The biggest lie in personal finance
THE CONVENTIONAL WISDOM in public health attributes rising obesity in the Western world to two factors: improper diet and lack of exercise. The theory goes that, in addition to eating more calorie-dense foods more often, we also burn fewer calories sitting at our desks than our ancestors did while hunting and foraging.
But when anthropologists studied the daily energy expenditure of the Hadza, a hunter-gatherer tribe living in Northern Tanzania, they were shocked at what they found. Yes, the Hadza were doing far more physical activity than your typical Westerner. Between the men hunting large animals and chopping down trees and the women foraging for food and digging through rocky soil, their lifestyles were quite active.
However, this physical exertion didn’t translate into higher daily energy expenditure. In fact, after controlling for body size, the Hadza were burning roughly the same number of calories as their sedentary counterparts in the U.S. and Europe.16
What this research implies is that the human body will adjust its total energy expenditure over time based on physical activity. So, if you decide to start running one mile every day, you will burn more calories initially, but then it will level off. Your body will eventually adapt to this change in physical activity and adjust its energy expenditure accordingly.
This adaption is something that has been documented in the scientific literature for decades. For example, a review of all studies concerning exercise and fat loss from 1966–2000 found that increased physical activity did lead to more fat loss in the short term. However, “no such relationship was observed when the results from long-term studies were examined.”17
This suggests that, despite the many documented health benefits of exercise, its effect on weight loss seems to be limited by human evolution. Though physical activity can have a moderate impact on weight, changes in diet seem to be more important.
Similar to the diet vs. exercise debate in the weight loss community, there is a two-sided debate going in the personal finance community over how to save more money. One faction believes that you should focus religiously on controlling your spending, while the other claims that you should grow your income.
For example, the control your spending faction might claim that making your coffee at home (instead of buying it at Starbucks) can save you up to $1 million over the course of your lifetime. On the other hand, the raise your income group may argue that it’s far easier to earn extra income through a side hustle than to question your every spending decision.
Technically, both sides have valid points. Going back to our equation from the prior chapter, savings is defined as:
Savings = Income – Spending
Therefore, in order to increase your savings, you either have to increase your income, decrease your spending, or both.
But is one of these sides more correct?
The data suggests so. Similar to the effect of exercise on weight loss, cutting spending seems to have inherent limitations when it comes to saving more money.
To illustrate this, let’s take a look at the Consumer Expenditure Survey which summarizes how much U.S. households spend on a variety of different categories. After breaking this data into five groups (quintiles) based on income, we can see that cutting spending isn’t a feasible option to help many U.S. households save money.
For example, if you look at how much after-tax income the lowest 20% of earners spend on food, housing, healthcare, and transportation, it is evident that their income isn’t sufficient for even the necessities.
Going back to 1984, the bottom 20% of earners have consistently spent more than 100% of their take-home pay on these four categories. Note that this doesn’t include spending on education, clothing, or any form of entertainment. Just the necessities eat up their entire paycheck and then some.
Considering that the average after-tax income of the bottom 20% of U.S. households was $12,236 in 2019, these households only had about $1,020 to spend each month. However, in 2019, their average monthly spending on food, healthcare, housing, and transportation was $1,947.
If we break this out by category, we see that they spend the following amount each month:
· Food: $367
· Healthcare: $238
· Housing: $960
· Transportation: $382
If you think any of these amounts are excessive, where do you think they could reasonably cut back? Frankly, I don’t see much wiggle room.
Remember that these households only earn $1,020 a month while spending $1,947 a month (on average). This means that, in order for them to save money, they would need to cut their spending in half! This doesn’t seem realistic to me, especially considering their already low level of spending.
But this logic also applies to households above the bottom 20% as well. For example, if we look at the next 20% of earners (the 20th–40th percentile of U.S. households), we see a similar story.
While this group of households earned $32,945 after taxes in 2019—nearly three times higher than the bottom 20%—they spent almost all of it on the necessities.
Once again, spending on the basics eats up most of their paycheck. However, when we look at the absolute level of spending for these households, a pattern starts to emerge.
While the average income of households in the 20th–40th percentile is nearly 200% higher than the average income of households in the bottom 20%, their total spending is only 40% higher. This illustrates a key point in the cutting spending vs. raising income debate:
Increases in income aren’t followed by similar increases in spending.
Of course, you may know someone who has a high income and spends it all. I’m not saying these people don’t exist. The important point is that the data suggests that these individuals are the exception to the rule. In aggregate, higher income households spend a smaller percentage of their income than lower income households.
