When a Dollar isn’t a Dollar: The Case for Cutting Costs

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What if I were to tell you that a dollar isn’t really a dollar? You’d certainly look at me like I was crazy, right? Of course you would. But it turns out that most of the time when we think about spending or earning a dollar, it really ISN’T a dollar at all. At least, they aren’t the SAME dollar.

It’s a tricky mind-game, and part of the reason I believe we tend to spend more than we think.

Make Believe Time

Let’s imagine a scenario where after graduating college you land a job making $1000 each week ($52,000 a year). You’re elated – it’s a good job, good pay, and a solid company. You find an okay apartment for $800/month to save some money because you’ve got other debt to take care of. Smart move for you.

For the purposes of this illustration let’s assume that you get paid twice per month, on the 15th and 30th. Your take-home pay is about $1500 each pay period, or $3000/month. Over the next few months, you hammer through your work quickly and effectively. You become a rockstar on your team. You focus on paying down debt and keeping your expenses low, but the $800 apartment you’re living in starts to feel cramped.

Hard Work Pays Off

Then comes the end of the year. At your year-end review, your manager recognizes the hard work you’ve been doing and gives you a $6000 raise going into next year! Woot!! You’ve been super cheap with your living expenses, and your lease is up anyway, so you decide to move into a nicer place. Since you have gotten a raise, you can afford it, right?!

Quick: how much extra do you have each month to allocate to this new place compared to last year?

If you answered an extra $500 ($6000/12), I’ve got bad news for you.

When A Dollar Isn’t A Dollar

You see, a dollar earned isn’t really a dollar in your pocket. When your income increases, it’s subject to taxes, a frequently over-looked expense from your gross income. If you’re contributing to a 401(k), that also eats a percentage of your raise.

Psychology is a weird thing. Getting over this mental hurdle is crucial in order to understand the impacts of earning more money and what it means to your net pay. But that math also points out an equally important truth, albeit more subtly: a dollar decrease in your expenses is worth more than a dollar increase in your income.

How To Make A Dollar Worth A Dollar

That extra $500 you’re after in your budget? It’ll take much more than $6000 in additional income each year to generate. Due to taxes and other deductions from your gross pay, you’ll need to be earning an extra ~$7500-$9000 each year to get an extra $500 in your monthly budget.

If that doesn’t seem like it’s appealing or possible, I’ve got good news. Freeing up money in your budget by cutting expenses can often lead to even better results. Reducing your monthly dining out expenses by a dollar directly puts an additional dollar into your budget to be allocated elsewhere. Being able to use that extra dollar, fully, however you want is nice. You won’t get that from just increasing your income by the ‘same’ amount.

Long-Term Benefits

The nice thing about finding places to slash your budget is that if you can do so comfortably, you can repeat those savings month after month. Make sure you save or invest the difference. Cutting out money from a bloated monthly expense is great, but not tracking where it goes to instead is a net loss. At least when you knew you were spending too much on eating out at restaurants you knew where the money was going.

Income Matters

Of course, I’m not trying to imply here that growing your income is foolish or a less-than-admirable goal. I’ve focused significantly on growing my income throughout my career with great success. It’s an important part of the equation that deserves a solid effort on your part. However, it’s important to understand what the actual impacts are to your net pay. Psychology WILL get the best of you if you let it.

It’s important to be aware of how changes in both your income and your expenses truly impact your financial well-being. It is quite easy to overestimate the power of raising your income and underestimate the power of cutting your expenses. It’s true that income has virtually no ceiling while expenses certainly have a floor. A dollar slashed from your budget, however, will always be worth more than an extra taxed dollar earned. Until you’re at the point where you can’t slash expenses more, don’t overlook this part of the financial equation, no matter how much you raise your income.

Question:

What do you like to focus on more: earning more money or cutting expenses? Or have you found a healthy balance?

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10 Comments

    1. It’s definitely under-estimated by folks who don’t want to practice frugality. I can’t deny the power of increasing your income, but the impact that cutting costs has is HUGE. Plus, it means you can live on LESS which means you need less money to be FIRE!

  1. True. It’s math! I wrote something similar over at my blog about this, opportunity costs I think. And when a dollar isn’t a dollar, that type of thing. It’s good to reinforce this concept by continuous repetition. Like anything worth remembering. Once you start only making 50 cents on the dollar, the justification for one additional dollar gets to become lower and lower. The incentives start deteriorating. That said, I’ll take that extra 50 cents any day =) haha! Back to work, I go…

    1. Haha I totally agree with you on taking the extra, no matter how small it is. It is important to not overlook the other side of the equation though which some folks tend to!

  2. While the income side of the house is important and can be “ceiling-less”, I agree with the previous commenters that cutting expenses is truly key. If one can learn to live on less and take pleasure in simple joys without everything the marketers tell us we “need”, the result is a more free, enjoyable life filled with real value.

    1. So true! I always wondered why companies spend so much money on advertising and Superbowl ads, but when you see how much money people spend on stuff they don’t need to impress people they don’t like, it all makes sense (and is a bit depressing haha)

  3. Cut them costs. It is the only way. I have recently stopped chasing income and just started focusing on getting my spending back under control. I always think back to the tiny amount I spent in college and right after I graduated. I really want to hit that magical 50% savings rate.

    Even Floyd Money Mayweather is having to take fights against MMA fighters to pay off his tax bill. High income earners prove time and time again that you can always out spend your income.

    1. Nice! 50% is awesome. I just did some napkin math and we’re around 45%. I want to do a much better job moving forward of tracking SR as compared to just worrying about income, expenses, or net worth. Having the complete picture is crucial!

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