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

Ben Leybovich
5 min read
Most Americans Overspend & Fail at Frugality… But It’s Not Why You Think

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.

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!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.