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The first law of personal finance: Spend less than you earn

The first law of personal finance: Spend less than you earn

“Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness.

Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”

– Wilkins Micawber (David Copperfield, by Charles Dickens)

Were you to stick to just one New Year’s Resolution – and assuming “I will not kill again” is surplus to your personal requirements – then you could do a lot worse than vowing to spend less than you earn.

Living within your means is about the least sexy concept in personal finance, I know.

The magic of compound interest, the principle of risk versus reward – heck, even the Dr Who-ish sounding Time Value of Money – they all have a certain frisson.

But none of them adds up to a bean if more money goes out the door than you have coming in.

And that’s true regardless of your net worth, or the size of your monthly wodge.

One rule for everyone

Some think that watching the pennies is only a concern for people on the poverty line, Dickensian characters, or natural born tightwads.

They’re wrong. Spending less than you earn is as important when you’re rich as it is when you’re trying to get there – assuming you want to stay that way.

Just think of all the sports stars who’ve gone bankrupt, or the lottery winners who end up with nothing.

There are many ways to go broke, but persistently living beyond your means is the one that never fails. Anyone who’s seen Brewster’s Millions knows that even reckless investments occasionally pay off. But outgoings exceeding income is guaranteed to leave you with nothing.

You might be thinking those sports stars were retired, and hence their days of earning mega-bucks were behind them. Surely they had a licence to hoover up designer goods to ferry across town in the supercar that best fitted their mood?

As for the lottery winners: who wants to win a million to be freed from wage slavery, only to keep their spending to a few measly tens of thousands a year?

But that isn’t the right way to look at it. Not if somebody wants to stay wealthy.

Sports stars and lottery winners who give up work are no longer earning, but their capital can still earn for them. A sensible approach would be to figure out what inflation-adjusted annual income your loot can give you, and then live with those means, just like a wage earner.

Result, happiness!

How to start growing your fortune

The joy of spending less than you earn is it always leaves you with something.

An acorn. A spark. A bit of grit that you can grow into a pearl.

And that leftover money you have every month holds the key to your future financial freedom.

By saving and investing this surplus – by never spending more than you earn and so continually saving and adding a little more, and then a little more again – the daunting task of securing your financial security becomes nothing more onerous than a habit.

Yet the results can really add up. This is the bit where any decent financial writer busts out a compound interest calculator, and I’m not about to let the side down!

  • Invest just £200 a month from age 21 into the stock market and you might retire at 67 with a pot of over £400,000, in today’s money.1
  • Start late but put away your full ISA allocation of £960 a month from age 40 into a mix of shares and bonds, and you might end up with around £500,000 in today’s money.2

Or ignore me and choose instead to spend more than you earn. Then you will have £0 to save. And you will have £0 to invest.

Which whether you leave it for 21 years or 46 years or 100 years will still see you end up with a big fat £0.

Become an automatic millionaire next door

A great book to read to discover the power of this simple strategy is The Millionaire Next Door. It’s the result of a lot of research that shows that ordinary people often become rich over their lifetimes by spending less than they earn, and saving the difference.

What’s a good target? Up to you. Perhaps 10% of your earnings. If that seems impossible right now then maybe start with 5%, and try to save most of your pay rises from here.

Of course there’ll be a bit more to learn. For instance:

  • You’ll want to invest in very cheap passive funds to capture as much of the market’s return as you can.
  • You’ll want to decide whether an ISA or a pension – or both – is the best tax-sheltered way for you to save.
  • You’ll want to subscribe to Monevator to get occasional nagging reminders like this one to keep you on the straight and narrow.

Too boring? Want to start a business to make your millions? Invest some of your money in fast-growing companies? Build your own property empire?

Go for it! More power to you.

But whatever you do, spend less than you earn. Attempts to sidestep this simple rule (such as by borrowing to invest) have a poor track record of short-term success, and a guarantee of eventual failure.

That said, there’s one group who are allowed to splash the cash.

You’re over 75? Feel free to figure out how to sensibly spend the lot before you discover you can’t take it with you.

The rest of us? That’s what we’re aiming for!

  1. I’m assuming a 5% real return here. A real return is an inflation-adjusted return, so you can think of it in today’s money. This assumed rate of return is a smidgeon less than the average from UK shares over the very long-term. []
  2. I’m assuming a 3% real return here, a lower rate than in the previous example, to allow for the lower return potential of the bonds. []

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{ 15 comments… add one }
  • 1 Len Penzo November 11, 2009, 4:49 am

    The Penzo Principal: The secret to a happy marriage is to always remember what’s hers is hers and what’s yours is hers. 😉

    Len Penzo dot Com

  • 2 neverland January 10, 2014, 9:46 am

    Interesting factoid, comparison of international household saving rates in 2013 from EU estimates:

    UK – 6.2%
    France – 14.4%
    Germany – 16.1%
    Italy – 12.4%
    Spain – 10.5%

    USA – 3.8%

  • 3 JJ January 10, 2014, 1:37 pm

    @neverland – that is interesting, what is that a % of? Gross/net/disposable income? I hope the latter, but…

  • 4 BeatTheSeasons January 10, 2014, 1:43 pm

    It would be interesting to see a comparison of rates in Asian countries.

