed with millions of dollars in blue chip stocks, a collection of Series I savings bonds, and some good real estate investments. He likes nice things. At night, he sits at home in an $800 cashmere sweater, writing with a $2,000 fountain pen, drinking out of a $400 gold-rimmed coffee cup, listening to music on a mahogany grand piano with a player system built into it, giving away thousands of dollars through his family's charity, and reading $300 leather-bound, gold-edged books. For dinner, he spent $200 taking his family out to a decent mid-tier restaurant.
Adam is a retail worker. He works hard. He earns $10 an hour ($20,000 per year). He lives in a run-down apartment. He hasn't bought new clothes in five years. His car barely runs. He keeps the heat off to save money. For dinner, his family spent $30 at McDonald's for cheeseburgers, fries, and Coke.
John is behaving far more frugally than Adam when it comes to saving money. For dinner, he only had to trade 0.8 hours of his time to pay for food, whereas Adam spent 3.0 hours of his time. That is, even though John's family dinner was $200, it was cheaper on an economic basis than Adam's family dinner at $30. To be specific, Adam paid 375% more for his food than John did. Adam can't afford to eat at McDonald's. He should, instead, grow and prepare his own food and put the excess in savings so that he can end up like John. In fact, looking at the data for the United States, almost all of the John's of the nation began like Adam. Adam could have been John when John was younger.
Focus On Your Savings Rate - The PSAVERT Ratio
A good way to measure your success at savings is your so-called savings rate. Look at the total cash you save each year, money parked in the bank, principal repaid on debt, and investments added to 401(k) plans or IRAs, and then compare that to your household income. Alternatively, you can use the PSAVERT ratio, the Personal Savings Rate, released by The Federal Reserve. You can view the historical savings rate of your fellow Americans by year.
I'm a big fan of savings rates over 20% but I elaborate in How Much Money Should I Be Saving?. If you earn $1,000 a paycheck, I'd want to see at least $200 of that going to some sort of well-researched and chosen savings or investment account.
The big lesson is to stop spending out of someone else's pocketbook, as my grandmother would say. The guy a few blocks over might be behaving far more frugally buying a $200,000 Bentley than you would be buying an $80 watch. Every year, you should be adding to your bottom line and your household income above and beyond the rate of inflation. If you aren't, you are doing it wrong.
