Personal Finance

Most Americans Overspend & Fail at Frugality… But It’s Not Why You Think

Expertise: Mortgages & Creative Financing, Personal Development, Landlording & Rental Properties, Personal Finance, Real Estate News & Commentary, Real Estate Deal Analysis & Advice, Real Estate Investing Basics, Business Management, Commercial Real Estate
175 Articles Written
frugality-fail

I recently saw an article on the blog entitled, “Living Frugally vs. Spending on What Matters: How I Achieve a Happy Medium” by Elizabeth Colegrove. Liz told us that with respect to frugality, she is an “onion.” I thought that was kinda cute indeed, though I must admit that I did get lost in Liz’s layers somewhat… I’m not that bright, y’all.

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This topic of frugality keeps coming up on BiggerPockets, as it should. In fact, Scott Trench dealt with this issue as well in his latest installment. Frugality and overspending: the sexiest subject matter on the BP blog. Who knew?

Well, you know Ben Leybovich won’t be left out of a sexy conversation. So, here we go.

Logic

There are no easy answers to this question. Why? Because frugality is a moving target. Let’s explore.

Fundamentally, what we are talking about here is the relationship of what we earn (make) to what we spend. In other words, the question we could ask is this:

What percent of your income do you spend on living expenses?

Or:

How little of what you earn does your life cost; what is your “burn rate?”

tax-changes

If you answered 25%, I think most people here would agree that you lead a rather frugal life. If you said 80%, the entire BP community would jump on you to get on a budget. And if you said 105%, meaning you spend more than you make, then we’d right away tell you to attend one of Brandon Turner’s webinars, buy a Pro membership, and use the BiggerPockets Rental Calculator to analyze a multiplex (and buy it with $0 down) ’cause this is gonna solve all your problems…

Disclaimer: That last sentence was a sarcastic funny for which Ben Leybovich is infamous. If you smiled as you read it, congratulations. In addition to a pulse, you also have common sense and a sense of humor. If you didn’t smile as you read that, then, well, I guess you are missing either the pulse, the sense of humor, or both – sorry for that. Regardless, please don’t go buy a fully leveraged multiplex to correct the problem of overspending, even if a calc says it’s a good deal – make sure you do your homework, which is more than just plugging in a number!

More Logic

So, if we agree that spending 25% of the take-home cash flow qualifies you as frugal, then with an income of $100,000, you’d have to figure out a way to live on $25,000. Is that likely?

Related: 10 Things Only Personal Finance Nerds Would Understand

First of all, with an effective tax rate of, say, 30% (and that’s generous for W2 income folk), you’d have to earn $143,000 to bring home $100,000 – not many of you are in this category. But even if you are, what are the chances you can swing life on $25,000? How about $30,000…?!

Fixed Costs

The reason most people lose money in real estate is because when evaluating their deals, they simply plug percentages into their pro forma to represent expenses. Unfortunately, most of these costs are actually fixed numbers, and trying to represent them as percentages leads people to underestimate the cost of ownership rather dramatically.

For example, a water heater for a $30,000 pig and a water heater for a $400,000 home cost the same – let’s say $750 all in. If the pig is rented for $750/month, while the $400,000 home is rented for $3,000/month, the cost of the water heater as a percentage of annualized Gross Potential Income on a $30,000 pig is 8.33%. However, it is only a burden of 2.1% on the $3,000 rental. This is a huge swing, from 2% to 8%. If you were using the BP calc, how would you pro forma this expense in terms of percentage… would you use 2% or 8%?

You see, you cannot pro forma this expense as a percentage – it’s not a percentage expense; it is a fixed expense, and you need to allocate a dollar amount in your pro forma underwriting. You need perspective, which comes from either experience or from reading Ben Leybovich’s articles, and you need to build a pro forma that allows much more sensitivity than that which a percentage of GPI can provide.

And by the way, this is why all of those 2%, 50%, and the rest of “percent” rules are absolute garbage — the real world is not accounted with percentages. I’m not making any friends with newbies here, and my dear friend Brandon Turner will be pissed at me for dissing those rules again. What can I say? They are garbage…

budget

Works the Same With Frugality

Some things in life just cost what they cost. In fact, most things in life are that way. This is what makes it difficult to think of frugality as a percentage of income. If we agree on $75,000 as an amount that is reasonable for most families with two kids to live on, then most families in America spend everything or more than what they make.

