.Net Programming - Financial independence

Reducing Spending vs Increasing Earnings

Which one is more relevant? Reduce your spending or increase your earnings? We’ll do a quick comparison of both and then I will explain why I think reducing your spending is way more important than increasing your salary or getting a second job.

Reduce Spending

Increasing Your Earnings

Increasing your earning is good, everybody likes a pay raise or a money gift of some sort. It will effectively make you reach financial independence quicker if used properly. You can find more ways to make money by working a second job, starting a business or having a sideline. It’s a good idea but it can drain your energy faster than you might think.

Reducing Your Spending

Reducing your spending is to cut back on some of the things you spend or that you might not need. Small issue is that it’s a bit of a downer because you often lose something that you had in order to take back the money. Nobody wants to reduce their lifestyle. That’s why reducing your spending can be a bit more difficult than its counterpart but much more effective.

Why Spending Reduction Has More Impact

Increasing Your Lifestyle

When you get a raise, it’s very tempting to go out and buy some new clothes or increase your lifestyle accordingly. If you want to attain FI or simply want to reduce your financial stress, you should try to keep the spending down. It’s just like buying a house or a new car on your first full time job. I can’t say I am perfect on that one!


Another major issue with increasing your earnings is the tax man. Here in Canada we’re taxed like crazy and that’s mostly why I consider this solution is better. You can think of it this way: every dollar you make will be taxed twice, once when you earn it and once when you spend it.

When you earn it, it will be taxed at your average income tax rate*. Then it will be taxed again when you spend it at around 15 % (Quebec, please see this link for more information). For example, if my salary was 60 000 $ in 2017 (we’re now in 2018), I will be taxed at around 29.50 % average, then if I buy stuff with that money it will be worth even less. Let’s have a look at how much 1000 $ can buy me after all taxes.

Let’s calculate my money after income tax.
0.705 (or 1 – 0.295) X 1000 = 705 $ after income tax money.

Then let’s buy something and see what I can buy with 1000 $ of my hard worked money (15 % sale tax in Quebec).
0.85 (or 1 – 0.15) * 705 = 599.25

That means I can only buy something that’s worth 599.25 $ with 1000 $ pre-tax money. That’s aweful! Don’t spend it and you just saved around 105 $ (in Quebec) in taxes that will be working for you instead when invested!

Earning more also increases your average tax rate and will not give you as much as you deserve since you’ll be even more taxed on each dollar you make at that point.

*Average income tax rate simply means that it will combine the brackets to give you the tax percentage on every dollar.

Tax Rate for High Earners

If we refer to this calculator, we will have a better idea of the income tax rates and how they affect our next dollar when we get into the high incomes. For instance, at 60 000 $ a year, I am at 37.12 % (on my next dollar) tax rate. Go up to 100 000 $ and you will get a whooping 45.71 % on your next dollar! That’s crazy, even if you earn a lot more you’re taxed even more. Your average tax rate becomes 33.51 %. In other words your buying power will be reduced by 48.51 % (33.15 % + 15 %). For every 1000 $, you only have 514.90 $ of buying power.

As you can see, the less money you make, the more buying power you have on what you make. That’s because the first number (income tax average rate) will go down and why making a lot more money is not necessarily desirable. Spending less is a lot more important, especially in Canada and even more in Quebec where your tax report makes you want to cry more than anything else!

That’s also why working two jobs is arguably worth it. It might seem like you’re making more money but you are actually over-using your body instead. That’s why investing and growing assets is very important!

Note: depending on your situation you might have tax credits that I am not taking into account here in my calculations.

How to Increase the Power of Your Money?!

For financial independence, the point is to have less income on your standard income and more capital gains and dividends (especially eligible) instead. Only 50 % of the capital gains are taxed at your average rate and dividends have their own separated taxation system that is not dependent on your income. Or even better, not be taxed on the money you have invested by using special accounts that you must open right now at your financial institution!

Index ETFs will help you accomplish the task of being more tax efficient by reporting less capital gains in part because of less transactions. Special accounts like the TFSA (my personal favourite), the RRSP or the RESP can help you reduce your taxes paid on investment income. In these special accounts, the interest on your money is not taxed (at least not right now in the case of the RRSP and RESP), that’s what we call tax deferred. In the case of the TFSA, you pay taxes right now on the amount when you earn it and then the interest on your investment are tax exempt but you’re limited on the amount you can put each year. Want more information, here is a link explaining the rules of these accounts.

There are other ways of making your money grow but this is out of the scope of this blog post.

In any case, how do you think rich people make their money grow? Certainly not by working more, but instead by making their money work so they can play more golf! If you’re at the start of your career it’s even more the right time to be aware of your spending and stack up that paycheck! Especially if you’re aiming for Financial Independence.

Bottom line:

  • Reducing your spending is a must because you want to minimize the amount of sale tax you pay and optimize your lifestyle accordingly to be able to save more.
  • A second job is not necessarily as effective because of more income tax and you are most probably better off investing what you can instead to make the money work for you.
  • Investing can be very tax efficient compared to standard income.
  • If you want to become financially independent, you have to reduce your expenses and become more efficient, do it right now and it’s going to be a lot easier with the mindset already established!
  • Reducing your spending will reduce your consumption and your impact on the environment.

Want to Reduce Your Expenses?

If you’re now convinced that you can save on your next dollar, you might want a few tips! I won’t reinvent the wheel, this is a really good post with a lot of interesting ideas on how to cut your spending.

My classic note saying that you are in control of your spending and finances, not me. Invest wisely and consult a financial planner or another expert if you do not feel comfortable enough to manage all of this by yourself. Investing always carries risk and you should only invest what you can afford to lose or will not need for a long time. You might also want to check out Canadian couch potato for great information on ETF investing.


For FI People!

I was going to end this post but I wanted to show you a calculation I made today that can illustrate my point of view even more. Let`s have a look at two different person, one with really small expenses and FI money and one with only one source of income and more expenses.

High Earner, High Spender

Income Tax high earner

With only his salary as the main source of income, the income tax paid is incredible. In other words, most of the hours he worked will be sent to the governement instead of freeing time. The more he works, the more money and time of his life he spends without reaping the full benefits and without having the choice of what to do with it. That choice is given to the government instead.

Let’s consider 40 hours worked on 49 weeks throughout the year. 29,5 % of his time goes to the governement or 578,2 hours on 1960 total worked!

Low Earner, More Time

Income tax low earner

The other person, financially independent with 300 000 $ invested and different sources of income including a small business in which he works 15 hours a week. Less hours worked and more free time as well as a lot more choice on what to do with his money because of a lower level of income tax. Hey, I’m not saying that paying tax is not good, everyone needs to contribute, I am just saying that you can reduce that amount to have more time at hand. If you consume less, you will pay lower taxes and be a smaller burden on the whole system.

15 hours times 49 weeks gives a total of 735 hours work during the year. This gives our person around 3,90 % income tax rate, in other words, 28,6 hours paid to the government. I don’t really need to add anything else to this calculation as it speaks for itself! The time worked is worth more in term of returns.

Even if you make less, you work a lot less and what you make comes back to you directly while still contributing. If you want to make more money because you spend more it will almost exponentially take more of your life time to do so, a bit why buying a house early is more or less of a good investment depending on how you see it.

What is to remember is the power of spending less money on its value on your lifetime. Money is not the end, it’s the mean to whatever you want to do or become in life. Trying to make more money with two jobs or so might not be the best idea especially if you don’t really need that money because your expenses are so low. It’s a bit of a contrarian way to think but definitely something to look into if your goal is to become financially independent.

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