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

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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.

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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?”

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…

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!

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!

About Author

Ben Leybovich

Ben Leybovich has been investing in multifamily residential real estate since 2006. His area of expertise is creative finance. Ben works extensively with private as well as institutional financing. Ben is a licensed Realtor with YOCUM Realty in Lima, Ohio. He is also the author of Cash Flow Freedom University and creator of a cash flow analysis software CFFU Cash Flow Analyzer.

42 Comments

  1. Mark Ferguson

    What you are basically saying is the rich start their own businesses and take control of their lives, while the poor rely on jobs and others to pay them a wage.

    I completely agree!

    I focus on making as much money as possible and saving enough to continually build up my investments. Rental number 14 is under contract now!

    • Ben Leybovich

      Well, Mark – I am not sure that this is all about income. The bottom line at 12% effective tax rate looks a lot different than it does at 35%. But, I suppose things work out either way. Just be sure that the income streams you are building are passive and sustainable in nature.

      Thanks for commenting, man!

  2. Scott Trench

    Well Ben, this is new – you being (mostly) complimentary! I like the change haha.

    Want me to be cynical? How’s this:

    If you call yourself an entrepreneur, investor, or are at all ambitious about your personal finances, then you’ll stop whining about your “fixed expenses” right now. Just like everybody else, I rented an apartment for the first year of my working adult life, drove a fancy new car, and accumulated wealth painfully slowly.

    Then I changed my mindset and started shedding those fixed costs systematically. I bought some pots and pans and started cooking, eliminating supposedly fixed food expenses and lunches out. I bought a bike and started commuting for free, eliminating supposedly fixed transportation expenses. Then I bought a duplex, rented out the excess available space, and started living for free, eliminating the supposedly fixed housing expenses.

    I’m now in the process of buying energy efficient appliances and finding creative ways to reduce my electrical and gas bills, eliminating another of your supposed fixed expenses.

    Fixed expenses? Give me a break. I done “fixed” ’em. You can too.

    • Ben Leybovich

      Scott – you are once again talking out of your ass…haha Always wanted to say that on a blog, so thanks!

      Listen, I drove a 1998 minivan that I bought used for $1,000 for the first 5 years of my kid’s life. My wife had a civic that we bought new in 13 years ago and had paid off in 3 years. That was a time to live frugally. Life allowed us to live frugally. We had no kids and we had no healthcare expenses, emergency visits, or anything else. We thought we were in control – just like you think now…

      I easily spend easily $25,000/year + on medical. not by choice, you understand? My son needs every holistic medicine that there is. My purpose in life is my children’s well-being. and these costs are fixed. Just dropped $2,000 on an HBOT rental for 5 weeks. Did the same 3 months ago. Will do 2 more within the 12 month cycle.

      I am not complaining. I can afford it. Why – I got Cash Flow. Serge S. has even more Cash Flow. That’s what it takes. We pass the burden onto someone else, and this is how we afford crap. You, work at BP. You should be saving every penny you earn and buying CF with those pennies.

      I am 40, Scott. I’ve worked hard to be here, and I am not done. I drive a nice car, and I enjoy getting into it every time. But, this is not the “expensive” expense in my life – this is peanuts. I could dump this expense in a sec. However, unless you are suggesting I sell my kids to Brandon Turner, there are much harder and more fixed costs associated with grown-up life, of which you’ll find out when time comes 🙂

        • Ben Leybovich

          Haha – Bella is grabbing stars right out of the sky on her violin. And Aaron is a darn genius… Brandon coudn’t afford em. And I am NOT doing owner-financing on this deal yo…

          I love Brandon enough, though, that I will share 🙂 Use your imagination on that one…

  3. Oh Ben, Ben, Ben,
    I do appreciate the lighter style. It suites you better, your readers, thank you. I guess that is presumptuous, I thank you.

    I am a saver, frugal, but also spend on what is important to me/family. Interestingly, we live on about 35-40K a year for our expenses. But because I’ve been frugal, I know have no house payment and no car payment and I drive an electric so very little maintenance costs. This would be considered well under 25% of gross or net. Many of the engineers I work with are also frugal. I’ve found that engineers are generally good at understanding money and saving. So, there’s some outliers for ya.

    I’d like to add a variable to your piggy water heater example. I’ll debate that the amount of the hit that the water heater causes to your cash flow, is not about if the property is rented at $750 or $3000. If the $3000 class A property is a negative cash flow hog, then, well, that ain’t good. Where as the $750 class B “pig” is cash flowing at $300 a month, well, I’d rather be there. Care to `splain your thoughts in more detail.

    Seems like you are a little late to the “attack the one percent” party. I get the meaning and the reference is to provide guidance and passive activity is were it’s at. I feel the need to defend my fellow one percenter peeps. I’ll rebut that the 1% pay for everyone else. (Let the flame war begin now!).

