The more you make, the more you spend

sad_manI’ve got several friends (I was once this person too) who seem to rely on future earnings to bail them out of their current financial situation, and it’s certainly the wrong way to think for various reasons.

I hear this quite often from this type of person - “If I only made more money everything would be alright.” The problem is, this won’t help them get out of the trouble they’ve got themselves into, in fact, it may just make it worse. That’s because, the more they make, the more they spend. Quite often, they’ve spent the money they will make before they’ve even made it. They never develop a true plan for controlling their spending while eliminating their debt and planning for the future.

In the personal finance world, there are typically two kinds of people; Balance Sheet rich or Income Statement Rich. Think of your balance sheet as a snapshot of your net worth, that is everything you own, less what you owe. For example, your home is worth $200,000, but you owe $175,000, if you owned nothing else or owed nothing else, your net worth (or owner’s equity) would be $25,000 ($200,000 – 175,000 =$25,000). Think of your income statement as your revenue less expenses, or your income less your expenses.If you bring in $3,000 per month and you spend $3,000 per month, you’ll have nothing left over at the end of the month, and you’re simply meeting your bills.

Let’s look at two people and discuss who’s balance sheet rich or income statement rich. Fred makes $30,000 per year and owns a home valued at $100,000, but he owes $30,000 on the home still. He also owns his two vehicles free and clear and has no credit card debt. He has also built a retirement nest egg of $250,000. Bill on the other hand makes $150,000 per year, owns a home valued at 1,000,000 – but he owes $950,000 on the home, and has two vehicles he’s making payments on, along with credit card bills, boat payments and much more. At the end of the month, Fred hasn’t a dime to put away for retirement and he finances anything he needs through credit card purchases.

Fred is balance sheet rich, while Bill is income statement rich. Fred will be better off in the long run even though he makes only a 5th of what Bill does. Bill lives modestly and is not burdened by debt and its associated problems. Fred on the other hand, makes good money at his job, but still, at the end of the month, he’s broke and is hardly accumulating any net worth (assets minus liabilities). In fact, he’s just going deeper into debt with no real hope of accumulating any wealth. He’s got all the fancy stuff, but he pushes himself further in debt month after month to maintain his lifestyle. If Fred were to get a big raise or bonus, he would just go out and buy another toy on credit, and never really build any wealth.

See, being income statement rich comes down to having the appearance of being wealthy, when in fact it’s far from the truth. The only person Fred is kidding is himself. He can’t sleep at night nor enjoy anything he has because he worries how he can make his next payment on the extravagant lifestyle he’s grown accustomed to. He’s at risk of defaulting on his loan if he were to lose his job for some reason. He’s got no plan for his future and is living a temporary life of fashion and comfort. Bill on the other hand, could survive without a problem for a year or two if he were to lose his job, because he has accumulated wealth and owns his property. He’s not as dependent on his monthly income to pay his bills as Fred is.

It doesn’t matter how much money Fred will ever make, he will always be broke and never own a thing. It comes down to managing your money properly, not how much money you make. Take the time to create a plan for yourself and build true wealth. Strive to own the things you need to survive, don’t allow those things to own you. It’s time to stop thinking you’ve got to impress anyone, or that more money will solve your problems, you must manage the money you take in properly.

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