Tuesday, August 12, 2008

The Problem with Frugality

I was comparing my financial situation with my sister's. I characterize myself as semi-frugal whereas my sister is almost the opposite. We started out with similar incomes but very different lifestyles and investment philosophies. But guess what – today our net worth is about the same.

So what gives? If frugality (or semi-frugality in my case) a lost cause. Probably not when you consider the following factors.

Income Matters
If you make more money, you can save more money or conversely spend more money. While a laser focus on spending and savings is always prudent, increasing your top line has a big impact on your financial goals. My sister’s household income is greater than mine so she is able to spend more while still saving significantly.

Small Change – Big Impact
You can spend small or smart and have a big impact on your life. You get instant gratification by painting your house without breaking the bank. You can vacation often if you plan your trips carefully and leverage deals, miles and discounts. There is impulse and indiscriminate spending and then there is smart spending.

Money Making Money
That should be the case but occasionally we mess up. We pay too much in loads, fee, buy the wrong stock or get snookered into investment strategies that just don’t work. Based on our investment decisions we will have different outcomes in our 401(K) plans, post tax investment portfolio, business ROI etc. How you grow your money will impact your net worth.

Frugality pays dividends over time. Usually long time horizons. I may get ahead of my sister (which is not an objective) in a few decades but in the short term there is hardly any impact. A latte skipped does not add up to a whole lot in a month or a year or even five to ten years. Compounding starts slow before the exponential gains manifest themselves.

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