Think about this, however: For someone who makes $400,000, $75,000 is only 18.75%. Haha — this means that in order to live on $75,000 and be considered frugal, one needs to bring home $400,000. Are you there? How many people do you know who are?

There’s Another Way

Thus far, we’ve been talking about spending as it relates to what you earn. And the gist is that it is really tough to be “frugal” because most of us flat out don’t earn enough; in other words, your ability to earn tees up your ability to be frugal in our conversation thus far.

Now, this might come as a shock to you, but the reason the rich are getting richer and poor are getting poorer is because the poor try to earn more to facilitate a better life, while the rich simply pass the responsibility of their income and their expenses onto others. Sorry if I offended someone’s sensibilities, but truth is what it is! The rich are getting richer because someone else pays for their lifestyle, and that someone else is… the poor.

I built a nice home for my family (ask Brandon — he saw it), and I drive nice cars. But I don't pay my mortgage; one of my businesses does. I don't make my car payments; my tenants do. It would be stupidly extravagant and reckless of me to do either if I were the entity responsible for making those payments, but I am not. I pass those costs along to clients and tenants, and as a result, I am spending a considerably smaller percentage of my GPI to facilitate a nicer lifestyle than most of my friends. Not to mention that my revenues are much more diversified and much more passive in nature than my friends with W2s.

Importantly, what this means is that my tax burden is much lower than most, which means that I don’t have to earn as much.

In this way, it could be said that I am using others to buy my life — sure, I am. This is America, this is business, and this is real estate.

Related: How to Get Rich: 7 Awesome Ways to Build Big Wealth Today

Conclusion

This conversation around frugality comes down to two concrete realities:

  • One, it is highly unlikely to achieve frugality if your mode of income-generation is W2 or 1099; it simply requires more money than most will ever earn, and
  • Two, frugality is not merely a function of dollars you spend relative to dollars you earn. Frugality is a total perspective on your financial life. Frugality requires that you not generate earned income and that you switch over to passive, because a passive mode of income-generation puts the burden of your income on someone other than you, and you must not be the one paying for your life — you can’t afford it!

So, open your mind…

P.S. Scott, you are talented as all hell, and you were almost there in your thinking. You just need to adjust your perspective one degree. You need to be one iota more cynical! I know this doesn’t come naturally to a pure heart such as yours, but dude, I’m just the messenger. Life is what it is, man!

[Editor’s Note: We are republishing this article so our newer members can weigh in!]

Folks: Would you like to yell at me now, or would you like to thank me?

Leave your thoughts, perspectives, messages of agreement or disagreement below!

