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December 14, 2010

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The gap in personal finance is reminiscent of the gap in weight loss. You can come up with all the different diets you want, Atkins, South Beach, Cookie diet, etc or all the different workout programs you want, Cross fit, P90X, Tae Bo, etc, but until you create a caloric deficit (i.e., the gap between calories burned and calories consumed), you're just spinning your wheels. And the bigger the gap you create between what you burn and consume, the faster your weight loss will be. Just like with personal finance, it requires personal discipline, and just like personal finance, it is a long term investment.

Hmmm, I called that gap my Savings Delta, but a Gap is basically the same meaning :)

For a middler like I am, it's like limbo! How low can I get my cost (the bar) down before I fall down...

Perhaps Pole vaulting would be more like increasing one's earnings!

I have found that "the gap" is not simply the difference between what I make and what I spend.

Rather it is the difference between what I make and what my wife spends.

I admit I don't even read those "pay down mortgage versus save/invest" discussions anymore. It just seems so insignificant compared to spending one dollar less or making one dollar more, the key is to have that extra dollar to do either.

One thing that has always amazed me is the consistency of the size of this gap throughout all income levels, especially for those considered "following the rules" (save 10 - 15% of your income toward retirement). I wonder if this is just herd mentality, or having that rate "justified" by the experts, instead of making any independent decisions.

When my family made $40K/year, our savings rate was probably around 15%. At 60K, probably still 15%. But I soon realized I could already buy all the comforts that make my family's life noticably 'better' by spending at that level. The future freedom/security of building the gap by a dollar after that meant more to us than an extra dollar of spending would bring.

Now that our after tax income has grown to 140K/year, and our expenses are 55K/year, I'm seeing the power of expanding the gap beyond the norm exploding. You realize the normal assumptions of a good savings rate being 10% and a really good one being 15% is based on the assumptions that normal Financial Independence is achieved at 65, and an 'early' one at 60. But why not 35?

Once you have achieved the success of a good income, Why not buy that extra 25 years of freedom instead of a nicer car, granite countertops, and just 5 extra years of freedom? Why not smile when someone says to "live a little" because you realize being financially free for the majority of your life allows one to truely "live" a whole lot more than a BMW does.

Absolutely true, and I think too many personal finance bloggers spend too much time focusing on the expenses side of the equation, but the reality is that you can only cut so much, but you can effectively increase your income (and thus the gap) by an infinite amount. I heard once that businesses should spend 90% of their time on revenue and only 10% worrying about expenses. The percentages might be off, but the idea is sound. I think most people who spend all their time going to garage sales, cutting coupons, and trying to save $5 on their monthly phone bill have an amazing amount of discipline and willpower but they might be focusing too much of it in the savings direction. They could trim 20% or 30% off their monthly budget, or they could double their income in five years. I know which one I'd rather have.

The intersting thing about this gap is that most americans think that by increasing this gap, they are making a sacrifice to thier standard of living. In reality, they are increasing thier standard of living.

The gap was much easier and perhaps wider before this old house. Housing seems to be a huge key to the gap. In the past, I've been a room mate, renting a room in a friends house. One simple rent payment and that was the end to my financial obligation. Now that I own a house, there seems to be things to replace, buy, and update quite regularly. I don't know if we will ever come out ahead with owning. I would like to, but I don't know if the trade-off between owning and renting is actually better. It really seems to hurt the savings gab.

The old "less is more" axiom applies here tenfold. I know that when I began to take control of my money and increase that gap, my desire to spend frivolously was stopped dead in its tracks. Focusing on goals and saving was exciting and much more interesting than eating out or buying needless items. Merry Christmas!

Widening "the gap" is absolutely what it's all about. In fact, my plan to become a millionare boils down to just that - grow my income at 10%/year, while not allowing my expenses to grow more than 5% per year. At that rate, I will be able to save over $50,000/year by age 31 or so (a 40% gap) vs the 10% gap I currently have.

We always had a nice "gap" between our incoming and outgoing money but never expected to enter the "wealthy" class. When we retired in 1992 when I was 58, eighteen years ago, we were well off but far from being considered wealthy, then along came the dot.com bubble as the internet came of age. Our investments started doing pretty well, I concentrated them all in hi-tech mutual funds and then in 1999 they increased by over $1M in one year, an amount which was greater than my total gross salary for the whole 32 years that I had worked as an aerospace engineer. I had enough knowledge and experience by then not to give most of it back in 2000 as happened to most people. Since we all know that with compounding, money makes money, we have never looked back since that unforgettable year.
Unfortunately my experience is very hard to replicate since it requires that you be in just the right place at just the right time, with just the right knowledge. For us it was a once in a lifetime opportunity that worked out beautifully.

I look at "the gap" as your personal profit margin. Think about it. The margin of a business is nothing more than revenue less all relevant costs. Stuff coming in less stuff going out. That's what your "gap" is.

If your gap is negative, then I agree with FMF, from a personal finance perspective, do not pass go until you fix that problem. Once you fix that problem, THEN worry about savings, investment, asset allocation, paying down debt, taking advantage of qualified accounts, etc.

The Brits had it right all along:

"MIND THE GAP"

-Mike

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