There’s a nifty little fact about personal finance that I LOVE: every positive thing you do in one area has a positive impact in multiple other areas of your finances as well. I call it the Personal Finance Multiplier Effect, and it’s what makes it possible for all of us to reach Financial Independence and Retire Early.
WHAT IS THE PERSONAL FINANCE MULTIPLIER EFFECT?
Because personal finances can be attacked from multiple angles, financial progress ends up happening faster than you might realize. A single positive action taken in one area will end up benefiting multiple areas of your financial life. 1 + 1 = 4. But beware – this effect isn’t limited only to positive actions.
If you make poor financial decisions in one area, the ramifications are also felt in multiple areas. Suddenly 4 – 2 = -5. Yikes! The negative consequences begin piling up faster than most people realize as well. This is how so many of us can find ourselves in a terrible financial hole before we know what’s happened to us, but more on that later.
To become financially independent your assets need to generate enough income to cover your expenses. One way this can be done is by saving up roughly 25 times your annual expenses, which should generate enough money each year to meet your needs. ; it’s called the Rule of 25. To save up that amount of money faster, you can either increase your earnings, or decrease your expenses. Or, you can attack from multiple angles by doing both.
When you decrease your expenses, not only are you freeing up cash each month, but that reduced expense means you now need to save up less money to become financially independent. The newly freed up cash can be used to increase your savings rate, which means you’ll hit your magic number sooner. And, as your pile of cash grows, your money begins to make money, and the money that money makes, makes money and before you know it – BOOM! You’ve created momentum which only picks up speed with time.
That’s the personal finance multiplier effect.
HOW CAN THE PERSONAL FINANCE MULTIPLIER EFFECT HELP YOU?
Well, it should be quite obvious how it can help you, but just in case it’s not – here are a few additional examples:
- When you eliminate an expense (like cable, gym membership, etc) …
- You instantly need to save less to live on during retirement
- The less you have to save, the faster you can retire
- You can free up cash each month
- Cash can be saved, invested, or used to pay down debt
- That cash can be used to pay down debt faster
- When you pay off a debt …
- You free up monthly cash flow
- Can save more each month
- Have have extra money to attack other debts
- Your net worth grows as your debt falls
- When you save money …
- Your net worth grows
- The more you have saved, the faster that money grows on its own
- The faster than money grows, the faster you’ll reach your magic number
- When you increase your savings rate …
I’m no doubt missing some examples from this list, but it should be clear that your road to financial independence doesn’t need to be a long, slow slog. Keep making positive financial choices like saving, paying down debt, and investing your money and before you know it these baby steps will become a sprint to your financial finish line.
WHAT SHOULD YOU DO ABOUT IT?
1. Spend less than you earn.
2. Invest the difference.
3. Eliminate and avoid debt.
There are three variables, but let’s focus on the first: spend less than you earn. On its own, that’s powerful advice and, if followed, will eventually lead you to a position of wealth. But when you combine all of the variables and allow them to work together, that’s like throwing gasoline on a fire – that’s how to Get Rich Quick’ish!
Don’t just spend less than you earn – invest your extra money! When you pay off a debt – increase your savings rate with that freed up cash. Don’t take on debt just because you can afford to make a monthly payment – debt is the great wealth killer and you should avoid it if you want to make significant progress on your financial journey.
SO HOW DO I GET RICH QUICK?
You don’t, sorry. There are two ways that I know of to get rich quick. One involves breaking the laws of probability and the other involves breaking the laws of the land. Don’t attempt either.
Getting rich quick takes time – but it doesn’t need to take a lifetime! Accumulating wealth is really just math and, thankfully it’s not rocket science. It’s not even algebra. It’s simple addition and subtraction and it begins by spending less money than you make.
Once you begin saving more than you spend, you’ll begin to accumulate a surplus of cash. What you do with that surplus will make the difference between getting rich quick’ish or simply accumulating enough wealth to (hopefully) retire at the socially acceptable age of 65.
Depending on where you’re at financially, you have two options for dealing with your surplus:
- Invest it
- Pay off debt
If you’re currently debt free, then the choice is clear – invest your money in the stock market. Money on its own loses value over time. Keeping your cash in a savings account isn’t doing you much good either. You need to invest if you want to get ahead. Investing isn’t risky; not investing is risky.
If you have debt, then you have an emergency. You’re living with a wealth killer and you need to eliminate your debt as soon as possible. Use your monthly surplus to eliminate your debts. There are situations where you might NOT attack your debt, or you might not attack certain debts as aggressively as others, but that’s a discussion for another post. For the purpose of this post, debt is an emergency.
Unfortunately, the Personal Finance Multiplier Effect isn’t limited only to positive choices. Let’s say you’ve made a poor decision to not save money. If you don’t save, then you’re not accumulating wealth, your money can’t go to work for you, and you won’t have enough money to retire. Ever. Think about it, if for some reason you can’t save any money whatsoever, then your savings rate is 0%, and you’ll NEVER be financially independent because you’ll always need a paycheck to survive.
If you’re fine with a certain level of debt each month, fine, but the money you spend servicing your debt is a lost opportunity. It’s money that can’t be invested. What would you rather have, a new car, or your freedom?
If you’ve made poor choices in the past (I know I have) then stop making them. Begin making better choices today. If you’re frustrated with where you’re at financially, don’t get discouraged. Start making good financial choices, keep making them, and sooner than you realize you will have created something with so much momentum that your money is making money faster than you ever could. Check out this tweet from Jeremy at Go Curry Cracker, let it sink in, then do something for yourself TODAY that will make for a better tomorrow.
— Go Curry Cracker! (@GoCurryCracker) December 10, 2016
Are you early in your financial journey and frustrated with the seemingly slow rate of progress? Maybe you got a late start to the personal finance game and are now discouraged with where you at? Hopefully you’re at the point in your journey where you are now pleasantly surprised at how quickly your situation is improving.