This is a guest post from J.D. Roth, who founded the Get Rich Slowly blog and currently writes at More Than Money. J.D. recently launched a year-long "Get Rich Slowly" course, which is based on the idea that you’d have greater financial success if you managed your money as if you were running a business. I’ve previously written about approaching your finances like a business.
I’m convinced that more people would achieve financial success if they managed their home economy as if they were running a small business. We all know that a company needs to earn a profit to survive, but few understand that the same principle applies to our personal lives.
To build personal wealth, you must spend less than you earn. When you do, you’re earning a “profit” and building wealth. But if you spend more than you earn, you’re losing money and in danger of falling into debt. The greater the gap between your earning and spending, the faster your net worth grows (or shrinks).
The key is to boost the profitability of your personal economy by spending less and earning more.
But not every path to profit is equal. Some opportunities are unappealing because they take either a lot of time or a lot of effort -– or both. Other options are a low priority because they have only a small impact on your bottom line. The best paths to profit – in business or personal life – are those that provide some combination of low difficulty and high reward.
There are four types of things you can do to reduce your expenses or boost your income.
- Pyrrhic victories are activities that take a lot of time or effort without yielding an equivalent payoff. In business, these might include sweeping the parking lot or leasing a large office space. On a personal level, these are things like making your own laundry detergent or raising money by collecting old newspapers door-to-door.
- Ongoing projects also require a lot of time or effort, but they provide huge payoffs when they’re finished. Last year, for instance, I organized and sold my collection of comic books. That project took over 100 hours of tedious work, but paid off with a $25,000 windfall. Similar projects might include moving to a cheaper home in a cheaper city or returning to school to earn a degree.
- Daily victories are the bread-and-butter of personal finance. They’re easy (or quick) actions that yield small rewards, such as working overtime, clipping coupons, or making use of the public library. Because there are so many small, simple ways to boost your personal profit, these are the things most commonly covered in books and blogs and magazines. These daily victories are great—but it takes a long time for them to affect your bottom line.
- Big wins are the Holy Grail. They’re the easy (or quick) things you can do to supercharge your saving rate. These include negotiating your salary (which takes minutes, but can pay off for decades to come) and reducing your transportation costs (which you can do in a matter of days).
You can improve profits by doing things in all four categories, but it’s important to keep each action in its place.
You should only pursue Pyrrhic victories when you’re unable to do any of the tasks in the other three categories. It’s foolish to try to get out of debt by making your own laundry detergent while you still have a huge mortgage. That’s like Microsoft trying to boost profit by spending less on pencils instead of selling more copies of Windows.
And what are the best ways to achieve these big wins? Well, it’s doing the things that most other people are unwilling to do:
- Down-size your home. Housing is the biggest expense for most Americans, and by a wide margin. The typical household spends $1408 on housing each month, or about a third of its budget. Drop that by 10%, and you’ll save $150 per month. Drop it by 30% and you’ll save more than $5000 per year!
- Drive less. Transportation is the second-largest expense for the average family. You can save big by biking or walking, using public transportation, or swapping your current car for a less-expensive used model with good gas mileage.
- Earn more. You can cut costs only so much, but your earning potential is theoretically unlimited. If you really want to boost your personal profit, make more money. Go back to school, become a landlord, sell your stuff, take a second job. Of course, as an entrepreneur, you’re already working hard to increase your income.
The biggest barrier between the average person and financial success isn’t ability. It’s psychology. Big wins require effort and sacrifice, which can be tough to stomach. But the sooner you see that these choices aren’t extreme measures but the best way to achieve your financial dreams, the quicker you’ll get out of debt or reach financial independence. The small stuff forms a great basis for behavioral change, but it’s doing the big things that will make you rich.
This is a modified excerpt from "Be Your Own CFO", the 120-page guide included with the year-long "Get Rich Slowly" course. The guide includes tips for boosting revenue and cutting costs so that you can maximize profit in order to achieve your dreams, whether those are to retire early, send your kids to college, or travel the world. Want to know more? Buy it now.
Updated June 22, 2016 and originally published April 22, 2014.