Framework For Thinking Through Personal Finance

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(Warning: The following post is very stream-of-consciousness and written on very little sleep.)

While doodling today (I doodle a lot) I started thinking about money and how it such an overwhelming issue at times. I read so much advice from so many different directions, my head starts to spin. I ended up drawing this:


Basically, the idea is that if you want more money, you should focus in on one of these three areas:

Spend Less
Either through buying less goods and services, or by finding a lower price for the same goods and services, one can spend less money each month. Much of this is psychological, as most of what we buy are “wants” and not “needs”. Long-time habits and deeply ingrained notions may need to be broken. Priorities need to be consciously decided. However, there comes a point where it is simply not possible to spend any less.

Invest Better
With the money that is saved, one would want to make it grow as much as possible. Here, I am focusing more on passive investments like stocks, mutual funds, bonds, or gold. There are many competing theories as to whether skill is a factor in picking stocks. Personally, I believe that the markets are mainly efficient, and that “beating the market” is exceedingly unlikely. All that can be done is to maximize your risk/reward ratio. Therefore, there is also a maximum value on how “well” we can invest.

Earn More
This is done via work, either through being an employee, or starting your own business and becoming the employer. Ways to advance in your career include more education, better interpersonal skills, or otherwise achieving positive results and getting promoted. Other more individual ventures include real estate investing, building a business with employees, or creative works that produce “passive income”. These come with additional risk of losing money, but also offer added upside.

Priorities and Diminishing Returns
I feel that the first two, Spending Less, and Investing Better, should be the first to be addressed. If very little attention has been paid to these two areas, a lot of progress can be made. Of course, it can probably be a lifelong process to make sure these things continue to be taken care of. Lots of energy can be spent trying to optimize both (!). However, at some point, I think there will be diminishing returns. When you start considering about whether you should flush the toilet every time you use it in order to save water, perhaps it’s time to focus on other things. 😀 Similarly, there is only so much I can make from maximizing bank interest and picking a optimum asset allocation. Of course, if you reach a happy place already, you don’t even need to Earn More.

In a way, I think Spending Less and Investing Better are appropriately located at the base of the triangle. After building a good foundation, you can start taking some risks in the Earning More area. I think for most people this is the hardest part. It can be very hard to increase one’s salary if they feel they are stuck in their current career. Maybe they are comfortable already. Taking classes, switching jobs, it can be very stressful. On the other hand, it is also the one with limitless boundaries.

I know I already discuss these things on a daily basis, but I think it can also be good to methodically examine one’s progress in each of these areas every so often.

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  1. I think I am okay in the spend less, invest better categories. I need to work on earning more. I’m trying to get a front office position as an analyst, but it’s been tough so far. Doing operations/back office is okay, but I need to make a leap to the front office to do what I really want.

  2. I work in the back office/operations..yeah it’s tough to move up to front office…

  3. I?m working on all three of these constantly. I certainly appreciate all of the discussions on index mutual funds, etfs, and buying through low fee/no fee brokers like Zecco. Lately, I?ve been revisiting the idea of no fee, direct stock purchase plans (DSPPs) and then buying and holding onto these reputable companies with decent earnings up until the second coming. In particular: PG, PFE, NVS, HCP, and AFL.

    There are many other low fee or no fee DSPPs and DRIPs out there of course, but these were my selections. Any thoughts on DSPPs?

  4. Good point.

    However, i have to say that if you spend less all the time, your life will be so boring, it’s not even funny.

    My goal is to hit a happy medium…where i can spend on something that I really like, such as watches ( i love watches) and still have enough to invest.

  5. If you wanted to make your diagram more complex, you could run a lateral dotted line across the middle of the triangle. Above the line could be the word “Earn” and below the line “Save.” I’m having second thoughts, but the line would illustrate that the bulk of personal finance has to do with saving (spending less and managing your savings) and more minimally with earning.

  6. You know what, I disagree with what I said above because one of the biggest ways to make a difference is getting a higher paying job (much more than deliberating in front of the lunch meat aisle at the grocery store).