    Please explain how having a low tax burden allows you to earn less to keep your life style? Tax is dependent on taxable income. Stating you have a low tax burden implies you have a great accountant if you make a lot of cashola. Since you followed with not having to make a lot of money, well, if ya don’t make squat in the wonderful progressive tax system we have, you pay no tax and ya are not contributing your share to our the growth, upkeep and defense of or great nation. (oh yea, let the comments continue!) Unfortunately, for me, I took care of ya.

    That should generate some activity for ya to keep up your ratings and controversy level!

    • Ben Leybovich

      Joe – Controversy…me…?!?! What? You must have me confused…

      The epiphany came about 11 years ago. That year, we, musicians, managed to pull in 6 figures. We felt happy as hell – until tax time…We were self-employed, to boot!

      That wasn’t gonna work…

      It’s a lot easier to maintain a nice life-style with tax burden 10%, than it is at 40%. It’s not a function of the accountant being good. I make it easy for them in how I structure my incomes and modes in which I take possession of money. Everything by the book! The book is written for us to succeed, we just have to know how to read…

      I love the 1%. I want to be the 1%. This is by no means an attack on 1%. If anything, I am attacking people for not taking control and figuring out “how”…

      • Hey Ben,
        I’m more interested in your deal and tax structuring and 10% tax rate now! Although a penny pincher, I still have a bunch of W2 income and from it, yea at the 40% marginal federal. Sucks.

        Perhaps a blog post on the tax structure used? Most of the bean counters I’ve consulted are not much help. WIth that said, there are only so many ways to get income with little or no tax. Roth, using depreciation (deferred or 1031), munis, corp structure where ya are paid in dividends (but the corp is taxed). Ya gots self employment tax, unless yer not counting that 15+%

        I’m retiring soon so getting my REI (rentals+lending) income in a smaller tax bucket would be very nice.

        pm me if ya like with more details on the tax side joefoster62 at gmail
        Joe

  4. Joe Harper

    This is brilliant. Thank you for taking the time to articulate these thoughts. I am right there with you but couldn’t figure out why I still believe the haters.

    “Don’t listent to your broke uncle!” – Dave Ramsey

    I am in the verge of quitting my w2 job making $55k and this math really clarifies the decision. This is like a mile marker.

  5. serge s.

    Leybovich the great has come around full circle! Wasn’t it just a year ago that you were bragging about driving a 20 y/o minivan and denying yourself any and all unwarranted purchases? Now your driving a fancy Lambo and eating lobster? Sounds like your tenants are treating you quite well. No more bragging on the forums about who drives the shittiest car.

    Scott Trench is right on his take at least partially. At his age everything should in fact be about converting wages into investment income. The more you can cut down on cost of living, the faster you get there. The problem Scott is that there is no limit to this mindset. You have been able to ditch the car and buy a duplex. Thats fabulous but why not rent out the extra bedroom in your side of the duplex? Why not recycle all the used coke cans in the BP office, doesn’t take but minutes. You see, what Ben is saying is that there comes a time when that lifestyle simply is not worth it. The real debate is as to when is that time. You learn to get comfortable living off a percentage of your income. When that income is passive and stable then you can increase that percentage. As that income grows, then and only then can your lifestyle follow.

  6. This amazes me. I had a conversation earlier this evening about raising the minimum wage to $15 an hour and I told the person who could have been my friend that all that would do was allow a few people to pay more debts off for people who owed at our current rates and eliminate some existing jobs.
    The numbers may change, but the game remains the same. I really do have to go back and read all these related articles. I know they will be worth the read because I have read some really good things from all the mentioned authors. Masterfully done as always, it does kind of scare me that I never understood that understanding that making more for most people only means they will pay more of another mans bills makes me cynical .

    • Ben Leybovich

      Gary – that’s the point. It’s all cynical as all hell. That’s the “read between the lines” component of this article. It’s cynical. Life is cynical. Money is cynical. business is cynical. Game is cynical…

      I try to make it a little less so by delivering more value than I charge in all of my endeavors, bit it is what it is – cynical. You have to make that OK in your own mind, otherwise you can’t function. And if you can’t function, you can’t win…

  7. Larry S.

    One should not confuse frugality with being cheap. I avoid cheap people. The ones that still leave a 10% tip for a good waitress annoy me. In a group setting they don’t leave anything and rely on the others to get the tip. Cheap people horde things because they cant get what they paid for it 20 years ago. Cheap people never give that young boy $10 for helping to get a clothes dryer down the steps to the basement. Cheap people don’t sent thank you notes. Cheap people never offer a few dollars to pay for gasoline. When a tenant moves out and offers to leave their new dining room set, cheap people never get them a nice Olive Garden gift card as a thank you.. Cheap people never buy lunch.

