Wednesday, June 19, 2013

Posted: 18 Jun 2013 01:00 PM PDT
As we’ve discussed before, an average American family with two children – a seven year old and a ten year old – spends $1,252 a month on food according to the USDA’s liberal food plan.
If that family adopted just a few frugal practices and were able to switch their food spending to the USDA’s low-cost plan, the family is now spending just $826.60 per month on food.
That simple shift results in a savings of $425.40 on food each month.
I certainly don’t have to tell most of you about the power of frugality, of course. Most of you know the mountains of savings a person can incur if they’re careful with their spending.
The challenge is that many people believe that a focus on investing means that you don’t have to worry much about frugality. After all, in the eyes of quite a few people out there, you simply can’t earn huge returns with frugality.
So, we’re going to stick just with this $425.40 per month that you can save just via food and not even deal with the money you can save on your energy bill, entertainment expenses, household supplies, automotive expenses, and other categories each month. This is just to show how important that $425.40 is per month.
For calculation’s sake, let’s remind ourselves that $425.40 per month is worth $5,104.80 over the course of a year.
Now, let’s say you actually have some money to invest. You took that money and did the obvious thing with it and stuck it into a very broad based index fund – the Vanguard Total Stock Market Index. Since 1992, this fund has returned 9.02% annually, which is a very nice return.
That’s the easy route – anyone could do this. Now, let’s say hypothetically you could spend ten hours a week focusing on investing strategy and find a way to earn 10.02% annually. If you were actually able to consistently beat the total stock market index by 1% year in and year out, you would be a total financial genius and ought to be working on Wall Street, but I’m trying to give investments the benefit of the doubt.
How much money would you have to have in investments to make those ten hours a week spent on investment management worth more than the ten hours a week spent on frugality?
Your target additional earning here is $5,104.80 – except, it’s actually more than that. If you’re investing these sums of money, you’re almost assuredly in the 33% tax bracket, so the amount we’re actually looking at is $7,657. Remember, money saved via frugality isn’t money you have to pay income taxes on.
So, how much money would you have to have invested in order to earn a $7,657 annual return by beating the Total Stock Market Index by 1% instead of just investing in it?
The answer is $765,700. If you have three quarters of a million dollars in your investments and you have the ability to find a way to consistently beat the market by 1% a year, only then can you earn as much via investing as you can via simple frugality.
Given that 72% of American households live paycheck to paycheck, I think it’s pretty safe to say that the vast majority of American households don’t have three quarters of a million dollars laying around to invest.
I’m not saying that investment is a worthless thing to think about. What I’m saying is that for most American families in their current situation, a focus on frugality is going to earn them much greater returns than investments will, and that statement will hold true for many years. If a family is very responsible with the money they save from frugality and use it to pay off debts and invest instead of finding other methods to inflate their lifestyle, then they will reach a point where investments matter more.
The truth is that it’s only a tiny minority of Americans have enough liquid wealth on hand to make their time spent managing investments worth more than their time spent being frugal once they have an initial automatic investment plan set in place. After that, almost all of us are far better off reading the grocery store flyer and making sure our tires are inflated than reading the latest mutual fund data.
The post Looking at Frugality as an Investment appeared first on The Simple Dollar.
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