  7. Steve Austin says

    Let me try that again. I used some bad code when I typed this:

    Instead of making the diagram more complex (Ryan), why not simplify it? Giving [Invest Better] its own triangle vertex is redundant. Matters of money come down to the simple, binary Earn More — Spend Less continuum. Investment is a subset of that continuum: the objective of investment is, for a given risk tolerance, to pay as little as possible [Spend Less] for the highest yielding/appreciating financial vehicle [Earn More]. (e.g. for stocks that would be high dividend yields and/or high capital gains).

    Note that ‘earn’ does not have to be defined per the IRS as W-2 earnings, but rather any activity in which time/effort/funds/luck is input and financial compensation is output.

  8. Hate to say this man, but you are obviously becoming more and more obsessed with money. I dont know if you are a religious guy or not, but perhaps you should start thinking about what happens if you were to die tomorrow. All that hard work you put into saving and thinking about money will be gone like a little flame that is extinguished in the eternal depths of space.

  9. I am in such a quandary also, left a higher paying salaried position for one with lower fixed salary with uncapped commission so now have to balance the increased outflow due to lower monthly income while trolling for increased income.

    Moves to increase income may or may not be stepwise improvements – and there may be added costs – you move into the front office and now you need a better wardrobe – you are required to travel (trust me no matter what the company reimbursement policy you will spent your own money if you travel to reasonably cool places), etc…

    I think the dilemma revolves around the fact that life progresses slowly and we can’t run the simulation any faster to see what the effects of say cutting out prosciutto from my deli order will yield but we know what a few extra $$ in the pay check brings.

  10. Although you stated it was “very stream-of-consciousness and written on very little sleep,” I’d just like to take issue with a couple of your points.

    1) “…as most of what we buy are ?wants? and not ?needs?”

    That’s not true. Housing (a need) usually makes up a third or more of income. I’d also argue that things like car payments (not Lexus car payments, but at least Honda car payments), food (not dining out, but at least groceries), certain types of insurance, utilities (perhaps not cable, but at least electricity), gasoline, clothes (perhaps not designers names, but at least clothes for warmth and work) and many other expenses are all required expenses where you have very little leeway. These line items certainly total more than half of income for the vast majority of people.

    2)”On the other hand, (earning more) is also the one with limitless boundaries.”

    Not true. Saving more is limited by how much you spend, but investing better and earning more are both limitless. Sure it’s tough to posts returns significantly better than the market, but it is also very difficult to earn significantly more than your peers. While not easily accomplished, both of these offer unlimited upside.

  11. This is Personal Finance 101. Very elementary and very boring.
    I expect better from you.

  12. very interesting — what a good point. The spend less/invest better strategies have less stress associated with them. Which is probably why it’s so fun to analyze how to do these better. I spend good thought on both of these, almost every day. Lately, I’ve gotten help investing (through my retirement plan). Spending Less? Not much lately, but if I had a good reason, I would.

    But that “earn more” thing – yes – that’s only when I feel brave. How would the “make money off of 0% credit cards” fit in here? Is that investing or earning more? Because it’s income that I wouldn’t have had otherwise. Honestly, I’m still not sure if the $250 I’m earning was worth the risk — but it did open my eyes that I could be earning “other” income. My question now is really what can I do in this regard, that’s kind of low stress with a big return? Probably not much, right? Because switching jobs is stressful and full of risks. I want something less yang.

  13. Bert – A happy medium is very important. Hard to quantify though.

    Ryan – I think you illustrate the back-and-forth that many people have. I tend to think saving more is easier than earning more, but others may disagree.

    Steve – I thought about that as well. I think my point is that people keep spending so much time on investing, when I really think after you reach a certain point it’s pretty hard to do that much better.

    Nick – I think it’s hard to judge somebody’s life based on a blog that only focuses on one interest. In fact, I think I’ve become less interested in money in the recent months relative to other things.

    Barry – I think you are where I am, thinking of things on a very abstract level.

