You Can’t Out-Invest Poor Spending Habits
In the current day and age where spending money is a tap away, gone are the days of having to physically pull cash out of your wallet and fumbling with your change while the person behind you is slowly putting their stuff on the counter.
There’s an argument that the ease of payment has encouraged spending in people due to the lack of effort it takes to get to that point. As financial advisers, you will never find us asking our clients to budget or how much they spend on coffee in a day, however cashflow is still an integral part of your strategy framework.
Why spending matters
One of the biggest misconceptions in personal finance is that wealth is determined by investment returns. While investment performance certainly matters, it is often a distant second to an individual’s spending habits. Put simply, no investment strategy can overcome a lifestyle that consistently consumes all available income.
Many people believe that earning more money will solve their financial challenges. Yet it is common to see high-income earners living pay cheque to pay cheque, while others on more modest incomes accumulate significant wealth. The difference is rarely investment skill, it is usually the ability to control spending and maintain a healthy surplus cashflow.
Consider two individuals:
- Sarah earns $90,000 per year and saves 20% of her income.
- David earns $250,000 per year but spends virtually everything he earns.
Despite earning less than half of David’s income, Sarah is likely to accumulate more wealth over time because she consistently creates surplus cashflow that can be directed towards investments and financial goals.
The reality is that investing only works on the money that remains after spending. If there is no surplus cashflow, there is nothing available to invest. A portfolio earning 10% per annum will achieve very little if contributions are irregular or non-existent. Conversely, a modest portfolio receiving regular contributions can grow substantially over time through the power of compounding.
This is where lifestyle creep becomes a significant obstacle to wealth creation. As income rises, spending often rises alongside it. Bigger homes, newer cars, additional subscriptions, more frequent dining out and increasingly expensive holidays can quickly consume pay rises and bonuses. While none of these purchases are inherently bad, they become problematic when increased spending eliminates the opportunity to build wealth.
Poor spending habits also create hidden financial risks. Individuals who spend most of what they earn often have:
- Limited emergency savings.
- Greater reliance on credit cards and personal loans.
- Increased financial stress.
- Reduced flexibility when unexpected expenses arise.
- Less ability to take advantage of investment opportunities.
When markets decline, investors with strong cashflow habits can continue investing and potentially benefit from lower asset prices. Those with poor cashflow management may instead be forced to sell investments at the worst possible time to fund living expenses.
As financial advisers, we often find that the most impactful strategy is not a sophisticated investment recommendation but helping clients gain control of their cashflow. Once surplus cashflow is established, almost every other financial objective becomes easier to achieve, from reducing debt and building investments to funding retirement and creating financial freedom.
The lesson is simple: investment returns can accelerate wealth, but only good spending habits can create it.