    Frugality is spending money wisely and carefully. Riding a bike to work is an acceptable frugal thing to do. Riding in an automobile to work with another person and never even offering to pay for an oil change is cheap.

  8. Michael Gabrieli

    The Thing about Personal Finance, its personal. Frugal living is all relative. Yeah you can still live frugally making 60k a year but all your expenses just add up for 30k a year (very easy to do if you are paying off multiple loans, plus rent, Health insurance, car insurance, cable and phone, not eating lunch out all the time and spending your weekends going to a bar and have a water with lime, and tell others its vodka).

    One person sees this situation and thinks he is poor because he has a poor mindset. Another person sees this as frugal living because he knows once he pays off his multiple debts, he would use similar $$ amount and put it on savings instead of paying for other people’s dreams while living a frugal lifestyle (my point in life).

    Most Americans Fail at frugality because they have a poor mindset, and they are only caring about the bills they see month to month and the income they make month to month. When I saw the title, I thought this was going to be an article about how Americans have a poor mindset and that are not really living frugally because they are not choosing frugality they are choosing survival. To chose a life of frugality, you have to come to the realization that you want to stop being of poor-mindset and in constant debt and they want to choose the path of being financially fit then to financial independence than ultimate financial freedom (residual income much greater than monthly expenses and that you are retired when you want to retire).

  9. Ben Leybovich

    Michael – don’t miss my point. You cannot be frugal by definition if you rely on W2 income. This type of income shaves results in a loss of 25% minimum before you even start to taxes. And then there’s the rest of it…

  10. Tim Hoffman

    Good article Ben. I see it as a coded message (and some straight talk) to those not yet living on their passive income. Frugality is a way of life, a mission, it is in your blood and who your are. Making the change from constant frugality to allowing yourself to enjoy some of the fruit of your (tenants) labor is the hard part. How do you go from bragging about driving an 18 yr old truck with 265k miles to buying a new(er) one and still call yourself frugal? I am slowly making the change and allowing myself to spend a little more but still put more in savings every month then the average person earns via w2 per month. The adjustment in mindset is like changing religions, scary.

  11. Frankie Woods

    This is exactly what I’m working towards. I have too much reliance on the W2 income. However, even given the small hiccups along the way, that is slowly beginning to change for the better. Thanks again for another killer article!

  12. Mark Forest

    I think any graduating high school senior should be required to read The Millionaire Next Door. The authors say to live BELOW your means. I can not understand how so many people can afford $100 a month plus for their cell phones, cable bills etc. Then there are the toys; big four wheel drive trucks and/or sports cars, motorcycles, snowmobiles.

    I want to spend my money to make more money.

    • Ben Leybovich

      That’s exactly the point – spend your money to make more money, spend other people’s money to have fun in life. Put yourself in the path of money, and position yourself so that a bit of it settles with you as it passes through you. RE works as well as it does precisely because it accomplishes this very objective…

      Man – I have a video on this on my website, but I think this is my topic for next week here…

  13. Daniel Mohnkern

    Nice article, Ben. It brings my mind to Robert Kiyosaki’s (3rd book?) where he talks about his wanting a Porsche, so he bought an apartment building that would make the monthly payments on his new car. Most people would just buy the car and ruin their finances. My tenants always buy me nice things. I once thought of thanking them but figured they just wouldn’t understand. P.S. thanks for saying “ass” only one time in this piece.

  14. DL Martin

    Excellent article, on many points. Consider rookie professional athletes. If the rookie athlete would just invest his signing bonus and live off of the residual income until he makes it to his second contract, then he would have a nice little (or maybe large) income for the rest of his life, without ever touching the principle. But that seldom seems to be the way that it works out for them… (I remember when Barry Larkin of the Cincinnati Reds signed his first Major League Contract. He could have bought any car that he wanted but He bought a new Toyota.)

    Because of my disdain for Ben, I refuse to give him credit for writing it.

    As a matter of fact, I am quite certain that Ben stole this content from someone else. (Probably from BBT. Brilliant Brandon Turner.)

    Note to self: Call the FTC !!!

    DL

  15. Ben,

    I walked away from this article with a new perspective. For so long I have been focused on saving 50% of my income to invest in passive income. I’ve also learn to create additional income over the internet and am now looking for a way to invest in my first multifamily property just outside of Cleveland, Oh. What articles of yours would you suggest for someone looking to get into multifamily housing?

  16. Christy Barton

    This is great. When we first started looking into real estate, I remember at a REIA hearing the speaker say “think of each house your purchase and the cash flow as one of your bills getting paid. The first one can clear your car payment, and the next the phone bill, etc.” I have never forgotten that. So, that’s why I’m really eager to get start purchasing rentals of my own. Thanks for the reminder!

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