We can see this most clearly when examining the highest 20% of earners among U.S. households. These households made $174,777 after tax in 2019, yet only spent about half of that on the necessities of food, healthcare, housing, and transportation in the same year.
When compared to households in the bottom 20%, households in the top 20% spent 3.3 times more on basic necessities, yet had an after-tax income that was over 14 times higher!
Why doesn’t spending go up proportionally with income? Because of something that economists call diminishing marginal utility. This is a jargonistic phrase, but its meaning is simple. It means that each additional unit of consumption brings about less benefit than the unit before it.
Personally, I call it the law of the stomach.
Imagine you are hungry and really craving some pizza. The first slice you eat is going to be amazing. From the first bite you will experience an eruption of flavor that will send pleasure signals directly to your brain. Compared to having no slices of pizza, having a single slice of pizza is wonderful.
But then you are going to have your second slice. Yes, it will still be very good, but it’s not going to be better than the feeling of going from zero slices to one slice. The same can also be said about the third slice of pizza when compared to the second slice, and so forth.
Each additional slice will bring you less joy than the slice before. And, at some point, you will get so full that eating another slice of pizza will actually make you feel worse.
The same thing happens when it comes to spending money. You can see your income increase by a factor of 10, but it is unlikely that you will spend 10 times more on food, housing, or any other necessity as a result. While you might increase the quality of food and housing you consume, these higher-quality items are unlikely to cost 10 times more.
This is why it is so much easier for higher income households to save money—they don’t spend on necessities at the same rate, relative to their income, as lower income households.
Yet much of the mainstream financial media won’t acknowledge this. Instead, they continue to perpetuate the same lie about how to save more and get rich.
The Biggest Lie in Personal Finance
Read enough personal finance articles and you will find no shortage of advice on how to get rich or retire early. These articles will talk about having the proper mindset, setting goals, and following a system, but what they won’t tell you is how the authors actually got rich.
Because if you dig deep enough into each of these articles, you will discover that the real way they got rich was high income, absurdly low spending, or both.
Yes, you can retire at 35 if you live in a trailer.
Yes, you can get rich if you work as an investment banker for over a decade.
But, no, you can’t accomplish either of these on mindset alone. The fact is that all the expense tracking and goal setting in the world cannot make up for insufficient funds.
After examining the Consumer Expenditure Survey above, it is hard for me to argue otherwise. Yes, some percentage of U.S. households don’t have the knowledge, habits, or mental framework to improve their financial situation. You can probably think of a few people like this from your personal life.
But, once again, these people are the exception, not the rule. While there are lots of individuals who are in financial trouble because of their own actions, there are also many others with good financial habits who just don’t have sufficient income to improve their finances.
Empirical research from around the globe has demonstrated this beyond a reasonable doubt. For example, researchers at the London School of Economics released a paper titled, “Why Do People Stay Poor?” that illustrated how the lack of initial wealth (and not motivation or talent) is what keeps people in poverty.
The researchers tested this hypothesis by randomly allocating wealth (e.g., in the form of livestock) to female villagers in Bangladesh and then waited to see how that wealth transfer would affect their future finances. As their paper states:
“[We] find that, if the program pushes individuals above a threshold level of initial assets, then they escape poverty, but, if it does not, they slide back into poverty… Our findings imply that large one-off transfers that enable people to take on more productive occupations can help alleviate persistent poverty.”18
Their paper clearly illustrates that many poor people stay poor not because of their talent/motivation, but because they are in low-paying jobs that they must work to survive.
They are, in essence, in a poverty trap. This is a poverty trap where their lack of money prevents them from ever getting training or capital to work in higher-paying jobs. You might be skeptical of these findings, but similar things have been found by experimental researchers doing random cash transfers in Kenya as well.19
This is why the biggest lie in personal finance is that you can be rich if you just cut your spending.
And the financial media feeds this lie by telling you to stop spending $5 a day on coffee so that you can become a millionaire. However, these same pundits conveniently forget to mention that this is only possible if you are earning 12% annualized returns from your investments (something that is well above the market average of 8%–10% a year).
And even if you could get 12% annualized returns, you would need to earn these while holding a 100% stock portfolio and not panicking for decades. Easier said than done.
This is the same financial media who write stories about how people save money by making their own dish soap or reusing their dental floss. What really upsets me is how these examples are touted as proof that cutting spending can make you rich.
