The concept of reaching financial independence where passive income fully supports your lifestyle is fairly simple in theory. Essentially you just increase your income, cut your expenses, and maximize your savings rate (see my article “Simple Math, Early Retirement“).
But, as we all know and as I shared in “Destination Financial Independence,” simple concepts like losing weight, exercising, and cutting our expenses are in fact extremely difficult. Good decisions and consistent behavior are not as easy as the simple math.
Why are these extremely important areas of our life so difficult? Why don’t we stick with diets and savings plans over the long run like we should?
The causes are many, but I would argue that the pain of not sticking with our long-term plan is not as great as the short-term pleasure of doing something else.
For example our minds might console us with, “The ice cream tastes sooooooo good right now, and I can always get back on the diet tomorrow or next week.” Or we might rationalize, “This large house is so comfortable, safe for my children, and the kitchen is beautiful. Why should I live in an older, smaller house when the interest rates are so low and it doesn’t cost me that much to live somewhere better?”
For the tough choices, sometimes we need a more compelling argument to win the battles within ourselves.
An Alternative View of Regular Expenses
One way to tip the scales financially is to understand the real cost of our daily, weekly, and monthly financial decisions. I will help you do that by explaining the rules of 752 and 173 (which I originally found over at the blog Mr. Money Mustache).
Let’s say you eat a nice meal out at a restaurant on average twice per week. Let’s say your bill is usually $50 at each meal. What is the cost of each meal? Is it $50?? Or is it much more?
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If you skipped just one of those weekly meals and ate leftovers at home, after ten years of saving and investing $50/week at a 7% compounded rate of return you would accumulate $37,600!! The real cost of a recurring weekly expense balloons by a multiple of 752 (aka The Rule of 752).
Is it possible to imagine that you could do even better and cut $100/week in recurring expenses from your budget and not even notice the difference? Think about habits like eating out lunch instead of simply packing a lunch. Or, what about drinking coffee at Starbucks instead of bringing a thermos?
If you need extra motivation to find these savings, $100/week x 752 = $75,200 in extra money in your pocket over the next 10 years. What could you use $75,200 for? Maybe to pay off your home? Invest in a rental property?
If smaller weekly spending makes such a big difference, then what about big monthly expenses like house payments?
Someone might decide to buy a $200,000 newer house in a fancier neighborhood instead of a $100,000 smaller, simpler house in a regular neighborhood. The cost of that extra $100,000 on a 4.5%, 30-year loan increases the loan payment by just $507/month. But, I know from experience that the bigger house also has much higher costs for taxes, insurance, maintenance, and fancier furniture. So the real extra monthly costs could be more like $1,000/month when compared with the smaller, simpler house.
So, what are the true extra costs of this bigger, fancier house? Is it $100,000? Or is it the extra $1000/mo x 173 = $173,000 over the next decade (this is the Rule of 173)! Or, over the next 20 years the expensive house costs the owner a whopping $520,927!
No Right or Wrong Expenses – Just Full Awareness
This is not a criticism of you if you happen to be making these choices. We all have our own unique circumstances. But if you intend to one day reach financial independence, I do want to be sure that you know the true financial sacrifice of the decisions you are making.
If living in the bigger, fancier house is worth $520,927 to you over the next 20 years, then by all means live there. If driving new cars on $500/month payments for the next 10 years gives you $86,542 in pleasure, then do it. But you might also decide, like me, that you would rather live a little simpler (and for me happier) and in turn “buy” flexibility, free time, and autonomy instead of those extras.
The choice is yours and there is not a right or wrong answer, but I hope you now have better tools to make your choice with open eyes.
What do you think of the rules of 752 and 173? Do you have any regular expenses that could be cut? What are the easiest places to find savings? I’d love to hear from you in the comments below.
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Ever thought about how that extra bit of frugality and conservatism effects your willingness to take action or to take risks? How if you put yourself in that mindset to always be looking for ways to cut back and cut corners, you might miss a great opportunity that requires you to stretch a bit? Will you recognize the difference? What about how others perceive you and their willingness to “invest” in you or rely on you based on your perceived frugality and lower level of perceived “success”? Certainly spending beyond your means, or even up to the edge of your means, is not a winning formula. But sometimes you have to spend money to make money. Spend wisely and in a way that doesn’t bind you or your options, but it’s ok to indulge and invest in your own happiness, confidence, and image as well… within reason of course.
Chad Carson says
I appreciate the comment. I always welcome a fun discussion!
I think from your initial statement you misjudged my intention in this article. This was not about extra frugality, cutting corners, or missing opportunities. This was about awareness of opportunity costs. One person may choose to personally spend $40,000 per year and the other $140,000, and they can be equally successful as long as they’re both aware of the true costs.
The best entrepreneurs and investors I know are keenly awareness of this principle. This awareness is essential, to as you say, in order to spend money to make money.
The real point of this article was to increase awareness of the true costs of personal expenses so that people can make decisions with open eyes. If you put money in a nonperforming asset by purchasing an extra $100,000 worth of house, you’re MISSING opportunities not suppressing them. If you instead buy a less expensive house (that can STILL be an investment in your happiness, confidence, and image, by the way), you’re freeing up capital to use for higher financial return.
And I’m not sure I agree with the implication that others will think less of me and not be willing to invest in me because they’ll perceive personal frugality as a lower level of success. The opposite has been the case in my 14 years of raising investment capital. If they’ve accumulated money, they likely appreciate this opportunity cost rule. And they recognize and appreciate my consciousness around money. They are MORE confident that I’ll be a good steward of their money.
Thanks for bringing up the discussion. It’s a good topic to think about.
What an interesting article! I am constantly amazed, as I have been “studying” (I use the term very loosely!) financial concepts for years, and have heard of the rule of 78’s, 72, 4%, thirds, etc., but I’ve never heard either of these rules before.
It certainly is a good reminder to count the opportunity cost of eating out (again) vs. eating at home. Since there is decision fatigue at the end of the day, grabbing something on the way home is one less decision for me to make (somehow, “where to go” is an easier decision than “what can I make that is currently frozen and won’t be ready for an hour or more and doesn’t require me to stop by the store anyway for one or more missing ingredients”). But remembering to look at it from this perspective may help drive down that monthly expenditure total.
Must discuss these concepts with hubby! Thanks for an informative post that challenges us!
Chad Carson says
Thanks for the comment, Dani! I think you hit the nail on the head about using these rules as a decision tool. It’s not wrong to eat out sometimes when you’re tired; it’s just about making that decision with open eyes about the opportunity cost.
Good luck applying the rules!