Some people think a raise in income should automatically equal a raise in their spending. But if our spending always follows our earnings then we would have to change our lifestyle habits every time we change jobs or get salary adjustments. Does this mean Elon Musk, CEO of Tesla Motors, who made $78 million last year should only drink water from Acqua di Cristallo? It’s the world’s most expensive bottled water. Each 750 ml bottle sells for $60,000. Jumpin’ jelly beans 😯 After all, Elon has to find ways to spend his money in order to match his income right? 😛
Thinking about income and expenses on a year by year basis leads to myopia and it’s how many people get stuck living paycheque to paycheque 🙁 They fail to see the longer term picture because they can’t escape their short term cycle of income fueled spending. What they should try to focus on instead is goal oriented spending 🙂
Making money usually gives us the power to spend. In today’s world however, we don’t need incomes to spend anymore. We have credit for that 🙂 Student loans for example, allow people to attend school even if they have no income. It’s okay to spend beyond our means because we’re just stealing money from ourselves in the future, which we can always repay later. This is true for saving money as well, but has the opposite affect. The reason we should unchain our spending habits from our incomes is because how much we spend and save shouldn’t be determined by how much we make. The decision should instead be based on what our future goals are.
A popular rule in personal finance is to live within our means. But what percentage of our incomes should we be saving? Well instead of picking an arbitrary target savings rate, it’s much easier and practical to decide on a long term financial goal and pick a reasonable saving rate based on that 😉 For example, based on how many more years you plan to work, your current portfolio value, and your current salary, you can get a rough idea of what your current savings rate should be. The detailed calculations can be done however you want. The important thing is to understand why you’re saving that amount because if life throws you a curve ball you’ll know how to adjust your savings accordingly 😉
But it’s hard to think differently sometimes when even financial experts are giving confusing advice. Here’s a quote from Canada’s largest bank, RBC Royal Bank’s website about emergency funds.
Most financial experts suggest you have at least three months’ salary in your emergency fund. How much is that for you?
How much is 3 months’ salary for me? The answer is irrelevant for setting up an emergency fund because RBC is assuming my salary is the same as my expenses. No wonder people identify spending with income so closely.
Random useless fact: Belgium spent $1.15 billion on World War I.