Early sacrifice means more options later

I guess this post is very Dave Ramsey-esque.  But it’s true, if you “live like no-one else” you will be able to “live like no-one else.”  [Update:  To be clear, this is NOT a Mr. Money Moustache post.  MMM is more about being content with a flat level of consumption rather than enjoying a rising level.]

In economics, we learn about something we call consumption smoothing.  With this idea, if you knew your full lifetime income in advance, you would borrow early on at some interest rate and pay it back when you had money.  At some interest rate it would be worth having loans, even though it means you’ll be less flush later since you paid to borrow from your future self.

This simple model ignores two very important things.  1.  You don’t know your full lifetime income in advance so you can’t actually consumption smooth perfectly, 2.  People prefer to have gradually increasing consumption rather than flat consumption throughout their lifetimes.

Because we don’t know our full lifetime income in advance, there’s always the worry that we might borrow too much and hit a bad time that we can’t borrow our way out of.  Additionally, since lending agencies have no guarantee that we’ll actually pay things off, interest rates are much higher than they would be in a world of perfect certainty.  Plus, it’s not like our lifetime income is fixed– we can take on more or less work if we’re feeling worried or relaxed about finances.

Because people prefer to have gradually increasing consumption, that means it’s a good idea to pay things off early in life (after borrowing for education and/or transportation and/or other things that are true investments in our future potential), even if that means more sacrifice early on.  It’s a temporary sacrifice that will lead to more security and more freedom later, when we will enjoy it more.

This is why it wasn’t stupid to pay off DH’s undergraduate loans and to put money in IRAs when we were in graduate school, even though it was pretty clear we wouldn’t have a combined income of $36,000 in an expensive city our entire lives.

By spending less than we earned and investing the difference in loan-prepayment, retirement savings, and an emergency fund we were able to move for my job with the promise of only one income.  Later when we had real incomes, spending less than we earned and following the “rules” for buying a house (20% down, fixed rate mortgage, etc.) and car and so on allowed DH to quit a job he disliked without another one lined up.  Because of these early sacrifices, we’ve had steadily increasing or level consumption with only minor sacrifices when our income has dropped  dramatically or we’ve had major emergency expenditures.

Early sacrifice also meant that we could take risks that paid off.  Ironically, we probably wouldn’t have been able to make the ridiculous amount of money we’re making now if we were worried about money.  DH would still be working for the university making half his current salary or less because we’d have been too afraid to make that jump to let him quit without another job lined up.  So even though we make a ridiculous amount of money now (IMHO), I’m still glad we made those earlier sacrifices, because without them we might not be making a ridiculous amount of money now (or enjoying our jobs so much).

And now, if we do decide to move again, our lack of debt, healthy retirement savings, emergency funds, and low level of spending compared to our income mean that we’ll be ok for a long while even if we have to drop to one income, even if we’re living someplace crazy expensive.  We don’t want to move (permanently) to paradise right now– DH and I both like our jobs– but we could if we needed to.  Our early sacrifice means we can take a pay-cut and we can move someplace more expensive later.

What does that mean if you’re not a poor grad student in your 20s?  It’s never too late to start.  If you still have loan payments dragging down your monthly expenditures and/or you don’t have an emergency fund and/or you haven’t saved enough for retirement, then you can still drop your consumption and temporarily increase your income to get rid of monthly obligations and to get yourself onto sound financial footing.  It may hurt at first temporarily, but the hedonic treadmill means that as you gradually add consumption back in as you get on firmer footing, you will start feeling pleasure again even at levels that are lower than what you started with.  And you’ll still have hope and you will know that the future will be brighter, as opposed to a future that is full of worry that ends in catfood.

tl:dr:  Often times you have to make sacrifices for financial security, and it feels better the earlier you make them because it’s easier to increase your spending than to have to cut it.  If you’re financially unhappy and didn’t make sacrifices before, now is the best time to start!

Have you ever had to make sacrifices for your financial future?  Do you wish you had sacrificed more or sacrificed less?  Have you been able to have steadily increasing (or steady) consumption over your lifetime or have you had to cut back ever (and how did that feel at the time)?  How did you live when you graduated school?