Consider yourself like a company. Your annual income is the same as a company’s revenue. Companies have expenses, so do you. After a company covers all their expenses, whatever is left over is their net profit. Net profit is the money a company keeps. Your savings is your net profit!
To understand that it is easier to save a dollar than it is to make a dollar, you must first consider how hard it is to save each dollar.
A company calculates its net profit percentage by dividing its total income by its total revenue. Follow along with this example, but use your own income and savings.
The average person in the U.S. earns about $32,000 per year and saves about $1,200 of their income each year. Using a calculator enter $1,200 and divide this by $32,000 equaling .0375. Rounding this to .04 is the same as saying the average person has a 4% savings rate (net profit).
OK so what do we do with this “net profit percentage”? Think about it this way. If you only have 4% net that means for every $100 dollars you earn only $4 dollars is going into savings, or more importantly $96 dollars is being spent in order for you to save a measly $4.
Now take a look at this same math in a little different way. If you were to waste $100 on a pair of shoes, or that new gadget you’ve been wanting (but don’t need), where does the $100 dollars come from?
$96 out of every $100 is already spoken for, the money you want to spend will come directly out of your savings!
Now time for the pain, assume you wasted $100 dollars and realized after the fact that you didn’t really need that gadget. How long would it take you to recover the $100 dollars wasted?
To calculate this you would divide $100 by your “Net Profit%” or savings rate. $100 divided by .04 equals $2,500. This might sound a little crazy at first, but take a moment and think about it. If you are only saving $4 out of every $100, to recuperate all the money you spent ($100) requires $2,500 of income to have enough money to pay all your bills and be left with $100.
Did you find this interesting? Leave a comment and let me know!