Just think about how condescending this message is to the typical household. The author of these posts might as well say, “The reason you aren’t financially free is because you keep buying Tide Pods!”
You can already see the trick they are playing on us. They are taking these outlier cases and passing them off as normal. Yet, nothing could be further from the truth.
The most consistent way to get rich is to grow your income and invest in income-producing assets.
This doesn’t imply that you can ignore your spending altogether. Everyone should do a periodic review of their spending to ensure that it isn’t wasteful (e.g., forgotten subscriptions, unnecessary luxuries, etc.). But there is no need to cut your lattes.
If you want to save more, the main point is to tighten up where you can, then focus on increasing your income.
How to Increase Your Income
I will be the first to admit that increasing your income is going to be much harder than cutting your spending, at least initially. However, if you want a sustainable path to saving more and building wealth, it is the only option.
And the best way to increase your income is to find ways to unlock the financial value that is already inside you. I am talking about a concept called human capital, or the value of your skills, knowledge, and time. Your human capital can be thought of as an asset that you can convert into financial capital (i.e., money).
What are some good ways to convert human capital into financial capital? Here are five methods you should consider:
1. Sell Your Time/Expertise
2. Sell a Skill/Service
3. Teach People
4. Sell a Product
5. Climb the Corporate Ladder
Each one of these has pros and cons that we will discuss in the following sections, but all of them can be utilized to start increasing your income.
1. Sell Your Time/Expertise
As the old saying goes, “Time is money.” Therefore, if you need to make more money, consider selling more of your time, or your expertise.
There are a variety of ways in which you can do this, but I recommend that you do research to find where your set of skills are put towards their best use. You may not make much from this initially, but as you develop expertise, you can start charging more.
The only downside to selling your time is that it doesn’t scale. One hour of work will always equal one hour of income. Nothing more. As a result, you’ll never get extremely wealthy by only selling your time.
There is nothing wrong with selling your time to start, but eventually you’ll want to have income coming in that you don’t have to work for. We will address this shortly.
Selling Your Time Summary
· Pros: Easy to do. Low startup cost.
· Cons: Time is limited. Doesn’t scale.
2. Sell a Skill/Service
Now that we have discussed selling your time, this naturally segues into selling a skill or service. Selling a skill or service is developing a marketable skill and then selling it through a platform (likely an online one).
For example, you could advertise your photography services on Craigslist or do graphic design work on websites like Upwork. These are just a few examples of the hundreds of marketable skills that are being bought and sold online every day.
Selling a skill or service can earn you more income than selling your time because you can sell things that are not perfectly linked to your time. This is especially true if you can build a brand around your work and charge premium prices.
Unfortunately, similar to selling your time, selling an individual skill or service doesn’t scale. You have to do the work for each service delivered. Yes, you could hire others who are similarly skilled to help out with the workload, but this brings additional complexities.
Selling a Skill/Service Summary
· Pros: Higher pay. Able to build a brand.
· Cons: Need to invest time to develop marketable skill/service. Doesn’t scale easily.
3. Teach People
As Aristotle once said, “Those who know, do. Those that understand, teach.”
Teaching (especially online) is one of the best ways to have scalable income. Whether you choose to do it through YouTube or a learning platform like Teachable, teaching something useful can be a great way to grow your pay.
Teaching online can either be done through pre-recorded, self-paced courses, or live cohort-based classes. While self-paced courses are more scalable, you can’t charge as much as you can with a live course.
What can you teach? Anything that people are willing to pay to learn. Writing. Programming. Photo-editing. The list goes on.
The beauty of teaching people something is that you can also build a brand around it that you can market for many years to come. Unfortunately, this is also one of the difficulties of teaching online. Unless you are in a niche space, there are going to be lots of other people with their own courses teaching people as well. To compete with them, you are going to need to find a way to stand out.
Teaching People Summary
· Pros: Easily scalable.
· Cons: Lots of competition. Attracting students can be an ongoing battle.
4. Sell a Product
If teaching isn’t for you, you could consider making a product that is beneficial to others. The best way to do this is to identify a problem and then build a product to solve it.
The problem could be emotional, mental, physical, or financial in nature. Whatever you decide on, solving a problem through a product helps you create scalable value.
Why? Because you only need to create your product once, yet you can sell it as many times as you want. This is especially true for digital products that can be sold online an unlimited number of times with few additional costs.
Unfortunately, creating a product will require lots of upfront investment to build it and even more effort to market it to others. Products are not easy to do, but if you can find one that people like, you can earn income from it for an extended period of time.
