2. What Is the Difference Between Spendings and Investments – and Why Is That so Important?

2. What Is the Difference Between Spendings and Investments – and Why Is That so Important?

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On the way to financial freedom, we first need some basic knowledge. It’s similar to learning a new language at school: at first, we get to know a few new words. Without them, it won’t work. But don’t worry, we limit this to two terms in total. Very manageable. If you understand these two and the difference between them, you have won half the battle. It’s about spendings and investments.

In short, when I spend money, I buy something that will be worn out or used up afterwards. The item does not bring in any more money. On the other hand, when I want to invest some money, I hand it out with the intention of making more. On the way to financial freedom, we essentially want to make investments and avoid spendings.

About Spendings, Luxury and Knick-knack

Let’s make a few examples: classic spendings are if you buy some food (will get consumed) or clothing (will get frayed). This unfortunately applies also for womankind: the beautiful, new, shiny pair of shoes is an emotional investment at best. But as soon as it disappears in the closet among the other hundreds of pairs, it has to be written down as a spending. Further examples of spendings are new furniture, a new car or owner-occupied properties.

“But Markus, I need those things to stay alive. Without food I’ll starve to death and without a car I can’t get to work. Then I can’t earn the money that I need to become financially free.”

That’s right! So there are two classes of spendings. Let’s call them necessary expenses and knick-knack. The food that I need to avoid starvation or the clothes that I need to do my job are necessary. If spendings allow me to live more comfortably and, by that, gain more motivation to earn money, then a fancy car or a nicer apartment can also be necessary expenses. However, this needs to be carefully questioned. We’ll find out how this works in a moment.

First we need to know a little more about the second class of spendings: By knick-knack I mean expenses which go beyond what’s necessary. Things that “only” offer emotional added value. If I use my car only for driving to work and for necessary daily shopping, then in theory I could restrain myself to a small used car which costs a few thousand dollars. A Porsche on the other hand would clearly be knick-knack, especially for this purpose — or even impractical because the second beer crate won’t fit in the trunk. And putting it on my lap while driving the car could be a little bit dangerous.

Please don’t get me wrong. I don’t want to deny anyone an adequate deal of luxury. It can help if certain nice gadgets, carefully dosed, provide better motivation to achieve your own goals. You just shouldn’t spend too much money that could be put into investments otherwise. When buying luxury goods, I always weigh up: do I really need this piece now? Or can it wait until I have enough passive income and the purchase no longer costs working hours directly? Because later on, such a purchase is practically for free. It no longer eats up the foundation I’m building up right now. And I most probably have way more time to enjoy it.

I can make an example from my own life: until now, I never owned a car. I know, one day I’ll buy a really fancy luxury sports car. I already have a certain brand in mind. But right now, I would not enjoy it that much, because it would burn too much investment potential. I’ve realized, in a big city with a fair coverage of public transport, I don’t need a car. I was usually able to choose the location of my apartments, so that I could go to work by subway or bike. And cycling in particular has always provided me with a large part of my daily sports dose. For the party shopping at the weekend, there was car sharing. OK, the apartments usually were a bit more expensive because they were closer to the city center. But i liked this proximity even more than owning a car because everything was really close when I wanted to go out in the evening. The luxury of a nicer apartment gave me more motivation to reach my goals than a fancy car.

The example may sound a little bit extreme to some of you. But not everyone has to do it that way. The important thing is, that you question your expenses and check if they are necessary. If you’ve never done this before, you’ll be amazed what amounts of money you can save. You don’t have to optimize everything towards this “one big goal”. There should also be left some room for fun, so that you know what you live for. There’s one thing in peculiar about the path to financial freedom: it’s often longer than you think. But especially for people who are a bit cash-strapped here and there or who want to excavate even more potential for their investments, it can be worthwhile to critically question one’s expenses for a while and optimize your own lifestyle. If you think about the various options for a while, sooner or later you will find a reasonable compromise.

About Investments, Scaling and “Vitamin B”

So much for the expenses. Investments on the other hand are made with the intention of bringing in more money than they originally cost . In the best case, with less time investment than in the current job. It is important that the time that is put into the investment brings in more money per hour in the medium to long term than the current work. Otherwise I could go to work better instead because I earn more with it.

There is one exception, however: a new investment can at the beginning often yield a little less. Sometimes it takes time to negotiate the learning curve and make the necessary progress to get things going. But backwards I want my investments to be more lucrative than my current work.

And how do I know how lucrative my work is? You can calculate that right away. You simply divide the monthly net salary by the number of hours worked per month and you already know your own hourly wage. This gives you a good benchmark of what your own work is worth and you know what an hour of invested lifetime brings in money. Let’s take an example: with a net salary of $4,000 per month and the classic 40-hour week, I get an hourly wage of $25 ($4,000 per month divided by 40 hours per week divided by 4 weeks per month). If I now spend around 3-4 hours a month to maintain a well-running share portfolio, in which twenty thousand euros increase with a return of, say, 5-10% per year, then it is worth it. Above all long term. If I invested even an hour researching the best possible interest rate on an overnight account for the same twenty thousand, it would take at least a year to pay off. If I include inflation, this “investment” even remains permanently in the red. I could better spend that time working overtime – especially if I generally enjoy my work.

The hourly wage is a powerful tool. Even if it’s only a fictitious number, as most employees will. With him I can make things comparable that would otherwise be difficult to compare. Most freelancers work out an hourly wage for their projects, even if they only work at fixed prices. This makes projects comparable that B. have a different duration. In addition, as a self-employed person, I often have a lot of hours for acquisition and marketing, i.e. working hours that a client does not normally pay me. If I add them to the projects, I get an hourly wage that makes the work of freelancers comparable to that of employees. And very important for us: with the workload of investments. It is important that when calculating the hourly wage of an investment, we think a little longer and leave out the initial structure. I would like to know how much time the investment will cost me in the long term once it works. Only then do I know how passive it really is. But more about that in the corresponding article. At this point, the first thing that counts is that we take the first step to get started. Take a short break from reading now and calculate your current hourly wage, if you don’t already know it.

