What would you do with an extra $20,000 a year? Would you buy a car for cash? Maybe use it as a down payment on a new home? Would you invest it in the stock market or use it to build an emergency fund?
I admit, different amounts mean different things to different people. But for us, once we start looking at five figures ($10,000+), we’re starting to talk about serious money. For some people who belong in lower income brackets, that figure is easily lower. For my wife and I, with dual incomes, and an annual take home pay of about $90,000, $10,000 represents over 10% of our annual income.
If I told you that without doing any extra work you could increase your annual take home pay by 10% or even 20% what would you say?
Maybe you’d think to yourself that would be easy… just get a second job. Work a part time side gig. Do one of the many side hustles I’ve talked about. All of those are great ways to increase income, but they’re not the best way to increase your annual take home pay.
The best way to increase your annual take home pay is to decrease your annual spending
Amazing, right?! Depending on your annual income, and obviously depending on some of your circumstances, the very best way for you to increase your annual take home pay right now is to decrease your discretionary spending.
Like I said, we make about $90,000 annually between the two of us. That’s nothing to turn up your nose at, but it’s not remarkable either. Our annual expenses are about $45,000 at a minimum right now, or about half of our income. Another $10,000 to $20,000 ends up getting spent on discretionary spending.
What this means is that annually we are able to save and invest only about $25,000 collectively, or around 25% of our income. By most standards of saving for retirement, we are hitting it out of the park. Since the golden rule of saving is 10%, we are more than doubling it. Not that bad, right?
Here’s a couple caveats to our situation though:
- We are already debt free
- We have dual incomes
- We have certain benefits provided by the military that others don’t have
With all that being said, it’s not too far fetched to suggest that you can get close to, or better than where we are at.
Here’s how we increased our annual take home pay by decreasing our discretionary spending.
Use budgeting software
Whether you create your own budget spreadsheet or use something like Mint.com, it’s important to have a game plan or a way to track progress. I’ve heard that most wealthy people don’t actually stick to a budget. This makes sense. Once you get good with money, it’s like muscle memory. You learn to recognize the value in your expenditures and learn to control your spending naturally. Your budget should take care of itself at that part.
There’s a saying that if you’re poor your entire life, it means by default that you’re not good with money. Circumstances play a part, but in a large part I agree with that.
So first and foremost, we looked at our current budget/money tracking software. To get out of debt, we had used an Excel sheet that I developed myself. It tracked our expenses and helped us keep from over spending. Once we were out of debt (over $60,000+ paid off!), it became a lot easier to over spend.
It felt like we suddenly had all this money. Instead of saving like we were before, we felt like we had no limits and started spending like crazy.
Getting an account with Mint.com really helped us put things in perspective. It expertly keeps track of all transactions, expenses and accounts you can throw at it. It helps you set up specific spending budgets, and visually track monthly progress. It’s a tremendously helpful tool.
In particular, my spreadsheet that I made was very useful to me, but not particularly useful to anyone else. Mint is great for everyone to use.
Earmark money for specific expenses
We looked at a history of our last 6 months of spending. We averaged out monthly expenses like food, the mortgage, entertainment, etc. and started coming up with realistic budgets for each category. Then we set up those categories on Mint and treated them each like one of Dave Ramsey‘s money envelopes.
In the past we had set up individual checking accounts for each type of expense. This was really useful but it added a lot of extra documentation and tracking. Come tax time, we were getting a dozen 1099’s, and it was just a pain to keep track of. Mint does this all digitally for us.
So we came up with a few figures:
- Our total income, including rental income
- Our total expenses
- What was left over
Total Monthly Income: $9,596
This includes both of our pay checks and our income from our rental property.
Total Monthly Expenses: $7,957
Total expenses include both mortgage payment(s), car insurance, gas, utilities, home maintenance, and so on. This figure must be the bare necessities!! It is super critical you are honest and transparent with your assessment of what expenses are truly critical.
This took a lot of debate between my wife and I, as we came up with figures about how much we spend on entertainment and other things.
Leftover: $1,639
Annually this leftover nets us about $20,000 in investable income. Not bad, right?
Well, as it turns out, through this exercise, we identified multiple expenses that were discretionary. We discovered that we were often double dipping on food spending. Many times we would go grocery shopping, stocking up the fridge with a week’s worth of food, only to spend several nights eating out as well.
We looked at the cost of the food we would end up throwing away each week. We also took a hard look at other discretionary entertainment and leisure expenses like Starbucks, unnecessary “toys” and furnishings, among other things.
These unnecessary expenses were costing us almost an additional $1,200 every month.
Eliminate unnecessary discretionary spending
After we did our self audit, we identified multiple areas where we could cut back. We set budgets on Mint to limit our monthly grocery expenses to $500. This limit ensures that we are only spending money on food we will actually eat and nothing more. It keeps us from eating out more than once a pay check as well.
We also decided that the best choice was to keep some discretionary spending, but define a concrete limit to it. This limit doesn’t mean we have to spend the money, but it lets us enjoy our lives and spend money on leisure and entertainment without feeling guilty.
Our budget set us at $500 each per month on discretionary spending. This was a pretty high cap to start with, because we didn’t want to shock the system so much so that we couldn’t stick to it.
We freed up almost $2,500 per month!
All of this intense budgeting and introspection ultimately ended up freeing up an additional $2,500 per month!! This is on top of the ~$1,600 we had leftover to begin with.
So our initial annual savings/investments went from about $20,000 to nearly $50,000. This was without any extra income whatsoever. It also doesn’t take into account the appreciation on these investments (save to assume an annual 5% growth rate), or the increase of the equity we have in our two homes, which is over $10,000 annually.
This is the power of controlling discretionary spending. Our goal was to add $20,000 annually to our take home pay, which we could use to invest or put towards retirement or emergency savings. We smashed through our goal and nearly doubled it.
What to do with the extra income
Doing the work to free up this income has the benefit of teaching you to be disciplined. This discipline is critical when it comes to using that extra income wisely. Since you were disciplined enough to control your spending, you should now be disciplined enough to invest the leftover and make that money work for you.
Our prior investable income of about $20,000 would give us about $80,000 in 4 years (not accounting for interest). $50,000 comes out to $200,000! Our current net worth, including house equity weighs in at about $510,000. With our new, aggressive savings plan, we could increase our net worth by almost 40% in only 4 years, without earning a single extra dime.
Once you account for appreciation and interest, that number only goes up. Investing the money wisely is important, but through dollar cost averaging and compounding, the extra money can only do good for you.
If our expenses stay the same, we would need about 5 or 6 years of spending at this pace in order to become truly financially independent. Don’t misquote me, though, I didn’t say “wealthy.” I believe wealth means lots of different things to different people. So when I say financial independence, what I mean is that our assets and net worth’s annual appreciation will be able to cover our annual expenses.
That would mean we could be free to work any jobs we wanted… or no jobs at all, and still maintain our current standard of living.
This is true freedom, and I hope this post is motivation for you to start looking at your own financial picture and goals.
Conclusion
Financial independence depends more on your discipline than on your income. Learn to budget and be aggressive in your discretionary spending and you will be amazed at how much money you can put towards your life goals. Whether you are saving for an early retirement or trying to buy a house or see the world, these simple steps can help get you there.
For us, cutting our discretionary expenses helped us build fiscal discipline and also appreciate the things that we really feel we need to spend money on.
Have you had success with cutting discretionary spending?