Some people who criticize my various budget tables are annoyed that I list pension contributions and investments as expenses. Therefore, I thought I would explain my logic in this post.
Once you start treating your retirement contributions and investments as expenses, you’ll start accumulating a lot more wealth than the average person. And once you’ve accumulated more wealth than the average person, your frustration will subside and you’ll feel freer.
The key is to shift from a defensive mindset to an offensive mindset to create more wealth. Let’s start with a basic understanding of two financial statements.
Income Statement: Investments as Expenses
Below is a sample budget for a household earning $350,000 per year.
The budget below can also be considered as an income statement. The income statement only contains income and expenses. Therefore, you must categorize any line item that is not income as an expense and vice versa.
Since the money must be spent to contribute to a retirement plan, a 529 package, a mortgage, and various Insurance conditions, these items are expenses. These expenses reduce net income, which is the line Cash flow after expenses in green.
To stay consistent with the income statement analogy, the line item Cash Flow after Expenses should be labeled as Net Profit, because there is also a cash flow statement in finance. However, no one calls the money they have left as a net profit.
Balance sheet: investments are considered assets
Please do not confuse an income statement with a balance sheet. A balance sheet is where you can label all investments and pension contributions as assets. Whereas an income statement only contains income and expenses.
A personal balance sheet essentially calculates one’s net worth. And net worth is calculated by adding the value of all assets and subtracting the value of all liabilities.
Even if your investments lose value, they are not considered liabilities. Examples of liabilities include mortgage debt, credit card debt, money owed to suppliers, taxes owed, and wages owed.
Below is an example of a business balance sheet. You can translate equity to net worth if the following was a statement of net worth.
Why are people distorted by investments as an expense?
Not having a fundamental understanding of financial statements is the reason most people get upset. I consider investments as an expense.
These people think I’m trying to trick them into thinking that a family with a family income of $350,000 is poor with only $19 a month or $224 a year of cash left over. No, they are not poor. You are only deceived by what you see if you do not understand what you are looking at.
At the same time, critics rightly point out that such a family contributes $41,000 a year into their 401(k), $26,400 a year into their 529 plans, and builds $25,200 a year into home equity. The total net worth contribution to these expenses is approximately $92,700 per year.
As someone who wants to achieve financial independence, one of your goals is to minimize taxable income and maximize net worth. Once you achieve a net worth of at least 10 times your gross income, you are close to financial independence. Once your net worth is equal 20X your gross incomeyou are absolutely free to do whatever you want.
Difficulty investing for the future
Another reason some people don’t like to treat retirement contributions as an expense is that investing requires discipline and delayed gratification. Sometimes all you want to do is spend your money to live now. Many do it logically revenge spending given that the pandemic is well into its third year.
Therefore, it may be difficult for some people to conceptualize that in order to live a freer life later, you must first spend by investing. Although there are no investment guarantees, historically, investments in stocks, real estate and other asset classes have offered positive returns.
Deferred gratification through investment is an expense. You sacrifice good times now for hopefully good times later. Those who failed the marshmallow test when young are likely failing to save and invest enough for their future.
Investments as a luxury expense
Some people struggle more than others to survive. When you’re struggling to get gas and groceries, it may upset you that others can. In other words, the investment is seen as a luxury expense that they cannot afford.
Yet, deep down, everyone knows that we need to invest for our future. Otherwise, we will end up working for a long time when we are fully able or want to.
So yes, investing is considered a luxury expense for those who have a harder time making ends meet. Fortunately, investing in stocks is now free due to the absence of commissions.
We can buy ETFs and fractional stocks with less than $100. We can even invest in a private real estate fund with just $10 to start Fund raisingmy favorite real estate investment platform for all investors.
Therefore, investing may not be as big of a luxury expense as some might think. The more we can learn about the power of investing, the less we will view investing as a luxury expense and more as a necessity.
Insurance as an expense
Most people won’t argue whether insurance is an expense or not. You spend money to pay something to protect you in the future in case of calamity.
I’ll be happy to pay $115/month for my new $750,000 20-year term life insurance policy that I got through PolicyGenius because I have two young children and mortgage debt. Protecting my family over the next 20 years is paramount. Once my kids hit their twenties, they should be able to fend for themselves. My life insurance premiums are definitely an expense.
Therefore, why would anyone argue that contributing $41,000 a year to two 401(k) plans should not be considered an expense when contributions are made to take care of the household for example in retirement? Few people can and want to work forever. I collapsed before the age of 35 into a traditional day job and fake pensioner. When I’m 50, I probably won’t want to write as much either.
If insurance is considered an expense to protect your future, investments should also be considered an expense.
Crazy about the amount earned and invested
The final reason I think some people don’t consider pension contributions and investments as expenses is because they’re upset with the amounts I’ve highlighted.
Thanks to inflation, my income statement of $300,000 from several years ago has now grown to $350,000 today. Thanks to the government increasing the maximum 401(k) contribution from $19,500 to $20,500, the total 401(k) contribution for two is now $41,000 in my chart, not $39,000.
However, if I published a statement of household income of $60,000 and an annual 401(k) contribution amount of $3,000, that might be more “acceptable.”
Please don’t obsess over absolute dollar amounts. We all live in different parts of the country with different standards of living and tastes. I use these numbers because $300,000 and up is what it takes to live a middle class lifestyle with two children in San Francisco. Meanwhile, I’m still a fan of maximizing your 401(k).
It was hard to max out my 401(k) when I was only doing $40,000 and living in Manhattan. But I did it because I shared a studio with a friend. I also worked late so I could eat in the free cafeteria every night. In retrospect, the sacrifices were worth it.
Keep your capital expenditure high!
I was going to conclude by encouraging everyone to limit their expenses in order to accelerate their pace towards financial independence. But then I realized it was a defensive way to save your way to wealth and freedom. Instead, I’m a much bigger supporter of spend your way to wealth and freedomwhich is the subtitle and central concept of my new book.
Since we all now agree that our investments should all be considered expenses, allow me to encourage you to keep your investment expenses high! Go on the offensive to earn more wealth. It’s a critical mindset shift that I encourage everyone to embrace.
Ultimately, you want your investments to generate as much passive income as possible to be free. Depending on where you are, your investments could be your biggest expense of all!
Readers, do you consider pension contributions and investments as expenses? If not why ? Why can’t some people consider investing in their future as a current expense?
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