Personal Finance In One Simple Equation

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We’ve heard it all before haven’t we?

The simple way to build wealth is to spend less than you earn.  Let me demonstrate this as a simple equation:

Spending < Earnings = Savings

That’s it in a nutshell.

Take what you earn.  Now look at what you spend.  If what you spend is less than what you earn then what is left over is savings.  Let that grow and invest it properly and you will build wealth.   You only need two numbers to figure out that math!

Let’s use dollar figures.  You earn $3000 a month.  If you spend $2999 you have a dollar left over for savings.  What’s a dollar you ask?  In today’s economic climate one dollar of savings will put you in better shape than corporate giants like Lehman Brothers, which is declaring bankruptcy, Enron, Worldcom, or Merrill Lynch, which was bought by Bank of America.  And that dollar will have friends joining it every month as long as your spending is less than your earnings.

Now imagine if you could increase that savings amount either by spending less or earning more?  The savings will build up faster!

Let’s change the equation slightly now:

Spending > Earnings = Debt

Spend more than you earn and you are in debt.  You have to be.  Where else could the money come from unless it’s borrowed?

Back to the numbers…  You still earn $3000 a month but now you spend $3001.  You’re in debt.  Where do you get that extra dollar to get out of debt?  Maybe you borrow it from a friend?  Maybe you put it on a credit card (another name for debt)?   Either way it won’t materialize from out of nowhere.

And what happens the next month? 

Either you lower your spending by a dollar (assuming no interest) or you increase your earnings so you can pay back the debt.  If you don’t then your debt increases!  Just like our savings example that debt will keep growing until you find a way to pay it off.  If you let it grow too long then you get to be in the same boat as some financial institutions as you either have to declare bankruptcy or find someone to bail you out (and really if someone bails you out you will probably still be in some sort of debt).

As complex as personal finance can be sometimes it still boils down to a simple equation.  Plug in your spending and earnings. 

Too often we over-complicate the ideas that make up personal finance.  In reality the concepts are pretty simple, aren’t they.  Sure, you can go nuts poring over the different ways you can invest your money but the simple concept is clear — spend less than you earn and you can save.  That savings can help you build wealth.

Are you saving or in debt?

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Published or updated May 15, 2013.

Comments

  1. Tanner (does Utah marketing) says:

    It’s so simple, yet so many people don’t realize this.

  2. Great post! I also like the idea of “make more than you spend.” It seems more proactive — and like you are in control of your financial destiny — than “spend less than you earn.”

  3. See My Money says:

    Such a simple concept, yet so hard for many to put into practice.

  4. @ Tanner – I know. Yet it’s what a budget really boils down to.

    @ Miranda – You’re in control either way. And you have the choice too. If you can’t live without certain things that’s ok, just make sure you make enough to cover them.

    @ See My Money – I think it’s hard because many people don’t want to take that hard look at their finances. Hiding from it though won’t help.

  5. Great example of the simplicity of a savings program. I actually know someone who may have lost a bundle in Lehman Brothers. Luckily he invested in the preferred shares, so he may get something back from his investment.

  6. @ Dusty – Thank you. I hope your friend comes out ok.

  7. Good post.

    Simple but effective. Now the hard part is actually trying to do that. Keeping spending below earnings is hard to do when your are up to your eyeballs in debt and trying to make the interest payments on credit cards.

  8. @ Until Debt – No doubt it’s difficult but it can be done. Keep chipping away at the debt and it will eventually disappear!

  9. You’re right – that’s about as easy as it gets. I always say that spending less than you earn is the most important financial principal to follow, which is basically saying the same thing another way. ;)

  10. As much as the word budgeting may sound intimidating, it is the best tool to help us master the physics of these basic equations in our favor.

    A friend told me a few months ago about this little free online personal budgeting website, I have been using it for over three months now and it is too good to be free. I wish I had this at my disposal earlier in life before I went through my own hard financial lessons.

    For those who want to benefit from a powerful online budgeting utility but do not want to give out access to bank accounts and personal identity, Out Of The Dark (OOTD) is worth a check at:
    myexp.org/OOTD_gate.php

    Happy budgeting.

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