    Mike – There is certainly a floor, but much of it is still priorities. Housing may make up a third of your expenses, but I’ve seen 3 people share a 400 sq ft studio and pay $150 a month in rent. That fulfills their ‘needs’. Many people make do without cars.

    “Sure it?s tough to posts returns significantly better than the market, but it is also very difficult to earn significantly more than your peers.”

    Huge pension companies can’t beat the market after expenses, so I have a hard time believing I can. We’ll have to disagree on this one.

    Paul – I think you are where I was about 6am this morning when I thought “why did I post such an abstract post?”

    mimi – I would put it as earning more. As for the rest, lots of hard questions 🙂

  14. @Nick re: his philosophical comment

    I don’t think personal finance bloggers like Jonathon are necessarily overly obsessed with money or frugality. It is just a way of life and a hobby. Some people play an instrument, others like to run marathons, while some have a passion for golf. All of these things are just interests and a way of life. It’s just one of the many ways of organizing one’s life and living efficiently.

  15. You forgot to add in “pay more taxes” because in CA where anyone making 100K or more pay 10k right off the top to the state, another 20k to the feds/ss/etc. another 15-25k to real estate tax and another 8-9% on almost all purchases to sales tax and ludicrous vehicle registration fees tax.

    Did I miss anything?

    Leaves a six-figure earner who just bought a house with enough left for a cup of coffee. 🙂

  16. Steve Austin says

    Jonathan, I can convince myself of the converse: after one reaches a certain point in saving (accumulating investable assets), what one does with what one has saved becomes more important than how much more one earns for ongoing savings. (The Crossover Point from Your Money Or Your Life, and other books.)

  17. Paul – is the pot calling the kettle black? Sorry but my pet peeve is when people criticize unimaginatively and unconstructively.

    The “Four Hour Workweek” guy had an interesting rule of thumb on the work more/spend less decision… basically, if you can pay someone to do work for you (let’s say: cleaning your house), as long as it costs less than 1/2 of your salary (or for example, your “side work” monies) you should pull the trigger and outsource that work. The 1/2 of your salary roughly comes from a ballpark on how much you would pay of your salary on taxes.

  18. Robert,

    Ahhhhhhhhh…………you just brought up a good point!!!

    Property Tax!!!

    One of my strategies for keeping “LIFE” affordable is to make sure that I **NEVER** sell my house!! Bought new in So Cal in 1995 (think 1/2 price of today) and because we have prop 13 in place (fingers crossed) hopefully I’ll never pay any more than the prevailing percentage on the ORIGINAL SALE PRICE of my home in 1995!!!

    I may buy another house some day, but I’ll NEVER give the state of California the satisfaction of collecting any more money on my parcel of California Real Estate than they do as of this very day!!!!!! 🙂

    But I’m not bitter or anything………….. LOL!!! 😉

  19. I’d also like to point out that this is very dependent on where you are in life.

    For example, I am a college student and I will graduate with around 35k debt. Obviously, there is not much I can do on the investing front (sadly student loans are no longer 2%) – particularly because I want to pay off my loans before I put any money in stocks (some might disagree, but to each their own). Instead, I easily focus the majority of my time on building a strong resume through education and taking advantage of career building opportunities. I also attempt to spend less when I can (thrift stores, not eating out, used textbooks…), but I try not to skimp out on fun things – particularly group outings – such as going to concerts.

    Another example would be a retired person who does not want to do side projects to earn money. They would focus primarily on investing, as well as spending less. Disclaimer: this is from the perspective of a college student.

  20. I have to agree with the earlier commentor who said that actually most of our costs come from needs and not wants. It is the being able to control the wants that separates good savers from big spenders though.

  21. P. Lubinsky says

    DON”T MAKE THE SAME MISTAKE I DID!!! I posted a similar comment when I was finishing up grad school on a financial website and I was warned about paying off my student loans early. So I owe it you to pass on this knowledge.

    If your interest rates are fixed just pay the minimum payment.
    If they are variable and/or the interst rate is higher than say 9% THEN go ahead and pay off the student loan early.

