Wednesday, April 8, 2009

Get Leverage From Incremental Lifestyle Cost-Cutting

One of the themes in this recession is radical lifestyle cost-cutting. That is largely because of the way Tim Ferriss changed the meaning of radical lifestyle cost-cutting book in his book The 4-Hour Workweek. If you sell your home, or rent it out, because you won’t particularly be needing it for a few years, that doesn’t mean you’re homeless — it means you’re traveling the world. I touched on this topic last month, and I’ll keep coming back to it as long as the recession lasts.

In focusing on radical lifestyle cost-cutting, though, I don’t want to overlook the power of incremental lifestyle cost-cutting. If you can cut your cost of living by a few dollars a month, it might not seem like much, but it can make a big difference in your financial picture. And this is something that Americans are doing in large numbers.

I know this is true because of the consumer credit totals just released by the Federal Reserve. Consumer credit card debt (combined with any other “revolving” line of credit) fell from $963.5 billion in January to $955.7 billion in February. That is a $7.8 billion decline, or about $40 per cardholder.

A $8 billion change might seem small when you compare it to some of the numbers in the headlines, but it actually represents a groundswell of debt payment. It comes, after all, at a time when household income is declining, and right after Christmas, at that. And the reduction in credit card debt is corroborated by other measures: a sudden jump in the savings rate and declines in grocery and restaurant sales. When you understand that people are eating less so they can pay off their credit cards, it tells you that times have changed.

The important thing to understand is that these are incremental changes in spending, but they represent a sea change in people’s finances. If you are like the average American, you have recently gone from spending 98 percent of your income to 96 percent. That is not a big change in spending, but it gives you twice the financial leverage. For example, you could put twice as much money into paying down your debts, and pay them off perhaps three times as fast, depending on the interest rate you are paying. If you are 35 years old, this can make the difference between paying off your debts when you are 50 or remaining in debt for the rest of your life — a big difference in the big picture. When you look at the whole country, the rate at which people were paying down their credit card debts between January and February is fast enough that, if everyone kept it up for about nine years, it would theoretically be enough to pay off all the credit cards in the country. Nine years is a long time, but having no more credit card debt would be a massive change in American culture. That tells you what a little bit of financial leverage can accomplish.

If have debts and are making at least an average income, there is no reason not to go father with this. Cut back your spending by 10 percent, to about 88 percent of your income, and you can have six times the financial leverage of someone who is spending 98 percent of their income. All this is possible with incremental cost-cutting, finding ways to cut your cost of living by a little bit here and there.