Unless you are already rolling in cash, making frugal choices and finding ways to save money is much, much more effective than maximizing your investments.
That's not to say maximizing your investments isn't worthwhile, but you can often find a lot more money at home than in the stock market.
Let's look at Joe, a reader who wrote to me a while back asking some financial questions. He and his wife bring home about $3,000 a month, and they have a $900 mortgage payment. At the end of the month, Joe reports that they're usually about $250 ahead, and that $250 goes into a savings account.
Joe's initial question was how he could invest that money better so it would get a better return. I told him to stick it in a low-cost index fund at Vanguard and instead spend his time worrying about cutting his spending so there's more breathing room. Here's why.
Let's say Joe just sticks that $250 a month in an index fund that returns 10% a year. At the end of five years, Joe would have $19,359 in that account. That's a nice little amount to get started -- you can buy an excellent car in cash with that kind of money.
Let's say, instead, that Joe gets seriously into investing. He manages to spend three hours a day doing stock research and takes that $250 a month and actually gets a return of 18% a year. Tremendous! At the end of five years of focusing on investing, Joe has $24,054 in his account. The investing is paying off, right?
A better optionLet's take another tack. Let's say Joe just spends one hour a week looking for frugal things to do, like going for more energy-efficient lighting, installing low-flow shower heads, making some homemade meals and so on. Joe manages to save $75 more a month in the budget this way, giving him $325 a month ($75 isn't hard to do from almost any monthly budget without much life change).
If he puts that $325 into that index fund at 10%, he'll have $25,167 in his account. Even a bit of frugality blows away an incredible investment.
Unless you have a tremendous amount of money to work with, you're better off spending some time looking at frugal techniques than looking at investments. Naturally, there comes a point where the effort of squeezing out an extra percentage point on the return will be much more worthwhile than preparing meals at home, but most investors simply aren't at that stage -- and the ceiling is much higher than people think.
If your investment isn't well into six figures yet and you don't have an immediate, clear way of adding more than a percent to your investment return, you're better off looking at how to increase the amount you can add to the investment.
So, the next time you have an hour to burn and are looking for ways to improve your bottom line, spend the time figuring out how to tighten your budget rather than looking for an extra percentage point on that investment. Frugality provides far better returns.
This article was written by Trent Hamm, the founder of The Simple Dollar, a blog offering a peek at his recovery from near bankruptcy.
Published Sept. 6, 2007