What Is Most Important: Earning More, Spending Less, or Investing?

Earn more, spend less, invest?  What is the most important thing that you can focus on to become wealthy?  It’s a common question.  While everyone’s situation is different, I believe that there is an answer to this question that best applies to the average Joe or Jolene.  I’m not even going to make you scroll to see it like one of those lame internet recipes where the actual ingredients list is on page 7 (I hate that).  The simple answer is investing. However, a longer answer is much more helpful.  Let me explain why with simple numbers and a bit of help from Quentin Tarantino and Warren Buffet.  Along the way we’ll also cover whether it actually is a good return on your time and energy to become a stock market genius or to focus on other things instead.

The Setup

In past articles about how to get wealthy in one article, or the #1 Most Important money Skill, I’ve talked at length about the power of investing and compounding.  It’s like having a bunch of little dollar bills each getting up at the crack of dawn and working for you every day. As an aside, being in debt is like having all those dollar bills getting up at the crack of dawn every day working against you.  

According to the US Bureau of Labor, the average combined household income in the USA is $78,635 per year or $67,241K after taxes. The average annual household spend is around $59,269 once adjusted to remove retirement savings from spend.

This leaves $7,972 in household savings for the average Joes and Jolene’s after taxes and expenses.

The average retirement age is 62, which means the average Jolene spends 40 years working.

The market has averaged around a 7% return each year over the last 90 years (includes adjustment for inflation). While there are huge fluctuations of stock market booms and busts (hello COVID19), I’ll use this 7% per year average annual return rate for much of the rest of this article. This is what the difference in average household net worth looks like over a working career if money is simply saved versus invested:

While that’s cool, this graph is probably not a revelation to many. Compound interest is real.  However, a better question is how earning more or saving less compares to investing in the goal of turbo charging your wealth building.

Some Examples Tarantino Style

Long before each of his movies cost $100,000,000 to make, Quentin Tarantino made “Reservoir Dogs” for $1.2M.  Apparently stylized violence and mayhem can be done frugally like so much else in life.  In Reservoir Dogs, a bunch of criminals go by code names, Mr Orange, Mr White, etc. This keeps them each anonymous as they plan the big heist.  In the spirit of Steve Buscemi in a cheap suit, let me introduce you to Mr Red and Mr Blue.  Let’s hope this version ends better for our heroes.    

Spending Less With Mr Red

The only way to get wealthy is of course to start by taking in more cash than you put out. This means either making more cash or spending less. Mr Red is going to spend creatively and be thrifty in order to spend 20% less of his after tax income every year. As some like to point out, this increases savings and also gives the second benefit of getting you used to living on less so that later you don’t need as much in retirement either.

Earning More With Mr Blue

Mr Blue lives by the motto that you are limited in how much can be cut from a spending budget. However, earnings potential is limitless (at least in theory). He is going to focus on getting degrees, credentials, and working like a madman for aggressive raises so that he earns 20% more take home cash (after tax) every year than his peers on average.

Mr Purple Gets Paid

So which is better between earning more or spending less? Benjamin Franklin had it right that a penny saved and a penny earned are actually the same thing. Both of these tactics can be used to increase wealth interchangeably. In the spirit of a Tarantino movie, let’s say that Mr Red and Mr Blue got into an epic brawl over which is better, making more or spending less. Just like Uma Thurman in a blood soaked yellow jumpsuit clashing swords with Lucy Liu, they battled. When the dust cleared, Mr Red and Mr Blue had fused together into Mr Purple. By a combination of earning more and spending less, Mr Purple effectively makes 40% more take home money than the average American Household.

Enter Mr Green  

Now let’s compare earning more / spending less with the third piece which is investing. Enter Mr Green. It hardly seems like Mr Green belongs in this movie. He doesn’t have any flashy moves. All he does is take that $7,972 in average household savings discussed above and throw it into a solid total market index fund. Every year, Mr Purple is earning 20% more and spending 20% less of his take home pay which means he has is putting $34,868 into the bank every year.

1.40 x 67,241 = $94,137

$94,137-59,269 = $34,868

Even though Mr Purple is saving almost 5 times as much cash as Mr Green every year, let’s see who ends up with more cash in the bank at retirement: 

Investing Wins!!

The reason that I believe that investing heavily and early in your career is more important than earning more or spending less is illustrated in this graph above.  Mr Purple had to break his back to earn more and spend less over 40 years.  All Mr Green had to do was put his savings into a broad market index fund rather than a bank account and then live his life.  In the end both had similar results by retirement.  

