One of the things we hear often about is that you can get rich if you just save the right amount of money. While there’s nothing wrong with penny pinching and living a frugal lifestyle, frugality does not pave the way to wealth.
On top of that, if you take the pennies you pinch and just put them into a savings account (even a “high yield” account), there is a good chance that you won’t end up as rich as you might like to be.
The Savings from Penny Pinching Might Not Add Up that Fast
Much has been made of strategies, like the Latte Factor, that are built around the idea that you can give up small expenses regularly to save up a great deal over your lifetime. While it’s true that you can see some good from the small expenses, you can see a bigger impact from the bigger items.
If you give up that $6 latte five days a week, you can save about $120 a month. But what if you could save $300 a month by refinancing your home (like I recently did)? You can have your latte and still come out ahead.
By prioritizing, and figuring out what is most important to you, it’s possible to find ways to cut out the things that you don’t care about, possibly saving you even more money over your lifetime, without denying yourself the little pleasures that you enjoy most about your everyday life.
You Could Do Better By Concentrating on Earning More
Rather than focusing on what you can cut out of your life, consider earning more money. You want that latte everyday? Well, make the extra $120 a month to cover the cost. And if you can make even more than that, so much the better.
At some point, you run out of things to cut. However, you can always find ways to make more money. Whether you start a side business, pick up an extra shift, or develop an income portfolio, it’s possible to earn more money. Your potential to create income is greater than your ability to cut costs. And it has the potential to yield even greater returns, no matter what you do with that money.
Rather than getting caught up in how you can squeeze two more dollars out of your budget, create a plan for adding an extra $100 to your income each month.
Low-Yield Savings Don’t Grow Fast Enough
Whether you are cutting your spending or earning more, you will need a place to put that extra cash. While it’s tempting to put it all into a safe, FDIC-insured high-yield savings account, this might not be your best option. While you want an emergency fund, and you want some liquid assets, you also need to realize that your money won’t grow fast enough to build wealth if you keep it in something “safe.”
In fact, if you keep money in a high-yield savings account, you could actually lose money in real terms, thanks to inflation. Inflation is an erosion of your buying power. It’s the loss of the dollar’s value. If your keep your money in a high-yield account paying 1% APY, you could lose money if the annual inflation rate is more than 1%.
In 2012, the average inflation rate for the year was 2.1%. That means that if your money was earning 1%, you were actually losing out at a rate of 1.1% in 2012.
You will have to invest your money in order to overcome inflation for the long haul if you want to build up a nest egg that will result in long-term wealth.
While it is a good idea to save money, cutting out the unimportant things from your life, and making sure that a portion of your portfolio is highly liquid, saving money isn’t the only strategy to follow to get rich. If you want to achieve financial freedom, you’ll also need to improve your income and invest.