I previously posted about the small changes you can make each day that can help you save money and eventually gain financial independence. The small changes like a daily coffee or eating out for lunch each day will always add up in the long run and they are good to adjust in order to reduce expenses, but let’s face it, if you stop drinking a daily coffee for €5, you won’t break the bank. That will not be the reason you will save hundreds of thousands in the next 10 or 15 years.
The big things matter more. There is no point in saving €150 each month on a coffee when you are going to spend 2 or 3 times that amount on a car loan. Not just a car loan but finance on a car that you can’t afford and shouldn’t even have.
Lifestyle inflation is a common phenomenon, especially in your 20s. You are new to work, you are earning money that you never had before and you are working hard and climbing the ladder which includes healthy raises. The expenses creep up because you buy a newer car, and move into a bigger house in a nicer neighbourhood.
If this is your situation, focus on the bigger picture first. Saving more money by downsizing your house, and trading your car in for something cheaper or ever a bike. Fail at optimizing these bigger expenses is what will stop you becoming financially independent.
I live in an apartment for €860/month. A few months ago, I started looking at other places to live in around the €500/month mark. This means €4,320 extra savings each year, leading to a compounded amount of €61,578 in 10 years.
At the same time I cut out my beloved diet coke. One per day at €1.70 leads to saving €1,241/year which compounds to €7,283 at the end of 10 years.
As you can see, there is a marked difference between these 2 changes. The one I should strive to alter first is the housing. It will lead to massive savings in the next 10 years. That €61,578 will grow even further if left compound over another 20 years. It becomes a whopping €238,289 without any further contributions.
Compare this to €28,182 as the final 30 year tally of not drinking a daily diet coke. Now that is still a large amount to have at the end of the savings period, but I think everyone would agree that it would be nicer to have the larger amount!
People spend too much time sweating the small day to day expenses that they can try change. They lose sight of the bigger expenses and can easily let 5 years slip by, making little to no impact on your net worth.
Imagine you manage to sort out all the big expenses; your house is downsized or you move somewhere more affordable, you get rid of your all too expensive car and trade in for a cheaper but reliable one that you buy in cash. You are in a great position!
NOW is the time to start sorting out the smaller things. Once the bigger expenses have been optimized, you can try to adjust your spending, to increase savings and speed up your wealth accumulation, and to reduce your yearly expenses, so that you can reach financial independence that bit sooner.
Back to the diet coke. In order to have 1 per day during retirement will require €31,025 of a nest egg to provide the €1,241 each year to pay for them. At current savings rate, this will add an extra 1 year and 8 months to my retirement date. Is the diet coke still worth it? Maybe not…
What about the house? Stay in a nicer spot for €860 or save the €360/month? The €500 each month would require €150,000 in the nest egg to afford it. Consider the €860 each month, you will need an additional €108,000 to provide a passive income to cover this, or an extra 6 years of saving before FI. YIKES!
Pick out where you can accept saving money and go all in!
Look at the big picture:
- Optimize the bigger expenses first
- Optimize the smaller expenses next
- Invest the savings
I am Steve, the author and owner of Fire-ish, where I try to share my story and help people towards Financial Independence with small tips and tricks that add up. Follow me on Twitter at @fire_ish and on Pinterest. I am trying to grow my readership so if you enjoyed this post, please share it!