  • 5 neverland January 10, 2014, 10:23 pm


    Eurostat says its gross savings/gross disposable income

    Since they are saying its “disposable” income I’m assuming its after income taxes and employee social security payments


    The EU survey does report China (they only started including it a few years ago) but it doesn’t include that data

    A 30 second Google search reveals that in 2009, China’s average household saving rate was about 27% according to their governments stats bureau


  • 6 ermine January 10, 2014, 11:22 pm

    Although I can’t knock the sentiment, you need to qualify “spend less than you earn”. Don’t spend more than you earn on wasting assets – HMRC have a good definition.

    What most people want to overspend on are wasting assets – iFads of all sorts, fashion, holidays, cars, bling. However, even though I had a rotten experience of the housing market, as long as you don’t get foreclosed a house is usually a non-wasting asset, and if you are clever enough in the right area, education is a non-wasting asset though dreadfully hard to value.

    Tools of your trade are sometimes wasting assets but they may help you earn money — a CCNA or MCP course wastes to valueless over three years, but it may help an IT professional get work that way outweighs the cost and opportunity cost of the training as an example.

  • 7 The Investor January 11, 2014, 11:05 am

    Note: There was a typo in the first version of this article, which had our precociously compounding hero invested £100 instead of £200 from the age of 21. The maths is correct for £200 a month. Compound interest is good, but it’s not *that* good!

    Thanks to reader C.S. for the correction.

  • 8 SemiPassive January 11, 2014, 12:03 pm

    I spent more than I earnt in 2013 (the shame!) on account of a house extension, new kitchen and revamp, financed by borrowing back on the offset mortgage. My rules for borrowing back are its only allowed for investing in “bricks and mortar” (technically true) or unavoidable tax bills. There may have been a bit of scope creep though…”well we need a new TV”…

    The house should have increased in value, so although it hasn’t “added value” on top of the cost, our net worth should at least be roughly neutral on the money spent.

    2014 will be about going back to de-leveraging, reducing the amount put into index tracker funds but clearing anything on 0% credit cards before they run out, increasing mortgage overpayments, and buying less “doodads”. Still a form of saving I guess, reducing debt and thus increasing net worth.

  • 9 Jayliz 21 January 12, 2014, 7:02 pm

    I am fairly new to this concept, finally grasping how money works 2-3 years ago. The bit I like to think of is this:- As each year passes and your
    net worth increases, the tax you pay on your income by percentage of your wealth goes down each year. Until we die, we are not “yet” taxed on wealth.

  • 10 Adnan January 14, 2014, 3:11 pm

    Some other interesting facts include more people in UK are saving for emergency fund only… they don’t seem to have a vision for long term savings and a recent report suggest more don’t save for long term because they feel their savings will be eaten away by their long term care needs when they retire…
    We are really in a fix here…

  • 11 Brent Esplin January 16, 2014, 6:28 am

    Well written. This really is the key. If you can’t, or won’t, spend less than you earn nothing else matters. I believe so strongly in this principle that I named my website after it: http://www.micawberprinciple.com.

  • 12 @freepursue January 21, 2014, 5:11 pm

    Well put, as usual. $1 saved = $2 earned.

    Pay yourself first and invest in income-producing assets. A growing net worth (even from negative to less negative) makes everyone smile a little and adds a spring to your step.

    Thanks for the post.

  • 13 BeatTheSeasons January 22, 2014, 11:13 am


    I did the same as you in 2012, just before discovering websites like Monevator, MrMoneyMustache and EarlyRetirementExtreme.

    I now regret spending so much money on what was basically consumption. You rarely get your money back on extensions, although you can fool yourself that you did in a rising market.

    If I’d invested that money in equities I’d have grown it by at least 20% instead of maybe preserving half of it in the value of my house. If I’d used it as a deposit towards a second property I’d have doubled my money. Instead it’s just sitting there as an opportunity cost. This is one of the dangers of counting the value of your own home in your net worth.

    It’s certainly improved my quality of life sitting in the lovely new bright room….. when I’m at home, anyway, as opposed to when I’m commuting or sitting in an office working to pay off the (even bigger) mortgage!

  • 14 IvanOpinion January 24, 2014, 1:13 pm

    Having a higher savings/investings rate would also mean there’s more of a buffer for the bad times. The last 5 years have seen real incomes fall for the “squeezed middle”, but in the 10 years before that, real incomes rocketed. Most people in the UK squeezed middle is still way better off than they were 10 or 15 years ago.

    The trouble is that most people, upon receiving a pay rise, up their spending by the same amount (or even more). As soon as a future pay rise falls behind inflation, there’s no slack to absorb the shortfall and it feels like they are struggling.

    In, say, 2003, most people felt pretty well off, because the economy had been booming for some time. And I don’t have the figures to hand but I’m sure I have read figures that show that most of us are now earning more in real terms than in 2003. Everyone feels squeezed because in the meantime their real incomes at first boomed further but subsequently fell. If instead real incomes had smoothly risen at a steady annual rate between 2003 and now, no boom and no bust, we would all be feeling quite happy. Since booms and busts of real incomes will continue to happen, the only answer is to save most of any above-inflation pay rises in the boom years.

    (Incidentally, I’m not saying there’s no-one who genuinely has it tough, or that everyone can afford not to spend a pay rise. But the majority would/could have had much more resilient finances if they had not indexed their spending expectations to their increasing income in the boom.)

  • 15 FinanceQA January 5, 2015, 4:10 pm

    Spending less is probably the core of financial health and independence. One can never reach certain financial goals without curbing the spending appetite. However, this can be a challenge in today’s world where we are constantly bombarded with the latest gadgets and trendiest clothing. It takes a lot of discipline, but the end result is great.

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