Oct 5, 2021

Being Frugal Won't Make You Rich!

Skipping that frothy flat white on your way to work won't make you mega-rich. Frugality alone isn't going to turn you into “Jeff Bezos No2”. In fact, being frugal for the sake of reducing the strain on your wallet month-after-month can become a trap. If being a tightwad and counting every penny means drastically downgrading your life and taking the joy away, then what’s the point?

Sure, being cash-strapped and living below your means will help you hold onto your money for longer. But most of the millionaires you see posing in front of flashy cars didn't build wealth just by denying a materialistic lifestyle. They didn’t just walk rather than catch the train; they didn't just cook at home rather than splurge on a fancy restaurant; they didn't just get a housemate rather than live solo.

Most crucially, they realised their unlimited earning potential and savings rate, and acted on it.

Simply put, they:

Increased the gap between their income and costs
Saved the difference that the gap has created, and grew it over time. They invested the excess cash instead of indulging in unnecessary lifestyle inflation.

To gain the finance comfort you aspire, you should have a solid financial plan, buckle down and spend less, but also invest your savings in the stock market.

Let's explore this last approach in more detail.

Invest, invest, INVEST

Investing in stocks describes the way you use money to buy something that you believe you'll manage to sell at a higher price later and multiply your profit.

Essentially, it’s the return on those investments in the stock market that can make someone rich. That doesn't mean that this is an overnight success. Rather, it's a slow yet consistent way to accumulate riches.

With an 8% average annual gain, your initial investments could double in ten years. Stashing bucks in your savings account won't serve you long-term. To the contrary: in a decade, your savings will be worthless due to inflation!

Your income is either spent on liabilities or assets, with your daily expenses, such as rent and groceries, being treated as liabilities. Whereas expenses are a loss, assets can benefit your net worth, i.e., the value of your earnings after tax.

Purchasing a good stock is representative of an asset that can help you generate fortune. The reason is simple. Suppose you invested £10,000 over 5 years in stocks and shares, while your neighbour kept the same amount in a savings account.

If the interest rate on the savings was 1%, your neighbour’s savings pot would amount to £10,510 in 5 years. But, assuming your investment grew by 5% every year, it would be worth £12,763. (I make an assumption here, as there's no security of guaranteed returns when you invest — the share prices may rise and fall in value.)

To clarify, shares are divided-up units of the value of a business. Say that a company is worth £100 million and there are 50 million shares. This means that each share is worth £2.

Companies are issuing shares in order to maximise revenue. Investors, like you, buy shares in firms because they think the company will flourish and want to “share” in its success. They end up owning a tiny sliver of that company's profit and become a “shareholder”. All the stock exchanges, i.e., the buying and selling of shares, takes place through a stock exchange – the London Stock Exchange (LSE).

With the aid of compounding, a small amount invested today could turn into a fortune by the time you hit retirement. However, before you throw money in, you need to free yourself from all debt except your mortgage.

That said, you should pay off any personal loans you have, including debt with high interest rate such as overdraft and credit cards. Otherwise your interest payments will counterbalance any investment gains. So, from a financial perspective, it makes more sense to get rid of debts first.

Second, you need to set a “rainy day fund” or emergency fund. The amount of cash needed to kick it off depends on your current conditions. You could start by determining how much you can afford — anything from 1% to 10% of your revenue is great. If you have dependents, such as kids, or your job prospects are defined by uncertainty, then you might set aside more. A non-negotiable is that you save enough cash for at least 3-6 months’ living expenses.

Following is what can be your investment plan broken down in 5 simple steps:

Buy your first shares and/or funds via low-cost investment platforms, or else “fund supermarkets”, like Nutmeg or Fidelity.
Decide on a government-approved tax-free wrapper, which may include ISAs or Pensions (with these options, the tax relief is real! You won't pay a penny in dividend tax and capital gains tax).
Invest in anything from shares, bonds, funds, property, and precious metals to vintage cars, farmland, art, etc.
Pick an investment strategy — ready-made investment portfolios, or DIY. There are plenty of solutions if you don’t have the time or brain space to work it out alone. Hire a fund manager or professional stock picker with a good track record who will buy and sell on your behalf. Also, you can get an exchange traded fund (ETF) or tracker that imitates the ups and downs in the stock market's index.
Budgeting is key — start small before trickling in more of your savings as you progress. You could try an online personal budgeting course from Udemy.

Maximise or diversify your income

If you want to level up your money game, your attention should be focused on boosting your income rather than cutting costs.

Short of winning the lottery or an inheritance from some long-lost relative, incorporate other means to complement your income. Frugal living combined with a generous-paying job is the dynamic duo most people lean on to attain a staggering savings rate and, ultimately, financial freedom.

So, before you slice and dice your spending list, keep your ears perked for new opportunities to supplement your income.

When did you last ask for a raise?

Did you take a course or learnt new tricks of your trade?

Can you turn your crafting skills into a side hustle?

How about offering tuition to your neighbours' kids a couple of afternoons a week?

Or turning your affinity for fitness into a career.

Passive income is also known as money made whilst you're asleep. Unlike active income — your 9-5 salaried job — passive income is a money-making method that requires minimal effort.

Nicola Richardson, founder of finance blog The Frugal Cottage, contends that

Things like royalties, dividend income, affiliate income and rental income are all examples of passive income. You often have to do some work upfront but then it continues to be passive from that point forward.

Active employment has a ceiling in terms of income as there is an amount that it probably won't pass. With passive income this can be limitless, if you are willing to work at it

Passive income streams are another route you can take to augment your funds rather than leave them in low-interest savings accounts, where they get eaten away by inflation.

Anthony Morrow, co-founder of OpenMoney, claims that you can also be a passive investor if the idea of buying your own stocks and equities in firms or investing in property doesn't appeal to you.

Another great reason to start investing is compound interest. Compound interest helps make your money grow by adding to the interest you have already earned from investing, back into the market. The interest earned ‘compounds’ over time and adds to the value of your investments. It’s a great way to help reach your financial goals quicker.

Time for decluttering!

I bet that if you were to take an inventory of your possessions and decide on the items you make daily use of, it would be 8-10 objects out of the hundreds that you hoarded on. The rest of the stuff is, quite frankly, redundant.

We live in a world of conspicuous consumption. The idea of getting deep pockets easy and quick is ingrained in our culture. That doesn't mean that you should comply with this. Collecting stuff is just a total waste if you don’t use it. You probably have a house full of useless stuff; chuck it all away.

Research the best deals

Contentment towards simple things is a great way to remain true and humble. Life isn't always about having the latest and hottest, but rather what gets the job done effectively. The most expensive blow-dryer in the marketplace isn't necessarily the one to be trusted. So, carry out extensive research to sniff out the best deals — even when you have the resources or tendency to be an overspender.

A great benchmark is examiming how you spend on travelling. Spare extra time to track the most economical flights and accommodations. With the savings, you can often upgrade and feel better about treating yourself or friends to events and dinners. A thrifty or frugal mindset will benefit you in both your professional and personal life.

A penny saved is a penny earned and further grown if invested. Right?