Forget Frugality: Focus on Earning More

by Ramit Sethi

Sunday, May 1, 2011

• tweet92
• Email
• Print

provided by

Think of the last 10 pieces of personal finance advice you've read. Do any of these sound familiar?

• Cut back on lattes!
• The world's top 10 coupons
• Don't go on vacation this year!

If you boil all the advice down, there are just two ways to improve your financial situation: earn more or cut costs. So why don't more personal finance experts talk about earning more? Because most of them don't know how.

More from NYTimes.com:  • The Emotions That Get Lost in Budget Discussions  • The Craigslist Gym • Kicking the Costco Habit

And so we get lectures on frugality, giving us obscure advice like how to save on paper towels. With each tip, we get diminishing returns. And we start to believe that personal finance is about "No, No, No!" No, you can't spend money on lattes. No, you can't go on vacation. No, you can't buy those ans.

It's no wonder that most Americans simply ignore their finances. We don't want someone constantly lecturing us on what we can't do.

I believe personal finance should be about saying "Yes."

Yes, you can afford that extravagant coat, or iPhone or even a trip to the Bahamas. In fact, I believe in conscious spending, or spending extravagantly on the things you love -- as long as you cut costs mercilessly on the things you don't.

Once you've cut on the basics, the single best way to live a rich life is to earn more money.

The Myth of Frugality

Let's take a look at a typical person who tries to cut back to save money.

Jack has to cut back on a lot of things in order to save significant amounts of money.

What he does	Monthly amount saved
Drink 1 less latte per week	$20
Buy groceries in bulk	$30
Go out 4 fewer nights per month	$200
Cancel cable	$50
Eat out five times a month instead of eight	$100
Total:	$400

Not bad. $400 saved. But at what cost? Each morning, Jack has to decide if can buy that latte. He has to consciously cancel his cable. He has to decide if he can afford that dinner out. On and on -- and he has to do this every month.

Jill can focus on one thing to get the same result:

Action	Amount Earned Per Month
Finds an area she likes, spend five hours each weekend and charge $20/hour	$400
Total:	$400

Jill found something she was good at, turned it into a small side business, charged a reasonable amount and found a client willing to pay.

Cutting back may be easier for the first month. But it's likely unsustainable. After all, there's a limit to how much you can save. But there's no limit to how much you can earn.

Earning More: The Numbers

Let's consider three goals for your personal finances. If you could charge $25/hour for your services and work enough hours each month to generate an extra $500/month after taxes, what could that additional money do for you?

Let's say you're paying off a $10,000 credit card debt at 15 percent interest and want to add that $500 to your payment.

If your monthly payment isÂ…	You'll pay this much interest	Over this time period
The minimum	$11,979	35 years and 4 months
The minimum + $500/month	$1,085	Only 16 months

That's over $10,000 in savings on interest alone.

Invest the Extra Money

When you earn more and invest the extra money, the results are incredibly powerful. Here's what extra income can do for your investments.

Additional income	Value if invested for 40 years with a 6 percent annual return
$100 / month	$156,122
$300 / month	$468,367
$1,000 / month	$1.5 million

Pay off a mortgage

Putting even $100 extra per month toward your mortgage can dramatically decrease the amount of time it will take you to pay it off.

Additional monthly mortgage payment	Mortgage will be reduced byÂ…
$100 / month	3 years, 8 months
$300 / month	8 years, 8 months
$1,000 / month	16 years, 11 months

*Based on a 5 percent, $300,000, 30-year fixed rate mortgage.

How to Earn More Money

The simplest way to earn money on the side is to turn your existing skills into side income. Nearly everyone has skills that others would pay for. Can you play an instrument? Consider being a music instructor. Are you obsessed with personal organizing? Hire your services out as a personal organizer. Do you have expertise in Excel, Web analytics or even free-lance writing? Many employers would love to hire you as a free-lancer.

This is a new way of thinking, and it makes many people uncomfortable. "That's ridiculous," they say. "Nobody would pay me $25 per hour."

To them, I say two things:

1. You already pay service providers for things you could do yourself. Have you ever eaten at a restaurant? Changed oil? Gotten your hair cut? We all pay others for their services. Now, I want you to flip this around and charge for your own services. People will pay -- as you already pay others.

2. You don't know if your offer of services will work until you test it.

Twelve months ago, I declared it the year of earning more money and wrote a series ofposts on the topic. I then launched an online course on earning money, in which I took hundreds of people from around the world and taught them how to turn their skills into side income.

Dean Soto was one of them. He has a wife, two children and a demanding full-time job. How could he find enough time to earn money on the side? Dean went through several exercises to determine which of his skills would be profitable. He realized that the information technology skills he used at his day job could also earn him money on the side -- if he found the right clients. But his side income needed to be worth giving up his scarce time with his family.

Once he figured out a potential idea, he used his network to meet people and ask what their needs were. He found his first client by accident. When he heard Dean's asking rate -- $30/hour -- he scoffed and insisted Dean charge more.

To account for his busy schedule, Dean used a clever retainer technique, which lets him work flexibly as long as he gets the work done. "I come home from work around 5 p.m.," he said. "Then I spend time with my family until about 9 p.m. and spend about an hour a day on my side work."

"I never thought I could do something like this," he said. "Now I'm like a boxer, looking to take little jabs and see where there's an opening."