    I look back now at the investment opportunities I passed up for the mental pleasure of putting a dent in my school loans 5 years ago and I kick myself in the butt!

    Original reply by Phillip:
    Obviously, there is not much I can do on the investing front (sadly student loans are no longer 2%) – particularly because I want to pay off my loans before I put any money in stocks (some might disagree, but to each their own)…..

  22. There’s a good point there by P. Lubinsky. If your rate is fixed, then every year your payment is made by dollars that are less and less valuable (because of inflation). There’s something to be said for taking today’s valuable dollars and using them wisely in investments and holding off to spend your comparatively worthless dollars on that loan.

  23. Don’s comment is interesting. The max contribution for an IRA is 4,000. If next year stays the same, that 2008 $4000 is worth way less! The equivalent (at 3% inflation) is $4120. That’s less dinero that’s compounding.

  24. Mark Asbell says

    Nice doodle. Makes sense. Well supported by your statements. Would you mind if I develop that in to a little seminar and sell tickets to hear me talk about it? Its for my ‘earn more’ part of the diagram. I’ll give you a small percentage like a royalty – that’s passive income for you… If only it were as easy as I’m making it sound. I liked the doodle. Thanks for sharing.

  25. Steve Austin says

    Don, that’s how guv’mints explain away debt via budget deficits. But individuals are not guv’mints. Let’s hear what Lubinsky’s school loan rates are (were?) before we pass judgment on the merits of paying off fixed-rate debt vis investing in the variable-rate stock market (or other higher-yielding investments).

  26. Hey Jonathan;

    You’re getting a lot of flack, so I want to throw in my 2 cents and say that I appreciate the post.

    As to this comment though: After building a good foundation, you can start taking some risks in the Earning More area. I think for most people this is the hardest part.

    I think you may be wearing rose-colored “I make 100k/year” glasses. In your case you’re already way out in front here. The truth is, I know lots of people who could do way more of the saving and maybe a little more of the investing. But I know tons of people who could do more of the “Make more money” stuff.

    Making more money is part risk (as you’ve stated), but there are a lot of brains and hard work involved. Unless you’re already a working professional (and even if you are), there’s usually a lot of upward mobility for the top workers.

    You’re at 100k/year in computing which is pretty much top of the field for anyone under 30. To double your salary (200k), you would basically be in the “kid genius” range. Lots of under-30s (and even over-30s) that I know are making way less money, some with even more responsibility.

    I personally left a job that simply wasn’t paying enough for what I was doing. They haven’t really been able to replace me, heck neither of the past two jobs have found stable replacements for me and they’ve both made me offers to come back. I’ve been able to build my salary both by jumping around and by performing, but I also treat my career very differently than most people.

    I have a very business-oriented “you-scratch-my-back-I’ll-scratch-yours” take on work and pay. Very, very few people I’ve met actually run the numbers the way that I do, or do the readings and watch the finances the way that I do. They’re going to be hobbled not just by risk aversion but by simple failure to correctly play the employment game.

  27. simple, if it’s yellow let it mellow…thanks for the abstract thoughts.

  28. P. Lubinsky says

    My loans are all Stafford Loans (guv’mint) at a whopping 4.5% locked in 4 life. I just pay the minimum each month and expect to pay them like that till I kick the bucket.

  29. Regarding Earn More. I used to work in a high-tech PR and I earned all-right but I worked long hours. I now work as an event entertainer, a balloon artist. You can click on my name to see how I do it. And I earn just as much as I did with my PR job. I now only work weekends and I am self-employed. I am free all days weekdays to do anything I want and earn more if I want.

    My only regret is that I didn’t learn about this opportunity sooner. I have a serious academic background. I immigrated to the US from Russia where I got an MD degree. I also have a strong interest in finance. It is not like I came from a circus family, or something. I am serious as they come.

    Just an idea for some people if they want to explore this. Even if you have a serious job on weekdays, you can earn as an event entertainer on weekends. I wish someone told me this a few years ago.

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