How many times have you sworn to boost your savings by cutting some discretionary expenses here and there only to realize you’re not gaining much headway? There’s a lot of personal finance advice out there touting the way to save money is to cut your discretionary expenses. Be it brown bagging it to work to cutting out that $4 latte, to even cutting the cord (cable). These are al well and good to putting you on your way to save some money but it won’t be much.
Let’s say you found a way to save an extra $100 every month. Ok, that’s $1,200 after a year. Not bad you think. I say that’s small potatoes! One little trip to the doctor or untimely need for a dental procedure and poof, it’s gone. In reality, is saving an extra 1-5% of your income really going to move the needle for your financial situation?
Too many people get caught up picking up pennies but in the process stepping over dollars. If you’re reading this, this scenario will be no more for you. To really move the needle to get ahead financially in life, you must focus on your biggest expenses if you want to save the most money and thus grow your wealth, or improve your financial situation the fastest. Well what are your biggest expenses you may wonder?
Most of you would be right to think that housing would be at the top of the list. Everything else you can think of is probably not one of your biggest expenses, although, if you own a car or multiple cars, they can begin to creep up there into leading you to the poor house. So what are your two biggest expenses? Well here it is… Drum roll…
Yes, it’s true. Most people don’t think as these two items as an expense or they’re generally not calculated into the budget. But alas, focusing on these to items will bring you more bang for your buck than any other thing you can think of to cut or clip a few coupons to save money.
Our expenses are largely within our control. We put ourselves into the situation in the first place to have the expenses that we have. Although housing is one of the major things that can make or break a budget, most people are not very willing to just pack up and move into a smaller home or get a cheaper place to rent. It’s a drastic scenario. So we will not focus on this big expense in the budget today. Transportation expenses aside as well, as they can be easily cut by getting yourself a bike.
The first major expense we will look to cut is taxes. Taxes matter. They are a huge wealth drainer. The wealthy spend tens of thousands of dollars or more to arm themselves with the best tax accountants and lawyers possible. There’s a reason for this. In the process, they save themselves hundreds of thousands to millions or more. The question should not be, “How much does it cost to hire so and so accountant,” but rather, “How much can they save me on my taxes!”
In order to get the upper hand on paying less taxes, it’s important to hire a good tax accountant and then have consultations way prior to tax season to find out what you need to do to save money on taxes next year. That way you will be able to actively take steps to reduce taxes now and not be hamstrung at tax time when there aren’t many more options left to better your situation.
Consider for a moment the impact that taxes have on your wealth building. Let’s say the Joe Smith family makes $100,000 a year in income. Not bad right? Some would say they are sitting pretty! But the Smith’s are barely making it and wonder where all of their money goes. They certainly don’t feel like they are living a middle class lifestyle let alone feel wealthy!
Here we might shed some light onto why the Smith’s don’t feel like they have a lot of money. Here is a breakdown of their tax situation (They live in Oregon):
|Tax Type||Marginal Tax Rate||Effective Tax Rate||2019 Taxes*|
|Total Income Taxes||23.87%||$23,869|
|Income After Taxes||$76,131|
As you can see, they’re paying almost $24,000 in taxes every year. That is a quarter of their pay! For every 4th day that they go to work, they are working for free basically that day. They won’t see a penny of the money they earned on that fourth day. The story doesn’t end there unfortunately. They still need to pay more taxes! Here is a few more that you might not have thought of:
Total Estimated 2018 Tax Burden
Income Tax $23,869
Sales Tax $0
Fuel Tax $422
Total Estimated Tax Burden $27,027
Percent of income to taxes = 30%
Let’s also add in other excises taxes if you purchase any airline tickets, tobacco, alcohol, and health-related goods and services. Now the Smith’s are looking at about a third of their income gone to the taxman. Now instead of every 4th day working for free, it’s every 3rd day! Whoa this is heavy! All the Smith’s are left with is 66% of what they actually made. They haven’t even begun to pay one bill let alone feed themselves.
The bottom line is, taxes matter a lot! Contrary to what most think that taxes are unavoidable, they most certainly are to a larger extent. Here’s a hint how: The government rewards savers (by not taxing them) but they punish spenders (by taxing them.) It pays to schedule a visit with a tax professional who will be on your team and help you fight the tax man by laying out a plan to lessen your taxes. Yes, there are many ways.
Ok, so now, back to our family, the Smith’s. They’re left with 66% of their income before they can spend a dime. But what must be paid first before any other thing besides taxes? Yes, our second biggest expense, interest. The reality for most Americans is that we are a nation in debt. With debt comes interest. Before we even get out of bed, pour our morning coffee, or eat breakfast, interest has accrued that must be paid and paid now! First there’s interest on the mortgage (or if renting, interest on the Landlord’s mortgage passed onto you as part of the rent.) Then there’s student loans, credit cards, auto loans, home equity loans, personal loans, payday loans, and whatever else loan you can think of.
Recent studies have shown that the average American family spends roughly 15% of their income just on interest from debt. 15% just on interest, the privilege of borrowing money! That is the only utility that interest gives us. Now, when we apply that 15% to the Smith’s situation, we can see that they are now left with roughly half of their money that they made. 50%! Their $100,000 has now become $50,000 just like that. And they still haven’t paid their bills (or the principle on their bills) or even got to feed themselves. Its no wonder the Smith’s don’t feel wealthy.
This knowledge should be used as motivation to pay down our debts. Getting rid of debt will get rid of the interest we pay, thus cutting one of our biggest expenses and in turn giving us the freedom to breath. Having no debt will allow not only financial comfort but also give us more options as to how we live our lives.
I encourage everyone to get rid of all debt as fast as possible. This will allow you the freedom to be your own master over your lives and to not go about life being a slave to your debtor. Having no debt will also free up a large amount of money in your monthly cash flow which will in turn give you greater flexibility to take advantage of tax saving strategies. Wealth will begin to increase at a rapid pace. Picture a snowball rolling down the mountain with a fresh coat of powder.
Now is the time to get on the right path financially. By focusing on these two big expenses, you will be on the path to financial freedom. Don’t get caught up in the little things, agonizing over 100 little purchases. Better to spend that energy elsewhere like focusing on reducing taxes and interest. Then you will have a lot more energy left to enjoy life itself instead of stressing over money.