Continuing The Discussion: When Does It All Pay Off?

Over at Get Rich Slowly, J.D. posted an interesting discussion on the question of when the payoff comes for all the work of being frugal, saving, and investing. To quote Annie:

I look around and see people my age buying expensive condos, carrying expensive handbags, taking trips to Iceland and Mexico and Spain. I know that some of them have accounts at the Bank of Mom and Dad, and others are paying for everything on credit, but sometimes I wonder what I’m doing wrong. I went to college, I make… not a ton, but not peanuts, I try to live within my means, and yet I feel poorer the older I get. Yeah, I’ve got a great FICO score, but what good is that when I can’t afford to buy a home — or even merely move to New York, where there are more jobs in my field?

In short, I’ve been questioning my financial decisions lately. I have become quite depressed because I feel I am falling behind my peers. Should I be putting less in my retirement fund so I have more cash now? Adjust my student-loan payments (right now I pay $270 a month, but I could trim it to $150 a month [but, of course, pay more in interest in the long run])? Am I being naive — do most people have help from their parents? I guess I feel frustrated, disheartened and snookered because I made all the “right” financial decisions and although I’ll be totally debt-free in three years, I am getting tired of this eggs-for-dinner crap. It’s like wearing sunblock (which I also do religiously): All of this effort had better pay off, or I am going to seriously be one angry (and pale) woman.

J.D. goes on to describe in detail the general philosophy that being frugal is worth it – in the words of Dave Ramsey, if you will live like no one else, later you can live like no one else. But what this person needs is something more tangible than that, and I think I can demonstrate why frugality pays off in the long run.

How Frugality Pays Off in the Long Run

Let’s say at age 25, Annie makes $30,000 a year, but she’s smart enough to realize that she should be saving 15% of this money a year. Let’s also say that Bev (also age 25) makes $35,000 a year, but she spends like there’s no tomorrow, to the point where she actually is wasting 5% of her annual income paying interest on her credit cards. They’re going to both get 4% raises each year.

At age 25

Annie only spends $25,500 on her lifestyle, while Bev spends $33,500. Bev’s lifestyle is going to seem a whole lot greater than Annie’s from a consumerist standpoint. But let’s give them some time and see what happens.

At age 30

Bev’s lifestyle is going to make Annie really jealous. During that year, Bev will run through $40,453.71, while Annie will only spend $33,156. However, it’s worth noting that Annie’s dropping 15% of her income into a mutual fund that returns 10% a year, while Bev just keeps spending.

At age 40, Bev and Annie meet up again, and suddenly Annie’s lifestyle is getting more similar to Bev’s. Annie spends $54,349 this year, while Bev still spends more by spending $59,881 that year. But Annie has more than $100,000 in investments right now, while Bev has nothing at all.

At age 50

Bev and Annie touch base again and their spending is almost identical (even though, remember, Bev’s job all the way through has been a higher paying job than Annie), with Annie spending $86,566 this year and Bev spending $88,639. However, again, Bev has nothing at all saved for the future, while Annie has $234,000 in her investments.

At age 60

Bev and Annie touch base one more time. At this point, not only does Annie have more money to spend than Bev ($129,425 to $126,161), she has a retirement nest egg approaching half a million dollars. Bev not only doesn’t have as much to spend as Annie, she doesn’t have a dime socked away.

In short, even though Annie is always making 14% less each year at work than Bev, being frugal means that Annie ends up with a lot more money to spend in the long run. More likely, at some point Bev will realize that she desperately needs to think about retirement and suddenly Annie’s long term plan will look golden to both of them.

If this example seems familiar, it’s because I wrote about a very similar situation in the past, but the point is still true: careful saving and frugal living trump everything, even the relatively higher salaries of others.

Annie, you’re doing the right thing and the numbers prove it. Even if it feels like you’re “slipping behind” your peers right now in terms of consumer goods, you’re setting yourself up for the long run, while they’re burning through their money right now. Stick with what you’re doing right now and soon you’ll be leading the race while the others are playing catch up for the rest of their lives.

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