Recently during one of our local Choose FI meetups in Philadelphia someone posed the question, “What is more important, increasing income or reducing expenses?” The answer seemed simple enough, you would work to increase your income and reduce your expenses. Right? In the moment that is exactly what I said, but something was nagging at me. I just couldn’t put my finger on it in the moment. So, like I usually do, I started looking for evidence that might shed some light on the situation. Here is what I found.
In general, high income is fleeting.
A few weeks after the meetup an article about income in the U.S. came out in the Wall Street Journal and things started to fall into place. In that article Jo Craven McGinty cites a longitudinal study of some 18,000 people to point out that while it is relatively common for people to break into the upper income brackets in the U.S. their ability to stay there is fleeting.
Excerpt from WSJ article
As the graph above demonstrates, it is highly unlikely that a person who breaks into the top echelons of earnings stays there over the course of a decade. In other words, the probability that all your efforts to increase your income results in sustained out-performance is quite low. The data shows that while some 70% of people make it into the top 20% of earners over a decade only a paltry 20% remain there by the end of a decade. On the other side of the equation the data show extremely high rates of people experiencing economic insecurity, and poverty or near poverty, over the course of a decade at roughly 79% and 50% respectively.
So, what does this mean in the context of whether or not someone should focus on spending less or saving more? Well, like all nuanced questions, it depends.
On the one hand, it means that for most Americans if they have to make a choice between exerting their energy to either increase their income or decrease their expenses they are likely to only realize those high earnings for a short period of time. As a result it may be better to focus on decreasing expenses.
Why is that the case? It is the case because a person has much more influence over how they spend their money than how much money they earn. Establishing a habit of packing your lunches to take to work and riding your bike to the office are things that can be maintained with high degrees of certainty. Unlike the amount you earn, your choices in how you spend your money are well within your control. There is also the reality that every extra dollar a person earns gets taxed at the marginal tax rate which significantly reduces its value.
The theoretical worlds of Finance and Economics have entire cadres of people who do research on the topics of evaluating choices based on certainty. One thing that nearly every respected school of thought agrees upon is that the more uncertain the outcome the less value one should associate with it. So, dollar-for-dollar, a rational person would always choose the path that allows them the opportunity to increase their wealth with a higher degree of certainty over a lower degree of certainty.
On the other hand, there are some very tried and true ways to increase your income in a sustainable way so it stays relatively high. In Happiness and Wealth, Byproducts of a Good Education I point out how your lifetime wages can dramatically increase by obtaining ever higher levels of education. Other options of course involve investing in the stock market and real estate, just to name a few options.
But, where you start out matters.
So, why all the outrage? Why is there so much angst in the Financial Independence/Retire Early (FI/RE) community when this idea is put forward? I think it is a reflection of our personal experiences as a community. As many people who have been critical of the movement point out, there are a bunch of well paid white guys who make up a large portion of the community. To be fair, I’m one of them.
A recent study shows our country has the largest amount of income inequality since the Great Depression and trends suggest the divergence isn’t done.
[Source: U.S. Census Bureau]
As far as wage inequality is concerned there is a dramatic difference between being in the bottom 50% of earners and being in the top 50% of earners. If a person increases their position from the 10th percentile to the 50th percentile they may realize a 337% increase in earnings. However, going from the 50th percentile to the 90th percentile nets less than a 200% increase in earnings. While the differences at the higher levels are more substantial in nominal terms they lack some of the more profound life altering effects at lower ranges in the distribution. What I’m getting at here is that while a person moves up the income distribution the marginal benefit at each level is diminishing and the probability that they can continue to rise and sustain that position dwindles.
[Source: U.S. Census Bureau]
So, what’s the take away?
The take away is that depending on where you are at currently should be what dictates what you focus on to gain the most utility. If you happen to be a white male with a undergraduate or graduate degree, like seemingly most of the FI/RE community, you probably don’t need to worry too much about increasing your income. Likely, your income is already very large compared to the rest of the population and you would gain more from a disciplined approach to your spending habits. However, at the risk of sounding insensitive, if you happen to be a Hispanic woman without a college education, then you are likely underpaid compared to the rest of the population and would greatly benefit from seeking ways to improve your income like getting a bachelors degree. Certainly there are some barriers that will make it more challenging for one person to make their way up the income distribution versus the next person, but it is certainly worth exploring the various opportunities.
Are we even asking the right question?
Instead of focusing on the dichotomy of earning more versus spending less maybe what we really ought to be focused on is pursuing happiness. After all, isn’t that where this all began? You were sitting around one day dissatisfied with something in your life and you started to think that maybe there is a better way. Maybe there is a way I can get out of this miserable job and pursue a more meaningful life. Maybe there is a way I can spend more time with my friends and family and not work myself to the bone. Maybe I can be healthy and proud of what I do at the same time. Maybe we should take a step back and remember that what really matters most is our health, friends, and family.
Maybe we should be asking, “What is the best way for me to live a happy and healthy life surrounded by the ones I love?”
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