Ben has been investing in multifamily residential real estate for over a decade. An expert in creative financing, he has been a guest on numerous real estate-related podcasts, including the
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    Alison Meehan Investor from Montpelier, Virginia
    Replied almost 4 years ago
    This is the best article I’ve read on budgeting. I’ve read a lot about it as a stay at home mom, and most say income doesn’t matter. Trust me, I know that is BS. My husband and I are the opposite of big spenders. We buy used clothes, furniture, cars, etc. regardless of income and prefer to bike rather than drive when we can. We both saved the first 5,000 we earned in our early 20’s and put it straight into retirement (although I wish now we’d put it into real estate). Our retirement account is growing by about $10,000 a year, although we haven’t been putting much in lately. We have over $10,000 in our kids college funds although they are only in preschool. We’ve only had 1 car all 8 years of our marriage. Still, we only earn slightly more than our expenses. His salary effectively goes down each year because of increased health care costs for insurance. I’m home with our kids for now. So, although I try very hard to only buy what we need, only use cash, ect. I’m shocked by how little money we have and how quickly it goes. We do own 1 rental house. Our goal is at least 10 if not 25 at this point. Passive income is the ONLY way to get out of the sagging middle class for us and have the kind of life I’d like to have along with the careers we’ve chosen. Budgeting and cutting expenses is so limited! Income absolutely matters.
    Brad Lohnes Investor from Cambridge, Waikato
    Replied almost 4 years ago
    Hi, Alison. Income only matters once you get to the point where you are currently. Being frugal and budgeting has a far more dramatic effect on your future financial situation than earning extra money but not changing lifestyle (I’ve written an article here on BP about this 😉 ). But once you are living frugally, income absolutely makes all the difference. 🙂 Also, $10,000 in college funds while only in pre-school! Wow, impressive. How are you doing that – i.e. would the money be better invested elsewhere and used for education at the appropriate time?
    JL Hut Investor from Greenville, Michigan
    Replied almost 4 years ago
    Hang in there Alison, it maybe cloudy today but the sun will shine tomorrow. You have made a lot of good decisions so far. Your investing in your kids with your time, you wont have to bail them out of jail in the future. Also you have done better with your cash than most. Many ignore the risk of leverage in an up market, but I will save that for another post.
    Nathan Mansur Investor from Buffalo, New York
    Replied almost 4 years ago
    Thank you to BP for posting this article on the email updates. Being a newer BP member myself, I’m glad I was able to read this article and gain a couple nuggets to save in my notes. This type of MINDSET about creating passive income from your businesses to pay for the lifestyle you want to have is SEVERELY LACKING in today’s society. Simultaneously, adding more passive income by being “frugal” and saving the greatest % from a W-2 or 1099 ( your own energy/time input) is also extremely important. The concept of trading “good for great” comes to mind when I read this article. Stop paying for “good” mediocre wants/desires in the short term and live RADICALLY, so that in the long term you can live like others could only DREAM. I hope to continue applying this attitude of living on less of your own earned income in order to achieve financial Independence with passive income, and by my example be a role model to teach others how to escape the 9-5 “rat race” and working for someone else.
    Nathan Mansur Investor from Buffalo, New York
    Replied almost 4 years ago
    Thank you to BP for posting this article on the email updates. Being a newer BP member myself, I’m glad I was able to read this article and gain a couple nuggets to save in my notes. This type of MINDSET about creating passive income from your businesses to pay for the lifestyle you want to have is SEVERELY LACKING in today’s society. Simultaneously, adding more passive income by being “frugal” and saving the greatest % from a W-2 or 1099 ( your own energy/time input) is also extremely important. The concept of trading “good for great” comes to mind when I read this article. Stop paying for “good” mediocre wants/desires in the short term and live RADICALLY, so that in the long term you can live like others could only DREAM. I hope to continue applying this attitude of living on less of your own earned income in order to achieve financial Independence with passive income, and by my example be a role model to teach others how to escape the 9-5 “rat race” and working for someone else.
    Christopher Smith Investor from brentwood, california
    Replied almost 4 years ago
    I would prefer to read articles that stick solely to the efficient and effective operation of real estate activities rather than ones that appear to be fairly thinly veiled attempts to sidecar class struggle issues. There are numerous other forums for open, candid and straight forward polemical discussions on that issue for those who feel the need to express such sentiments. Just would really hate to see this blog become a home to transparent efforts to engage in guilt mongering and / or identity politics.
    Chris Field Investor from Milford, Connecticut
    Replied almost 4 years ago
    Great post! I won’t bat an eye spending 60k on upgrading one of my properties but I’ll cry like crazy spending $3 on a coffee when McDonald’s sells them for $1.
    Ramon Purifoy Realtor from Fayetteville, GA
    Replied almost 4 years ago
    I like the article, but this seems to be a matter of semantics in perspective. Your “earned” income whether from a boss or from a renter is still your source/earned income (assuming you are not doing anything secondary on the side). You will clothe, feed and take care of your family from that source and your limitations are based on the source. The benefit comes in that your rental income has a higher potential of growing than your traditional W2 position. It also comes with flexibility. I like to say time+money=lifestyle where time=life and money=style. The more you have on the left side, the better the right will be. I don’t disagree with frugality being relative as most things are.
    RJ Mitchell from Stockholm, Stockholms län
    Replied almost 4 years ago
    Honestly, the ‘golden nugget’ in this is that a life of frugality is relative and limited in potential for growing someones net worth. Boom