Written by Trent Hamm, The Simple Dollar is a popular personal finance blog that chronicle's one man's road back from overwhelming debt to financial security. Hamm declared the contents of the blog to be in the Public Domain in 2008 and available for sharing when attributed properly. We will share a couple of posts a week.
Have you ever noticed a certain trend in the reader mailbag questions? People often ask which approach to paying off their debt is better, or whether it makes more sense to rapidly pay down a 4% debt or to invest that money.
In both of those cases, we’re discussing a very small difference in financial benefit over the course of years. You can pay down tens of thousands of dollars in debt as fast as you can and the order of the debt repayment will end up only being a hundred dollars or so. The difference between a 4% and a 7% return on $100 a month over the course of four years is a few hundred dollars.
Here’s a tip. In both cases, finding a way to come up with ten more dollars a month to invest or to pay down the debt will blow away what you might gain by choosing the optimal path. Seriously.
Let’s look more closely at that example of $100 a month. If you invest that $100 a month in something that earns 4% a year (say, an early debt repayment), you’ll see $5213.28 in value at the end of the four years. On the other hand, a 7% investment would see you with a $5553.13 value at the end of four years.
Now, let’s say you skipped out on one Starbucks coffee and a scone per month and turned that monthly investment into $108. Investing that $108 a month – $100 plus your Starbucks fix – at 4% over four years will see you with $5630.34 at the end of that period. That’s better than either investment option with just $100 per month invested.
Increasing the amount you can save just a little bit – even a few dollars a month – often has much more impact than choosing the perfect investment.
That’s not to say it doesn’t make sense to choose the better investment – of course it does. At the same time, when even a little bit of a change in the amount you invest each month can have a much bigger impact than the investment choice, it might be worthwhile to broaden your focus.
It’s all about the gap.
The gap, for those unaware, is the difference between a person’s income and how much they spend. A person can improve their gap through earning more moneyand through spending less money. Self-control and conscious buying work, as does a career focus and an entrepreneurial streak.
In terms of quick, immediate impact, it’s really hard to beat frugality. Choosing not to spend money in that moment shores up your gap and gives you more resources with which to invest.
There are countless little effortless things you can do to spend less money without impacting your life much at all – or only impacting your life a little bit in the moment you make that choice. Skip out on a treat and put $5 in your kitty. Switch to doing laundry when you only have a full load and use a dryer ball to cut down on the energy use on your dryer and you’re probably saving a few bucks a month. Buy stuff you use all the time, like soap and toothpaste and trash bags, in bulk and save the per-unit difference. The list goes on and on and on.
For a longer-term boost, though, look at methods for increasing income. Take on a part-time job. Start a side business. Take some evening classes to improve your employability.
It’s all about increasing the gap. Every little step you take to make the gap between your income and your spending larger, the more you have to invest. It only takes a little change to make a profound difference in your investment returns, as only a few dollars a month can have more impact in many people’s lives than figuring out the perfect route for investment or debt repayment.