A Canadian's random thoughts on personal finance

Sep 21, 2008

Frugal living for the visually inclined

Today I thought I'd put up a few diagrams I usually end up drawing in the air with my fingers when I talk to people about this topic.

If your expenditures always equal your income, you'll have a situation like this:

In this diagram, the green line represents your income, which (hopefully) will increase over time. The red line represents your expenditures, which will also increase as your standard of living grows with your income. In this scenario, you end up spending every dollar you make.

How can you improve upon this? You could increase your income more, but if your standard of living grows along with it, you still won't have any money left when you retire.

The most obvious way to improve the situation would be to reduce your expenditures:

To achieve this, always put away a fixed amount of your income toward savings, and live your life as though your income were a little lower.

The light-green area between income and expenditures is your savings. The larger this area, the more you have when you retire (ignoring inflation, investment growth, etc).

The next most obvious way would be to grow your standard of living a bit more slowly than you grow your income:

To achieve this, don't spend your raises when you get them. Instead, increase your RRSP contributions.

Finally, an easy one to overlook is just to delay your increases in standard of living for a few years:

To achieve this, hold off for a few years on expensive upgrades on your standard of living. You can still have everything you want; you just get it a little later. For instance, after you get your first real job, all you need to do is continue to live like a student for a year or two, and then grow your standard of living at the same rate as you would have done anyway. This is all it would take to have substantial savings when you retire.

For those of us planning to get rich slowly, the easiest way is through a combination of these three effects.


Michael James said...

Nice visuals for the different savings patterns. However, the income line is probably unrealistic in the later years. Even people who are lucky enough to stay with the same employer until they are 65 tend to see their incomes flattening out sometime in their 40's or even 30's. There is also the risk of losing your job and having to take a lower-paying job (this is typical of laid-off Nortel employees).

I like your last graph best as a life plan. Fresh out of school most people are likely to be used to living modestly. Continuing that way a a couple of years after starting a job gets you on the right track with savings. Simply waiting until you can pay cash for a car puts you way ahead of other people financially.

Patrick said...

Hi Michael. I guess the argument still holds as long as the slope is positive, even if it's not constant. If income decreases, more drastic action would be needed.