Selling a Product Summary
· Pros: Scalable.
· Cons: Lots of upfront investment and constant marketing.
5. Climb the Corporate Ladder
Of all the ways to grow your income, climbing the corporate ladder is the most common and also the most despised. There is this prevailing attitude that working a 9 to 5 job is somehow less worthy than working for yourself or starting your own business or side hustle.
But, if you look at the data, a 9 to 5 is still the way that most people build wealth. In fact, the best chance that many Americans have of becoming a millionaire is through a professional degree (e.g., doctor, lawyer, etc.). As The Millionaire Next Door stated about a group of millionaires studied in the late 1990s:
“As a group, [millionaires] are fairly well educated. Only about 1 in 5 are not college graduates. Many of [them] hold advanced degrees. Eighteen percent have master’s degrees, 8 percent have law degrees, 6 percent medical degrees, and 6 percent Ph.D.s.”20
Not only are millionaires more likely to have followed a traditional education and career path, but they don’t become millionaires overnight either. In fact, it takes 32 years for the typical self-made millionaire to gain their wealth.21
This is why I am a champion of a traditional career path for growing your income, especially to those who are younger or who lack experience. While a 9 to 5 will rarely make you filthy rich, learning how to work well with people and developing your skills can be one of the best things for your career development.
And even if you want to do your own thing eventually, being an employee first is the norm. This explains why the typical age of an entrepreneur is 40 years old.22 By age 40 you have two things that most 22-year-olds don’t have—experience and money. And where did that experience and money come from? A traditional career, likely working for someone else.
Climbing the Corporate Ladder Summary
· Pros: Gain skills and experience. Less risk around income growth.
· Cons: You don’t control your time or what you do.
Regardless of how you try to increase your income in the future, all of the methods above should be viewed as temporary measures. I say temporary because, ultimately, your extra income should be used to acquire more income-producing assets.
That’s how you really give your savings a boost.
To Save Even More, Think Like an Owner
Guess who’s the richest NFL player in history? Tom Brady? Peyton Manning? John Madden? No, no, and no.
It’s a guy by the name of Jerry Richardson. You’ve probably never heard of Richardson. Neither had I. But he is the only billionaire to ever play in the NFL.
How did Richardson make his money? Not by playing football.
Richardson was a good enough player. He was on the team that won the 1959 NFL Championship. But he built most of his wealth by opening up Hardee’s fast food franchises across the U.S. Eventually he acquired enough capital to start the Carolina Panthers NFL franchise in 1993.
It was Richardson’s ownership of business ventures that made him fabulously wealthy, not his labor income.
I want you to think about growing your income in the same way. Yes, selling your time, skills, or products is great and all, but it shouldn’t be the end goal of your wealth-building journey.
The end goal should be ownership—using your additional income to acquire more income-producing assets.
Whether that means investing in your own business or in someone else’s, you need to convert your human capital into financial capital to build long-term wealth.
And if you want to do this, you need to start thinking like an owner.
Now that we have discussed how you can save more money, let’s turn our attention to how to spend money, guilt-free.
16 Pontzer, Herman, David A. Raichlen, Brian M. Wood, Audax Z.P. Mabulla, Susan B. Racette, and Frank W. Marlowe, "Hunter-gatherer Energetics and Human Obesity,” PLoS ONE 7:7 (2012), e40503.
17 Ross, Robert, and I.N. Janssen, “Physical Activity, Total and Regional Obesity: Dose-response Considerations,” Medicine and Science in Sports and Exercise 33:6 SUPP (2001), S521–S527.
18 Balboni, Clare, Oriana Bandiera, Robin Burgess, Maitreesh Ghatak, and Anton Heil, “Why Do People Stay Poor?” (2020).
19 Egger, Dennis, Johannes Haushofer, Edward Miguel, Paul Niehaus, and Michael W. Walker, “General Equilibrium Effects of Cash Transfers: Experimental Evidence From Kenya,” No. w26600. National Bureau of Economic Research (2019).
20 Stanley, Thomas J., The Millionaire Next Door: The Surprising Secrets of America's Wealthy (Lanham, MD: Taylor Trade Publishing, 1996).
21 Corley, Thomas C., “It Takes the Typical Self-Made Millionaire at Least 32 Years to Get Rich,” Business Insider (March 5, 2015).
22 Curtin, Melanie, “Attention, Millennials: The Average Entrepreneur is This Old When They Launch Their First Startup,” Inc.com (May 17, 2018).