Last year, Dean earned $22,700 on the side. He raised his hourly rate from $30 to $60 and then $150 per hour. The best part? "My wife loves it," he said. "She's able to stay home, which is her dream, and my kids have their mother all day."

There's nothing unique about Dean. But he is remarkable for taking action instead of being blinded by the frugality brigade that so permeates personal finance.

Frugality is important -- to a point. But after we cut back to a reasonable level, our biggest win will come from earning more money.

___ 

MILLIONS MADE SIMPLE

Take five steps, retire rich. Our in-house financial guru shows you the way

By Ben Stein, Photographs by Ture Lillegraven, Posted Date: March 12, 2007

When I was in junior high school, I was bullied by two large, nasty kids. I took up weight lifting to make myself stronger. It was boring and tedious, but it worked, and I was never bullied again by those creeps. You're probably too old to be bullied by eighth graders, unless you have children. But you will surely be pushed around by two thugs who are far harder to deal with: financial insecurity and its evil brother, retirement insecurity.

It's my job, as I approach my 63rd birthday, to help you bulk yourselves up so you will not be saddled with fear--or, worse, a bad financial plan. When I started lifting, I was told by my mentors in the gym that if I took it slow, I would get there. Likewise, we're going to take it slow. But if you execute this five-step plan, you'll reach financial nirvana.

Step 1 : Figure out how much you'll need to retire.

There's no one-size-fits-all answer to the "how much" question except "more than you think." As a general guideline, you'll need 90 percent of your preretirement income until age 80. If you're 30, your pre-inflation salary will roughly double by the time you reach 65, thanks to your increased productivity and seniority. (If you're in a field like law or finance, it may rise even more than that.) Then, the effects of inflation will probably triple that figure during that time.

So, if you're 30 and you're earning $50,000 a year now, it's quite possible that by the time you reach your mid-60s, your salary will have reached $300,000. To live comfortably after retirement, you're going to need about $270,000 a year for 15 years. Or, slightly more than $4 million. That seems like a lot now. It won't then.

Step 2 : Determine how you'll amass that kind of dough.

There are dozens of retirement calculators online that can tell you exactly how much you'll need to save each year to reach your goal. One of my favorites, because it's so simple, can be found at retireonyourterms.org. Plug in how much you make and how much you've saved, and it'll tell you if you're on track.

But remember: The earlier you start saving, the easier it'll be to reach your goal. If you're in your 20s or early 30s and not saving at least 10 percent of your pretax income already -- putting it into a 401(k) or IRA—you should increase your contributions, like, today.

Step 3 : Pick your investments.

The key? Keep it simple. Few investors can beat the overall stock market by choosing individual stocks, so don't bother trying. In fact, few Wall Streeters can beat the market for more than a few years in a row.

I like index funds—mutual funds that approximate the return of the total stock market. Vanguard and Fidelity, the big 401(k) managers, both offer them. So do other companies. Total index funds keep you well-diversified among large, middle, and small-company stocks. They're a solid, unexciting choice. Which means they're perfect.

Another good option: a mutual fund that tracks the S&P 500, or the 500 largest companies in America. It's a slightly less risky choice because of the large-company focus, but the potential for gains isn't as great, either.

A third option is a fund that mimics the Dow Jones Industrial Average, which tracks 30 of the largest companies in the country, from General Electric to Citigroup. These stocks tend to fluctuate less than the overall market, and they pay pretty nice dividends.

You can buy the Dow 30 in an exchange-traded fund, which is like a mutual fund but is traded in real time, like a stock. One major benefit is that the management fees are far less than those of most mutual funds. For more info about exchange-traded funds, go to ishares.com.

Step 4 : Diversify internationally.

You should invest roughly a third of your money in foreign stocks. But again, avoid individual stocks. Pick an index fund that tracks large foreign stocks in Europe, Asia, and Australia, such as the MSCI EAFE index.

You might also want some exposure to less-developed nations, such as China, India, Brazil, and Russia--these economies still have plenty of room to grow. If so, purchase a fund that tracks indexes, like the MSCI Emerging Markets Index or the Bank of New York Emerging Markets 50 ADR Index. You'll also find more information about these international investments at ishares.com.

Step 5 : Forget about it.

A century or so ago, the great investor J.P. Morgan was asked to predict the future of the stock market. His answer was "It will fluctuate." The portfolio I outline above will fluctuate. But over years, if history holds, your portfolio will rise 8 percent or so per year. That means it'll double every 9 years, and that's not bad at all.

Some years, of course, it will go down. When that happens, keep on buying. Some years, it will go up a lot more than 8 percent. Keep on buying. When the commentators on TV say we're heading into a period of staggering inflation, keep on buying. When the pooh-bahs of Wall Street say the market's way overpriced, keep on buying.

Over decades, broad indexes of stocks outperform real estate, bonds, and cash. They outperform art and coins and gold. Just keep buying. Put it on autopilot. Have the investments debited automatically from your paycheck or checking account. Just keep buying.

Don't worry about billionaires and their hedge funds. Don't worry about oil speculators or penny stocks. Just keep saving in those broad indexes and you'll get there. It's not exciting, but then neither is lifting weights. But pretty soon, the specter of financial insecurity will look as pathetic and puny as an eighth-grade bully.

You can do it yourself. But only if you start doing it now.