I was sitting here reviewing our income numbers the other day feeling somewhat down about how much we earn compared to some of our friends when it hit me; I shouldn't be fixating on how much we earn as how much we spend of what we earn. I know plenty of people who make more than us but who are worse off financially because they spend all of what they earn, plus some. What I suddenly realized is that I should focus more on our expense-to-income number -- what we spend compared to what we earn -- to determine whether I should really be feeling too bad about myself or not.
How I Figured Our "E/I" Number
Obviously, there are two main components to determining our expense-to-income number…expenses and income. It might sound simple enough, but it can take some time to accumulate the sort of data that goes into determining this number accurately.
First off, the incomes side can be relatively easy. Adding up income from work, investments, and passive income streams can provide an overall income. Otherwise, I could run the equation with just regular work income. Personally, I prefer to use all income, since I use all expenses as well (income taxes, health insurance costs, etc.).
The next step might be a little more difficult and time consuming for some people, as it requires a tally -- or at least a good estimate -- of all expenses. For me, this part isn't as difficult since I've been tracking my personal costs since I was 18 years old. However, I have to factor in my wife's expenses, which is a little more difficult since I don't track hers as closely.
Once I have my totals, the equation is easy; I simple divide my expenses by my income and get a resulting number. For example:
Expense-to-income number: .70
This would mean that for every dollar earned, 70 cents of it is spent.
Why it Matters
Some might be wondering what the big deal is, why this sort of equation and the resulting number would be useful.
First off, I find that it's important in gauging just how much of our hard-earned money is being put toward expenses. Knowing how much of every dollar earned flows back out of our pockets again can be a real eye-opener. But beyond that, it sometimes helps me put into perspective those feelings of despair I feel about those I hear earning $300,000 or $400,000 and knowing that I'm not one of them.
How do I do this? Well, with a little logic and reasoning, I can often figure that the same people that are earning such amounts are likely spending pretty heavily as well due to lifestyle inflation and having to keep up with the Joneses. Then I do some quick math.
Let's say a couple is making $300,000, but has an expense-to-income number of .95. That means that they're only saving $15,000 a year. But if I go back to the example of the couple earning $50,000 a year with an expense-to-income number of .70, they're saving $15,000 a year as well -- two substantially different incomes with a savings result that's the same because the lesser earning couple practices good savings habits and lives below their means.
If nothing else, it can be a nice indicator that not all is lost when it comes to saving money, even if I'm not the next Bill Gates or Warren Buffett.
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