Dear Money & Crisis Reader,
Everyone knows the secret to getting rich.
- Spend less money than you make.
- Invest that money and grow it over time.
Now, obviously there are a lot of little steps ingrained in those two big steps, but that’s essentially it.
Spend less. Make more. Retire early.
Yet despite being pretty much common knowledge, few folks will ever put this plan into action.
They want to save or invest more. They probably fully intend to start saving more… but life just keeps getting in the way.
Special occasions… celebrations… commiserations…
There’s always an excuse to spend the money you could be saving. And you can spend it guilt-free by simply telling yourself, “There will always be next month.”
The Next-Month Effect
The “next-month effect” is probably the most damaging impulse when it comes to getting rich.
Folks tell themselves that “20 years from now it’s not going to make a difference if I started saving in July 2018 or August 2018.”
And they’re probably right. One month won’t make a huge difference.
But one month becomes two months. Two months become four months. The months become years.
Before you know it, you’re two years away from retirement and still telling yourself, “One more month.”
I ain’t throwing stones at anyone here. I’m all too familiar with this line of thinking myself.
For years, my wife and I kicked that particular can down the road. We kept telling ourselves we’d start soon. But in the end, it took the worst American financial crisis since the Great Depression to knock some sense into us.
So believe me when I tell you that I understand how difficult it can be to break the cycle. But there’s a simple way of thinking (and one fascinating number) that makes the change much easier.
Treat Yourself Like a Business
Saving can be boring. And because it’s boring, it’s hard to motivate yourself to do it. After all, who wants to save for the future… when you could be living life?
But there’s a way of thinking about your money that helps put savings into perspective.
Start thinking of yourself as a business… and your savings as profit. Because there really is no difference between savings and profit.
Profit is a business’s earnings minus its expenses.
Savings are your earnings minus your expenses.
So you may not be selling a product… or employ thousands of people… but the money you save every month is your profit.
How does that help you get rich?
All Businesses Run on One Magic Number… And so Should You
Businesses think about profit a little differently than regular folks.
For one, profit isn’t something that can be “put off until next month.” It’s absolutely essential for the growth and continued existence of the company.
Second, and more importantly, the dollar amount of the profit isn’t what’s important… It’s the profit margin that’s important.
Your profit margin is simply your profit (or savings) expressed as a percentage of your total monthly income.
This number will tell you how much of every dollar of your income you keep as profit. For example, a 10% profit margin means you are keeping 10 cents of every dollar you earn.
This number will tell you how well a company manages its earnings and reveal the reality of just how profitable a business really is.
Just to show you what I mean, let’s say we have two companies: a supermarket and a tech company.
They each made $2 million in profit in 2017.
The supermarket brought in $10 million in earnings and spent $8 million on expenses. Their profit margin ($2 million expressed as a percentage of $10 million) is 20%.
Meanwhile, the tech company brought in $20 million — $10 million more than the supermarket. But they pay their highly educated employees more and have a lot of expensive, specialized equipment. So they racked up $18 million in expenses. With just $2 million left over, this gives them a profit margin of 10%.
As you can see, despite the fact that both companies made $2 million last year, the supermarket was 10% more profitable.
The exact same principle applies to you and your savings.
You might be saving thousands of dollars every month. But if you’re spending tens of thousands of dollars, you won’t be able to maintain that lifestyle on your current saving plan.
The dollar number that you’re saving doesn’t matter much because it doesn’t take into account your expenses or total income.
If you present your savings in terms of a profit margin, you get a much clearer picture.
It just takes a minute to work out. Simply:
- Subtract your EXPENSES from your TOTAL INCOME to get your PROFIT.
- Divide your PROFIT by your TOTAL INCOME.
- Multiply that number by 100 to get your PROFIT MARGIN.
This number will give you a rough idea of your long-term financial outlook.
To retire comfortably at retirement age, you need to have a 20–30% profit margin.
To retire rich, you’ll want to have a consistent profit margin of 40–50%.
And if you can bank 60–70%, you’ll be able to retire 20 years early.
Now that you know what your profit margin is, we’re going to spend the rest of this week focusing on strategies you can use to increase that number.
All the best,
Editor, Money & Crisis