Benjamin Franklin is famous for saying that a penny saved is a penny earned. With all due respect to Mr. Franklin, it is possible that he has under-estimated the return when yous save. The reason for this miscalculation is the fact that you must pay taxes on every dollar that you earn before you have the opportunity to spend it. (Remember the parable of death and taxes)
Taxes, Taxes, Taxes
When you add-up Federal + State + Social Security + Sales Tax + other government fees & taxes, most people pay somewhere in the neighborhood of 30%-50% of each incremental dollar that they earn in taxes. This means that if you go out and work hard to earn an extra $100 this month, you will probably end up with $50-$70 after the tax man has gotten his piece. Suddenly I start to see why my Father kept telling me to save.
Since taxes must be paid before we spend our hard earned money, we actually enjoy a greater benefit by saving an extra dollar than earning an extra dollar. The reason for this is because you need to earn $1.50-$2.00 first, and then pay 30%-50% of it to the government in the form of taxes before you have $1.00 that is available to spend. Because of this dynamic, it often makes sense to be discriminating in the way you choose to spend your money since it will take a lot more work to replace money that is wasted than to avoid spending it in the first place.
How Much to Save?
Does this mean that you should become a penny-pinching tightwad? I would certainly hope not . . . the reason why we all work so hard to earn a living is so that we can enjoy the fruits of our labor. Saving and investing is important because it focuses us on the most important things in our lives so that we can spend less time working on the things we enjoy, and more time enjoying them. The easiest way to see this principle in action is to track your spending for 2-3 months, and then rank your spending decisions from highest to lowest in terms of importance.
I have a hunch that a significant percentage of the total dollars spent will be in the lower half of your “importance curve.” (Every time I look at my credit card bill, I am amazed at how many transactions are on there for less than $50 dollars . . . it is likely that I could have done without quite a few of those purchases) The key point is not to cut every “low importance” purchase out of your life . . . but rather to ask yourself whether there is something more important that you should be doing with the money that is being spent.