Sat, May 03, 2008
Should I Earn More, or Spend Less?
At the time of his death in 1976, billionaire J. Paul Getty was the richest person in the world. It's said that he was once asked how much money he would need to feel that he had enough, to which he replied, “just a little bit more.â€
Many of the clients with whom I’ve worked feel that they don't have quite enough money to accomplish all their goals. On one occasion, a client who was trying to save for an ambitious goal asked me, “which would be better for me to do – reduce my spending or increase my income?â€
That’s a great question, and most people aren’t reflective enough to ask it! Often, we just do whatever comes naturally to us; people who are thrifty will figure out something to cut from their budget, while people who aren’t will try to find a way to make more money. But this question was a nice challenge, and because I remain a scientist at heart, I decided to analyze it quantitatively.
Suppose you’re a single person earning about $50,000 a year and living in Massachusetts. Let’s also say that you work in an hourly job and can make $25 an hour if you work more hours. How much will you have after taxes if you work another four hours?
Let’s assume that you’re not self-employed. Your marginal tax rate, the rate that you pay on the next dollar you earn, is 37.95% (25% federal + 5.3% state + 7.65% SS tax), so for every hundred dollars that you make, you get to keep $62.05.
In order to work with round numbers, let’s now ask how long you have to work in order to have $100 after taxes. You can calculate this by dividing $100 by 0.6205 (1.00 minus 0.3795), which gives you $161.16. Dividing this amount by your hourly wage, we can see that you must work about 6.4 hours in order to have $100 to spend or save.
With regard to reducing your expenditures, if you want a hundred dollars that you can spend (or save toward a future goal) you need to ask what you’d have to give up in order to save that much. Let’s say that you swing by Starbucks on the way to work every day and spend four dollars for a cup of coffee. If you can bring yourself to skip a cup once a week (or make your own homebrew once a week at a much lower cost), you’d save $100 every six months or so. If coffee isn’t something you spend money on regularly, think of some expense that’s relevant to you.
Now you’re in a position to ask an important non-quantitative question: which is less painful for you, working an extra six-plus hours or skipping (in this example) a premium coffee once a week? Only you can answer this question for yourself.
In my opinion, most people never stop to figure out what they have to give up in order to earn more money. Often, we just find a way to make more (take a second job, work more hours, look for a new job, etc.) instead of actually figuring out how that will affect our lives. Our brains are not very good at connecting soft questions – like getting what we want – with quantitative ones. Surely it’s better, though, to do this kind of analysis first and better understand the consequences of the choices that we’re making for our lives.