About Compund Interest and Scaling

What else should you pay attention to when making investments? One of the most important things is that compound interest works for me. Interest is one of the most powerful tools to generate passive income and to let wealth grow. This becomes clear with a small example: if my assets grow with a return of 5% per year and I have invested a total of 10,000 euros, then it increases by 500 euros in one year. Not bad, but not enough to eat out more than a few times. If I have a million in the depot instead, the income at the end of the year is a whopping 50,000 euros. You can keep yourself afloat with that if you don’t have too many demands. Even after taxes. If I don’t use the money right away and instead can continue to invest at the same rate of return, I’ll get interest on the interest and then the rocket will really take off. There are more than enough examples on the Internet that explain this nicely and clearly, so I don’t want to go into the details here. However, it cannot be emphasized enough how incredibly important it is for an investment to have an annual return. And not just in a year, but in the long term. This is one of the most important parameters for assessing and comparing investments.

It is also important: the annual return on employment is zero! I get the same salary every year in the classic salary. It won’t go up on its own unless I manage to negotiate a raise or somehow move up in the job. And that’s why we should look into investing. With an employment contract I can pay for my food and my apartment and support my family. With a lot of effort, maybe build a house and pay for it. But as an employee I will never (!!!) manage to escape the hamster wheel of making money. And in my old age I am at the mercy of our state for better or for worse, and I have to hope and pray that our pay-as-you-go pension system will still work. If that’s not enough for you, you have no choice but to take your fate into your own hands and look around for suitable investments.

So what are good investments? Classic examples are trading in shares, buying a rented property or setting up your own business model. But hobbies can also be investments if you can turn them into money. This can range from collecting and trading in any rare or valuable item to something as absurd as sweepstakes. When I was a student, I used to take part in all kinds of competitions for a while. Not just because of the money. It was fun for me at the time and I wanted to know if and what you could win. In the end, I actually automated it and even registered with providers who charge a little money in order to register for new competitions. I then sold the stuff I won on eBay. That was fun for a while. What was missing here was the further scalability. This is another important quality of investments. At some point they should bring in a multiple of what I earn through my normal work. The investment should be expandable ; I want to be able to take it to the next level at times. At some point in the sweepstakes I failed to increase the income per hour of work. With stocks or real estate you can start with a relatively small stake and keep increasing it up to the millions or even billions. The return mainly depends on the money invested and less on the time invested. And that applies to all types of investments that have an annual return, that is, yield interest and compound interest.

About “Vitamin B”

And there is one more important aspect that can help immensely when scaling an investment: relationships. By exchanging ideas with other people, I can test what is important to these people and what they may need . If I happen to have something that someone else needs and they are also willing to pay me more for it than I originally paid for it, then the classic win-win situation results. This can range from trading goods for money to placing an order that a competitor in the same business cannot process in terms of time and therefore passes it on to me. The latter, most likely in the hope that I would do a favor in a reverse situation.

With the notorious Vitamin B, incredible economies of scale can be achieved. It’s a shame that there are people who talk badly about relationships. It is often said: “He only managed it because he has connections.” I think people who say this either have no relationships themselves and are jealous of others who do. Or they have not yet properly understood the principle behind it or they do not yet know enough to be able to apply it in a way that makes sense. I definitely don’t want to offend anyone here. But if someone should feel addressed by these lines, then I recommend checking once whether the previous life has consisted mainly of a kind of lone warrior. How does z. B. Collaborate with colleagues at work? How often does it consist of teamwork? And is this teamwork fun? I’m writing this because I’ve been a lone fighter myself for a good part of my life. I often found the negative sides of the cooperation too exhausting. When you deal with others, there is always friction between people. Or you have to protect yourself against losses and fraudsters. I often found that more exhausting than what the benefits of working together brought me. In the course of time I have learned more and more how I can turn the downside of collaborating with others from an uncomfortable mammoth task more and more into a necessary routine so that collaboration works better and better.

And that brings us to the flip side of the coin: sometimes you should be careful when dealing with relationships. There are also people who do not have the noblest of intentions. Contracts for protection can help. Fortunately, in today’s world you no longer have to expect to be found with your throat cut in the gutter if you ever catch a black sheep in the financial sector. But the invested money – as the saying goes: it is not gone. It just has another. I’ve met some of these people myself, done business with them and wasted a lot of money in the process. Of course, I didn’t know beforehand that they weren’t going to play honestly. That usually only became apparent afterwards. What helped here is the first basic rule of investing: never put all your eggs in one basket. Whenever I’ve embarked on something new that I haven’t yet been able to gauge how it’s going, I only invest a little play money at first. An amount that doesn’t hurt if it’s gone. And if the cooperation over the years has been good or the investment has developed positively in the medium to long term, then it was time to increase the amount bit by bit.

Conclusion

On the way to financial freedom, we want away from expenses , i.e. purchases that consume money , above all away from unnecessary luxury (frills). We want towards investments , i.e. purchases that bring in more money than they cost . We want to generate passive income by increasing our own hourly wages through suitable investments and scaling these investments . The better the knowledge we have built up about the investments . A good network of relationships can also work wonders here and needs to be built up and maintained .

The next article from the “Basics” series continues here:

3. Mindset for Money – Why We May Accumulate It

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