In finance, there are some things that are harder to do than others. Because there's a limit to the resources we have, which influences the direction we can take.
Although we can't have everything we want, having anything we want implies that there's an opportunity cost on any financial choice we make.
For me, this usually comes in the form of thinking about the different possibilities and the risk/reward ratio of each. In theory, it's always better to choose the one with the highest reward and the most manageable risk. But in practice, there are surprises that are never accounted for.
When it comes to sorting out the financial dynamic between income and expenses, finding a good equilibrium often lies on understanding the extend or limitations of both income and expenses.
Cutting expenses can only take us so far, we will eventually have to put most of our focus on increasing income.
We humans tend to have a loss aversion bias by nature, we feel more pain in losing something than pleasure in gaining something. I think this stems from the emotional attachment we normally have on things, especially when we get used to them.
A example will be buying a car for $19,000, use it for a couple of years and then decide to sell it on the market to buy a new one. Let's say we list the car for $15,000 but the best offer we get is $12,000. We can either sell it for $12,000 or reject the offer and keep the car.
Rationally, the best offer can be a good deal but if we're under the influence of the loss aversion bias, we may prefer to decline the offer and keep the car, even though it may be worth less than $12,000 on the market.
On a psychological viewpoint, cutting expenses can be emotionally difficult than increasing Income because it requires giving up something that one values or needs.
Emotionally, the potential loss is magnified over the potential gain, which has us thinking that we're losing more than we gain in regards to cutting expense.
At some point, we will come to the realisation that there's a limit to how much we can reduce expenses, especially living expenses. If one spends $500 per month on living expenses, the maximum amount they can save by reducing expenses is $500.
This is because when one spends $500 per month on living expenses, the lowest possible amount they can spend is $0, which means the highest possible amount they can save is $500.
Mathematically, this is the limit or the ceiling of how much one can reduce their expenses, it can't go beyond zero.
However, there is no ceiling to how much one can increase their income. One can potentially earn more than $500 by working more hours, asking for a raise or even starting a business.
In practical terms, there are more opportunities and strategies to increase income than decrease expenses, especially in the modern world. Apart from the traditional ways, one could also freelance their skills on a part time basis or invest in assets that generate income.
Decreasing expenses may be limited by factors such as fixed costs(i.e living expenses), lifestyle habits, social norms, etc. There's a rigidity or fixity to them that we can't do away it. Whereas, increasing income can be more feasible and flexible compared to decreasing expenses.
A good and balanced approach that combines both increasing income and decreasing expenses can be the most effective way to navigate through in achieving one’s financial goals.
Expenses are an important part of managing one's finances and should not be ignored or neglected. But they should not be the main focus of one’s financial strategy. Instead, one should put more emphasis on increasing income and creating multiple sources of income.
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