Minimize expenses: Be thrifty (frugal)

If you want to accumulate wealth, you need to live below your means. You need to be aware of "what you need" vs "what you want". In "The Millionaire Next Door", Stanley & Danko found that the majority of the millionaires they interviewed were extremely thrifty/frugal. Spending money is easy, but earning money is difficult. By reducing our expenses, we can keep more of those hard earned money, accumulate wealth faster, and achieve financial independence sooner.

Minimizing expenses will help you accumulate wealth
Most people do not know where they spent their salary at the end of each month - they are spending unconsciously. The expenses that seemed to be small and acceptable add up to large sums and consume lots of your money - David Bach calls it your "Latte Factor". If we assume an annual return of 6.5%, by investing $3,600/year (adjusted for inflation @ 3% p.a.), you will have $63,249 in 10 years, $194,646 in 20 years, $467,405 in 30 years, and $1,014,503 in 40 years. By spending $5 on coffee and muffin and $5 on cigarettes daily, you are consuming $300/month or $3,600/year - money that can make a huge difference over time!

Keeping track of expenses
The first step to minimizing your expenses is be conscious of how you spend your money. Just as a short-term exercise (for about a month or two), you can carry pen and paper with you and record every time you spend money. At the end of each week and month, tally up how much you've spent on various items, such as meals, entertainment, utilities, etc. It will give you an idea of where you are spending your money.

If you want to do it long term, you will probably want to use a software, such as Intuit Quicken or Microsoft Money Plus, to help you manage the information. I use an old Quicken Premier version, but most will probably do fine with the Deluxe version. They also have a Home & Business version available if you own a home-based or small business. I heard that Microsoft Money Plus is just as good as Quicken, and they also have Deluxe, Premier, and Home & Business versions. If you really want to save money, there is also the free GNU Money available - but I have heard about stability issues before. GNU Money is an open source software, and open source software tend to evolve rather quickly, so the stability issue I heard about might have been fixed (you just have to try it for yourself).

I record my transactions at the end of every day on my computer. I find it important to keep it a daily habit. If you skip a day or two, you will forget your transactions for those days and be forced to use an adjustment entry for the missed data. By keeping detailed record all my transactions, I can look at my income/expense reports and know where I spent my money this month. I will know whether I increased or decreased my expenditures for meals or entertainment or utilities month-to-month. I find it really useful to be able to see the data and understand, "I am spending too much eating snacks. I need to control my snacking."

Asking questions before spending
After tracking your transaction and checking your month-by-month income statement for a while, you may develop the habit (as I have) of asking yourself before buying, "How will this impact my income statement at the end of this month? Will I be OK with having made this transaction? Or will I cringe when I see the expense on the report?"

It takes time to develop the "feeling" for how a purchase will impact your income statement. To reduce your expenses immediately, consider asking these questions before you make a purchase:

1. If I already have one, is it usable? If not, can it be fixed? (If you have the same thing at home that is usable, you don't need to buy. If it's broken and can be fixed below cost of buying a replacement/substitute, fix it. Good shoes can be resoled. Good furniture can be reupholstered.)
   
2. Can I live without this? Do I "need" this, or do I "want" this? (You can't live without "needs" such as food, but you can live without "wants" such as cigarettes. Stop smoking, and you'll also save on health care expenses in the future!)
3. Can I wait to buy this? (Try waiting a week. If you can wait, delay for another month. If you still want it, continue to the questions below.)
4. Can I buy this secondhand? (You shouldn't buy secondhand underwear, but a good secondhand car can be a smart buy. A new car start losing value once driven off the lot, and its value drops by 20-50% in the first year. A well-maintained secondhand car may be resold for close to purchasing cost.)
   
5. Is there a cheaper or generic alternative with similar quality? (A handbag bought at the flea market will probably look reasonable and work just as well as the LV or Coach bag you're thinking of buying.)
   
