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One of the most popular lists published annually is the Forbes list of the richest people in the world. Poor, middle class, and the rich themselves love to compare and see how the top earners fare on a yearly basis.

I often wonder how different the list would look if spending rates were included. Despite the vast fortunes many of these people are able to earn, it is common to hear of empires going up in smoke. The resulting bankruptcies, foreclosures, and other fallout of grand-scale financial failures draw considerable attention.

The general public wonders aloud, “How could they manage to screw that up? If I was that rich, I’d never go poor again.” The sad reality is that the average person does equally poorly with large sums. Lottery winners are as notorious for going broke* as ex-athletes who never managed to parlay their talents into a future gig while spending with reckless abandon.

It all begs the question: Why do people that were once rich eventually go broke?

The answer is actually pretty damn simple; it’s all in the spending. If you show me a sampling of people, the purest detector of whether they will one day be filing bankruptcy all rests on the single factor of savings rate. I don’t care how much someone makes except in relation to how much they spend. Someone who earns a million dollars a year but spends $1,100,000 is worse off than someone making $40,000 and while spending $35,000.

So what is a “savings rate”?

Your savings rate is the percentage of your income that you put away into investments or straight savings. It’s the portion of your income that you don’t spend.

Consider two examples:

These are fictional characters but probably sound like people you’ve met.

a) Dorothy works hard for her money. She earns a sizeable salary of $75,000 per year and enjoys the finer things in life. She doesn’t employ any restraint with regard to her spending. If she wants something, she gets it. Everyone at the bank loves her and they are always eager to hear about her latest adventure in the Caribbean. She believes in working hard and playing hard.

Dorothy has never missed a payment on her credit card or line of credit. She had her banker set all of her debt to have at least the minimum payment transferred just in case she forgets to make a payment or runs a little short. This way she protects her credit rating and good standing with her financial institution.

Just last year, Dorothy’s bank offered her a higher limit on her line of credit to reward her for being such a great customer. She eagerly accepted the increase from $10,000 to $20,000. After all, this increase will allow her to get the renovations done to build that sunroom she’s always dreamed of! What great timing for the bank to grant her some extra wiggle room. Dorothy is very confident that adding this sunroom is the thing to do for both the enjoyment she will get and the increased value she will recognize in her home. People love sunrooms.

Owning a high-end vehicle is a no-brainer for Dorothy. She loves to look good and feel all warm and fuzzy inside when people compliment her sharp ride. Leather seats were an easy decision at the time of financing as it would only cost a few extra dollars bi-weekly.

Amid her lavish lifestyle, Dorothy realizes, though never addresses the fact that she has a negative savings rate. She never quite feels the pinch since she lives a flashy lifestyle, but she is aware of the fact that she never actually pays her credit card or line of credit balance in full. She feels that’s okay because it seems to be what everyone else does and it’s worked thus far.

Dorothy’s savings rate is -10%. For every dollar she earns, she spends $1.10.Poor Dorothy.

b) Now consider Samantha. Samantha makes a modest salary of $45,000 per year. From the very first dollar she made picking and returning bottles from the side of the road as a youngster, she has put away at least 15% of everything.

Over time Sam realized she was living very comfortably with the 15% savings rate and decided to bump it up a little. She had her bank set up automatic withdrawals from her chequing account to her savings account each pay representing 20% of her income. Making the withdrawals automatic makes life simple and Sam never has to worry about forgetting to pay herself first.

Sam keeps a credit card with a low credit limit of $1,000. She uses the card simply for the small cash-back that she receives on her no-fee credit card. She routinely receives offers in the mail to automatically upgrade her credit card due to her good standing. She files these offers appropriately in the paper shredder. She has never had a line of credit and never intends to. She has accumulated a savings cushion that can be used in the case of emergency.

Sam doesn’t go to the bank often and shudders at the advertisements she sees recommending using debt to perform home renovations or go on vacation. She understands that every dollar she wastes will cost her future self the luxury of early financial independence. “Time is money”, she says, and quite literally can see in her mind that an extra $100 wasted per month can amount to years of having to clock in and clock out at her job.

Many of Sam’s favourite hobbies don’t cost much money at all. She spends plenty of her free time with family and friends, works out at home to preserve her physical and mental health at a lower cost, and even bikes to do groceries when the weather permits.

Sam’s savings rate is currently 20%, though she intends to monitor her spending and find ways to get that number up to 25%. Her goal is to get it to 50% where she would be living on only half of what she makes through a combination of increasing her income and decreasing her spending – burning the candle at both ends in a good way.Sam.

So, for every dollar Sam accumulates, she spends only $0.80.

I think you see where I’m going with this. I’m all for getting the most out of life and living every moment to the fullest. Both women in the example enjoy their lives and are doing well for themselves. The issue is that Dorothy is on the fast-track to financial failure while Sam is building a future for herself on much less income.

A healthy savings rate boils down to differentiating between wants and needs, and then having the discipline to put a plan in place to prioritize needs and put wants on hold. The funny thing about wants is that when you stop indulging yourself for a period of time, you get used to not having them around.

Increasing your savings rate is your most reliable ticket to taking control of your future and, if done properly, may someday land you on a richest person’s list for more than one year!

– Ryan

What have you done lately to increase your savings rate?

* I’ve tried to find reliable stats related to how many six-plus-figure lottery winners go broke but wasn’t satisfied with the reliability of the results to post a number. Suffice it to say, the population is significant.

Pictures courtesy of pixabay.com 

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