Posted by: fathersez | November 13, 2007

What turns you on – Expansion of income vs Reduction of expenses

Many PF blogs explain various methods of saving money and reducing expenses. Some of these posts are really good, showing ways to reduce expenses without affecting quality of life in any way.

See The Simple Dollar’s series on “One Hour Projects.” 

Others need a lot more commitment, things like baking our own bread, cooking for a week and storing them, sewing our own clothes, etc. 

We all can agree that the Number 1 cause for a terrible financial position is “living beyond our means.” So managing expenses and controlling them is a must. 

The debate on “whether we should pay down loans (hence reducing interest expense or invest to increase income” is a hot one. I don’t think there is any one single “right” answer.

We have mathematical arguments, talking about comparing the amounts and % that we expect to save and make, and then making our call.  Others who appear to be more risk adverse take the position that interest savings are clearly determined, while investment income is risky and unknown. This, I call, the “bird in hand vs the bird in the bush theory.” 

The Simple Dollar argues that the answer depends on one’s own goals and lists some of the benefits a debt free life can offer. He also calls the debt payment a psychological investment.  

Yahoo Finance drives home the point that :-

First, no one ever spent a sleepless night because she had millions in the bank and stocks but didn’t have her home paid off. On the other hand, if you pay off your mortgage and deprive yourself of liquidity, you could be in for some miserable times. As I see it, if money is even the slightest bit tight, hold onto it and pay off the mortgage month by month. There’s nothing magically good about having a paid-off mortgage, but there’s something seriously bad about not having ready liquid assets even if your home is paid for. 

Others comment that women and men have different approaches to this. They take the view that women are more risk averse, so they would more likely than not, chose to get rid of debt as soon as possible.  

Yet another interesting version to this “save or invest” is that presented by KC Lau. He presents the view that we can only save “that much”, whilst investment income is theoretically unlimited. 

So exactly what should we do? Whilst there is no simple answer,

I agree with KC Lau and the Simple Dollar. There has to be alignment to one’s own goals and feelings, i.e. basically doing what we feel most comfortable with.

However, the basic principles would more or less be similar. 

a)    get our basics anchored down first,

       a.    spend less than we earn,

       b.    build up our emergency fund,

       c.     pay off all our high interest rate debt, 

and, after having made our financial foundation solid,   

b)    invest as wisely as we can.  

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Responses

  1. Thanks for mentioning my article in this post. After digesting your article, I am sure that you are a great researcher that only publish ideas and finding after heavy research and consideration.

    I also learned several things from you:
    1. doing what we feel most comfortable with
    2. women and men have different approaches
    3. “bird in hand vs the bird in the bush theory.”

    Thanks again for the sharing.


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