In the graph above, we can see that the 2 lines intersect directly at 40 years (the average career span). The $7,972 saved and invested every year by Mr Green represents the average household and is 11.85% of after tax income (7972/67241). What this indicates is that if one is currently investing any amount more than 11.85% of after tax household income, that is even more impactful than a 40% raise in after tax income all saved without investing. Go Mr Green! However, if one is currently saving and investing less than 11.85% of after tax income per year over a career, then saving more through more income / less spend starts to become paramount very quickly because as savings decreases there is simply not enough principal in the investment account to compound fast enough over a career to outpace the impact of making substantially more and spending less. Go Mr Purple! Of course the truth is that there is no reason to not do both.

Earning More, Spending Less, and Investing

What if Mr Purple and Mr Green were to join forces earning 20% more, spending 20% less of that income, and investing it? They would become Mr Brown of course:

Mr Brown becomes a millionaire in less than half the time of Mr Green or Mr Purple with his combination of earning more, spending less, and investing in the index! Not to hit you in the face with it like the pearl handled butt of Samuel L Jackson’s gun, but combining all 3 strategies leaves Purple and Green in the dust with a net worth of over $6M by retirement for the average household. However, simply investing in the index takes little effort. What if there was someone that could beat the index?

Mr Pink: Is Becoming A Stock Market Genius Worth It?

Mr Pink wants to make the big dollars like Mr Brown. However, rather than working hard to make more and spend less, Mr Pink decides to spend his time and energy becoming an investing genius. His household income and savings are average like Mr Green’s but because he is a stock market genius, he can make a 12.5% annual return rather than the 7% total index return. Somehow Mr Pink is able to do this over 40 years! Let’s see how he does over a career versus Mr Brown:

Amazingly, even trouncing the index by 5.5% every year only puts Mr Pink dead even with Mr Brown after a newsworthy 40 year investing career on top of his normal job. There is a pretty profound message here. I’ve written in the past about how difficult it is to beat the market and some of the logic behind doing so. It is oft stated that the majority of professional money managers underperform the index even with all that knowledge. To quote Neil deGrasse Tyson, “One of the great challenges in life is knowing enough to think you’re right but not enough to know you’re wrong.” The only person that I have encountered who has achieved annual returns of 12.5% or more for over 40 years is Warren Buffet via Berkshire Hathaway. This makes him more like a one in a billion than one in a million exception.

Cost Benefit of Being a Stock Market Genius

Beyond the obvious and overwhelming likelihood that you may be wrong in your effort to beat the market over 40 years, is another even more compelling concern. Your time and effort are limited. Mr Brown used that effort to up his surplus savings through aggressive career focus and careful spending. Mr Pink spent all that effort becoming a stock market genius. Warren Buffet (17.1+% annual returns over 55 years) used to pore over company reports reading over 500 pages per day with 14 hour work days. Peter Lynch (29.2% annual returns over 13 years) worked 6-7 days per week sometimes investing in 1400 stocks at a time while managing the Magellan fund. It stands to reason that Mr Pink would have to do the same. While Buffet became a billionaire and Lynch made several hundred million, Mr Pink had to do the equivalent of work two jobs and simply broke even with Mr Brown!

Easier Ways To Outperform The Market

Mr Buffet’s annual returns of over 17% for more than 50 years are certainly remarkable.  However, do you know what else averages 17%+ annual returns for similar time frames?  Thousands of small family run businesses all over the country.  A good rule of thumb for a small business is to target a margin of 10-20%.  This raises the question of why try to become Warren Buffet when you can get similar returns opening a plumbing business or simply making more in your chosen career like Mr Brown?  

I’ve certainly taken advantage of opportunities for investing in my life beyond just broad indices.  I have written about this cautiously in Why You Won’t Beat The Market But Still Can, and How To Invest and Get Wealthy.  I have also pursued startups which is a higher risk higher reward sort of employment.  However, I write about these cautiously because there is a much easier path to financial independence that also has a much higher success rate.  It looks like Mr Brown even if that path is not as flashy.  Most households actually loathe finance and investing.  I personally am interested in investing and it has also taught me a great deal about business in general.  As my net worth grows, small changes in returns start to matter even more. Hence, knowing and learning more to optimize everything has bigger dollar signs attached to it.  However, the vast majority of my investing has always been and remains in real estate and a broadly diversified portfolio.

The Verdict Is In

I am a strong supporter of maximizing one’s salary as early as possible in a career and also cutting costs like Mr Purple. We looked graphically at a savings threshold below which this becomes a primary focus in growing wealth.  However, as shown in the examples above, simply investing savings in a broadly diversified fund like Mr Green is just as impactful for the average household and way way easier to do.  Moreover, if you combine all three like Mr Brown, millions in net worth can be created for the average household in far less time than average.  Lastly, we looked at the prospect of trying to beat the market and revealed a dubious cost benefit versus just working harder in other areas of life to optimize your financial situation.  

Like any good band of criminals in a Tarantino movie, each brings a specialty to the crew.  Amazing results can be achieved especially if each works together.      

What do you think? Do you agree that investing is the most important? Feel free to ask a question or share your thoughts in the comments below.

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