The Financial Equation Most Everyone in Debt Gets Wrong

Here's a financial quiz for people struggling with a lot of debt. What is the better answer for you to solve your financial problems: earning more or spending less?

Judging by the number of folks who play the lottery and people who daydream over pay raises, most of us think that the key to wealth is making more money. For every family that dreams that they could survive financially "if only" their income could increase by 15%, there is another equivalent family already earning that dream amount, pining that they could make ends meet "if only" they could earn 20% more a year.

Truth be told, income is important and if you can ethically and honestly bring home more money, that's a great thing. But you have less control over your earning power than you might think. If you work for somebody else, your pay is based on a number of factors, including overall business performance and market conditions-two things you don't have much influence on. If you work for yourself, your business depends on competition, market conditions, and how well your potential customers are doing. Again, these are things that are largely beyond your control.

However, most of us have tremendous control over what we spend. Now we do not usually bother to exercise control in this area; in fact, we may have allowed ourselves to be deluded into thinking we don't have any control at all. But we can all restrict our spending, sometimes in ways that have startlingly little impact on our lifestyle.

Lee Iacoccoa, former president of Ford and later turnaround boss at Chrysler, once wrote that he could trim 10% out of any budget anywhere without any noticeable pinch. Household budgets often have more fat than the budgets of lean-mean business operations.

Trimming expenses means evaluating expenses in view of the fact that every cut you can make will increase the amount of money you get to keep for yourself. If you spend $40 on a cell phone, $45 on cable Internet, and $90 for cable TV, you are spending $175 a month for those services. If you could consolidate them and get the whole package for $99 a month, you get to keep $76 for yourself.

Most people who are spending that way don't bother to save, because they don't think of that $76 as something they could rightfully keep. And don't just think $76. In a year, that's $912. In five years, it's well over $4,000.

One way to cut the fat out of your budget is to look at everything you spend and see where there is overlap (are you a member of two gyms? Do you have too many phones?) or ways to consolidate services into packages that offer better deals.

But that's just the beginning. Look at other things you spend and start to see where you can whittle down the spending. For a lot of people, food is a huge item on the budget. Don't go out to eat in restaurants as frequently (or at all) and you'll save money. If you already eat mostly at home, start cooking more from scratch and less from packages and you'll spend less.

The famous "tightwad" Amy Daczycn (Tightwad Gazette) once wrote that the food budget was one of the areas where frugal masterminds could keep exercising continuous improvement. Almost everyone can cut expenses here. Strangely, some of these cost-cutting efforts will result in better, healthier eating.

Can you reduce what you spend on utilities? Most families can reduce power consumption or water bills without making changes that are even really noticeable!

Look at other areas where you spend a lot. Clothes can be a huge expense, particularly if you're outfitting lots of school-age kids, but if you can deal with the garage sale scene, you can cut your clothes bill to a tenth of what it used to be. Granted, working the garage sale circuit takes time, nerve, and the ability to get up early on weekends. Some people dislike the whole notion of the garage sale wardrobe and I certainly don't advocate buying all your clothes used. But if you can get a decent pair of jeans for $1 or some gardening shorts and tees for a quarter apiece, why spend more? Kids outgrow their clothes so quickly that most families are quick to use hand-me-downs. The garage sale merely extends the universe of potential hand-me-downs!

If you just save for saving's sake, you can end up getting burned out quickly. You need to figure out a way to "count" your newfound wealth. If you've got debt, funnel your savings as quickly as you can into paying down high-interest loans. If you're debt free or close to it, you may want to take your savings and put them in a savings account. For instance, if you've figured out a way to trim about $30 off your electric bill and $50 off your food bill and $20 off your cell phone bill, take that $100 and put it aside. Use it to fluff up your savings account or start a specific savings fund (for college, a new car, or whatever you figured you were going to take out a loan to get).

If you play the lottery, here is a great and easy way to start saving. Once, I worked with people who kicked in $5 a week for group lottery tickets and another $5 on top of that for an office football pool. Lots of my colleagues were throwing away $10 week in, week out, with little return and a lot of good humor.

I started to do the same, except I didn't go in on the lottery or the football pool. I took $10 a week and put it in a jar at home. I put my money in the jar every Friday night, faithfully, and in a year, I had over $500. I used that to help fund my vacation that year. The idea that I was visibly saving the money and had a purpose mapped out for it made it not only easier to save, it got to be fun.

While earning more money might, in theory, be a good way to increase your overall wealth, the fact is that most of us increase our spending to match (or exceed) our newfound income. This is why millionaires can go broke. Reducing your spending is a great way to increase your wealth and, best of all, you have a lot more control over how much you spend than you realize.

You can even get radical and decide you don't need cable TV, a lawn guy, or designer handbags. But even people not prepared to make a major overhaul in lifestyle can still reduce about 10% of their household budget and not even miss it. If you earn $50,000 a year, that's $5,000 more in your pocket in just a year!