How to Be Really Rich With Less Money

Most people define their net worth in dollars. As a financial planner, I define net worth in time. Allow me to explain.

Hour glassWhen I ask people to tell me what money means to them, I hear words like freedom, security and independence. Money, and having enough of it, allows us to do whatever it is that makes us happy. Reframing wealth as time turns some millionaires into paupers, and it makes those with $250,000 in 401(k) savings into the very wealthy. That’s because it defines wealth in the following way:

Wealth in years = net worth in dollars / annual expenditures.

Using this measure, someone worth $10 million, leading an extravagant lifestyle costing $2 million a year, has only five years of independence. The person worth $250,000, who needs only $10,000 a year to supplement Social Security, has 25 years of financial independence. This second person might never need to work again.

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We would naturally expect their portfolios to grow, yet so would their expenditures as inflation and taxes eat away at their gains. It may be reasonable to assume that the after-tax growth in their net worth might only keep up with inflation.

Considering the lifestyles of both, one might think that the person with the $10 million and extravagant lifestyle would be happier. Research demonstrates, however, that he or she may be only marginally happier. Sure, the big house and luxury car might bring short-term happiness, but it would be followed by the anxiety of running out of money to support that lifestyle.

How to build wealth

Implications of this measure for building wealth are enormous. The main ways to build wealth are to earn more or spend less, or doing both.

Earning more is always good, yet it actually has a far lower impact on years of financial freedom than spending less. That’s because earning more means giving some away in taxes, combined with the fact that you hopefully won’t work the rest of your life. On the other hand, spending less has a much greater impact, as the government doesn’t tax money you don’t spend and we can spend less throughout our retirement.

As an example, let’s say that a 50-year-old can make $10,000 a year more and will retire in 15 years, which translates to $150,000. But if a third goes to taxes, he is left with only an additional $100,000. On the other hand, if he spends $10,000 a year less and has a 33-year life expectancy, that translates to $330,000 in savings.

In the above example, lowering annual expenditures by $10,000 had an approximately 3.3-fold benefit over earning $10,000 more. That means a dollar saved is worth far more than a dollar earned; in the example, it equaled approximately $3.30.

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finanical wealthSo how much money you need to live on is a far greater factor in determining your wealth, as measured by the freedom to do what makes you happy. Say you get to Social Security age and have saved $250,000. Depending on how much you need each year to live on to supplement your Social Security, your wealth could vary wildly from a couple of years to the rest of your life.

Spending less today has a doubling effect. It increases the amount of your savings and decreases the amount of the portfolio you will need to spend each year. Both will build wealth at an accelerated rate, and then you have the freedom to do what you want for the rest of your life. That’s what I call wealth.

Photo: DNY59/iStock

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1 comments
goldye
goldye 5pts

We followed this strategy to the T being frugal with our monthly expenses.  What the article doesn't mention is family, acquaintances & co-workers are ripe for bullying you because of your frugal lifestyle.  The worst is family because you can't discard them from your life.  The scars we had to endure from my Mom was unbelievable. The truth is her 2nd marriage was to a wealthy man & without his money, she would be the poor widower.   Now at 90 yrs. her fortune is gone with little to inherit.  Am I thrilled my husband & I lived a frugal lifestyle and socked away money in savings - you betcha!  We must have ESP!  Another thing - my kids learned it's OK to live in rented apartments instead of nice houses.  It's OK if Mom & Dad say sorry, we can't afford it.  It's OK if we don't go on vacation every summer.  On the other hand, I had the luxury of being a stay at home Mom for 13 yrs. & we survived on 1 income.  My husband had a secure teaching career with excellent benefits.  Fast forward today - we get to retire early (60 & 65 yrs.).  We're financially secure for the rest of our lives - thanks to all that frugal savings.  And I can brag & gloat to all my baby boomer cohorts that I will watch you suffer as you all need to work until you're 80 yrs. because none of you have enough money saved for retirement.  And while all of you are working 5 days/week, I'll be sunbathing myself in the Caribbean or some other vacation spot & teeing off on the golf course.