Ágúst Valgarð bloggar

Posted: 16 May 2009 03:08 AM PDT

It’s simple math really, spend less than you earn and you have a surplus and are growing your net worth. Spend more than you make and you’re going backwards no matter what else you do. This is the reason that my best piece of financial advice is to spend less than you earn. It’s also the first step to becoming rich (or growing your net worth if you prefer.)

Today we have an excerpt from Trent Hamm’s free ebook Everything You Ever Really Needed to Know About Personal Finance On Just One Page that deals with this subject. It’s a simple example that gets the point across very quickly:

In the end, this is the fundamental rule of personal finance: spend less than you earn. It’s the one point that comes up time and time again in almost every personal finance book you read or talk that you hear.

It’s easy to see it when you look at each side of the coin. Let’s say you earn $30,000 a year and you spend $31,000 a year. That extra $1,000 has to be borrowed, often from sources like credit cards. The following year, in order to maintain your lifestyle, you still spend $1,000 a year more than you make, plus you spend $300 more than that just making the minimum payments on your debt, leaving you a total of $2,200 in the hole (the $1,000 extra you spent the first year plus the $1,000 extra you spent the second year plus the $300 extra you spent repaying that debt minus the $100 you actually managed to pay off). The debt builds - after the third year, you’re $3,600 in debt. It keeps growing and growing and growing until that debt is eating up all of your income, leaving you in misery.

On the other hand, let’s say you only spend $29,000 a year - only $2,000 less in spending. That extra $1,000 goes into your savings account and earns 3%. The next year, you drop another $1,000 in the account and now you have $2,030 in there. The next year, another $1,000, bringing you to $3,060.90. That money builds up and soon you have a house down payment or the seed money to start the small business of your dreams - or even something as simple as the ability to easily pay for a car repair without your heart skipping a beat.

The difference between these two stories is only $2,000 a year. There are two avenues to achieving this goal: spending less and earning more. By working on either (or both) of these areas, you can increase the gap between those two numbers - and that gap is your ticket to freedom. The harder you work on either spending less or earning more, the bigger that gap will become and the quicker that train to your dreams will arrive at the station.

As I’ve documented again and again and again (and even more than that), these same principles apply even if you’re making a boatload of money. If you spend more than you earn, you’re going backwards financially — period!