6. Can I buy it cheaper? (Comparison shop or go online. You may find better deals.)
7. How often will I use this? (A $100 shoe you'll wear to work daily is a better deal than the $50 shoe you'll wear to a one-off special event. Consider borrowing or renting for one-off uses.)
   
8. Am I buying this for an emotional reason?
• Happiness, excitement and thrill associated with having "the new thing" will wear off. (No wonder game publishers always have a new game coming up and make new versions of the same game!)
  
• Boredom can be fought off with a free walk in the park or swim in the ocean (those are healthy activities too!). Movies can be disappointing and boring (consider renting instead of going to the movie theater), and amusement parks are all pretty much the same (plus the thrill wears off rather quickly).
  
• Stress can be taken care of by talking with your spouse/partner or good friends (it's good for your relationships!). Alcohol, gambling, and "other activities" will leave you poorer and with a hangover, a bad habit, or may affect your health, or may get you into trouble with the law (thus adding more stress in the end) .

These additional questions will push you to think in a more entrepreneurial or business-like manner:

1. Is this item extremely and ridiculously cheap? Is this my only chance to buy it at this price? (Learn to recognize good deals and act on it. Of course, this is provided that you will use it or re-sell it for profit. There is no point buying a really cheap thing without making use of it - there is the carrying cost of inventory.)
2. Is there something else better I can do with this money? (Opportunity cost.)
3. Can I make money on this purchase? Will this save me time or energy or both? (Remember to consider your time and energy as part of opportunity cost. If you will make more money with the time and energy saved compared to the cost of purchase, it can be a smart buy.)

A few quick tips

• Pack your own lunch: Eating out is expensive.
  
• Mobile (cell) phone: Skip the 10 messages if a short 30-second phone call will do (saves time too).
• Be environmentally conscious: Save water, turn off lights, lower heater settings, etc. You will save your money and the environment at the same time.
• Buy quality clothes, shoes, and furnitures: Take good care of them, and they will last a very long time. They can also be mended, resoled, and reupholstered.
• Write a shopping list and buy at discount warehouses (or Wal-Mart): A shopping list helps save time and avoid impulse buying. The price difference versus the 7-Eleven or neighborhood groceries store will add up over time, with volume, and using coupons.
• Go visit universities' student services or financial aid websites. They probably have plenty of free financial and other resources that you can use (even if you're not a student).
  

Be thrifty (or frugal)
I believe I am thrifty (frugal):

• thriving by industry and frugality;
• marked by economy and good management;
• reflecting economy in the use of resources.
  

(off topic: I'm inclined to use the words "thrift" and "thrifty", rather than "frugal" and "frugality".)

If you remember Economy 101, neoclassical economics assume people are rational and maximize utility and value. By spending unconsciously, you are being irrational and do not maximize utility or value. You can bring into your life the rational, economic being you learned about in Economics 101 by asking those of questions before making purchases. I choose to live an economic life because I value financial independence, much more than an "easy" life (i.e. not thinking about finances and economics), a high social status, or a lavish lifestyle.

Related posts:

• Eliminate debt.
• Accelerate wealth accumulation.
• Minimize capital loss.
• Minimize expenses (revisited).
  

References:

• The Millionaire Next Door - by Thomas J. Stanley and William D. Danko.
• The Automatic Millionaire - by David Bach.
• Intuit Quicken.
  
• Deluxe version.
• Premier version.
  
• Home & Business version.
  
• Microsoft Money Plus.
  
• Deluxe version.
• Premier version.
• Home & Business version.
• GNU Money.
• Carrying cost of inventory.
  
• Opportunity cost.
  
• PennState - Living Below Your Means.
  
• University of Melbourne.
• Keeping track of your money.
  
• Cutting costs.
  

## This post is part of "The Principles of Wealth Accumulation" series on this blog.

P.S. This post was featured in the Festival of Frugality #119 at Consumerism Commentary.

Discloure: Long WMT.