Passive vs. Active Expense Optimization

Puppy-christmas-free-license-cc0-314x224The idea of passive income gets a lot of play in the financial independence blogosphere–and for good reason. The notion of “passive” income is compelling: a single action reaps perpetual benefits. You take one action now and reap the savings “passively” (meaning, without doing anything) into perpetuity.

Action Today: Buy 100 shares of Johnson & Johnson.

Perpetual Benefit: Get a check for $70 every three months for the rest of your life—probably with yearly increases

Contrast this with its less attractive step-sister “active” income, whereby each benefit you receive is requisite upon its own action.

Represented Graphically:

image006 (1)

For clarity, let me offer a chart of passive vs. active income examples:

unnamed (11)

**There is forever a debate going on for several income sources as to whether they’re passive or active. For instance, rental income. If you manage your own property (maintenance, collecting rent, finding tenants, etc.) then about 10% of your rent check would be classified as “active” income, because you take continual action to receive it. If you were to outsource that task to a property management company, then everything left after the PM company’s cut is passive.

Regarding websites and blogging. Even Wikipedia shows these as passive sources of income. I disagree. I could stop blogging for good, and there’d be a small trickle of Adsense revenue that still came in—but it’d trend toward zero if enough time passed (maybe a month). A truly passive source of income should have a component of perpetuity; the income stream generated from it should be stable and lengthy. These are things like a pension, stock dividends, loan interest, or book royalties—to name a few.

Passive Expense Optimization

Everything I’ve said so far is probably elementary to most that have read it. As I said, passive income is widely known and spoken about. What I really want to talk about today is passive expense optimization.

Part of any smart, efficient, and frugal lifestyle is maintaining as few expenses as is reasonable and comfortable. The idea of reducing expenses turns off a lot of people to the idea of financial independence, but it really shouldn’t. This kind of thinking goes:

“What’s the point in retiring early and being financially independent if I have to give up all my “wants” and comforts of life? I like my morning Starbucks. And I’m not about to start bisecting dryer sheets, taking cold showers, setting the thermostat on 58 in January, and only flushing the toilet when I drop a deuce.”

Yah, I agree. That all does sound pretty terrible. But, I’m here to tell you that that mindset is totally backwards.

I’m generally a pretty lazy person. If I had to clip coupons every time I went to the store, had to shorten my glorious hot morning shower to 28 seconds, or wait for the ‘big sale’ to buy toilet paper, then I’m sure I would quickly start hating my life (and my wife would probably kill me). I would resent the idea of early retirement because every time I do something to reduce my expenses I’d be saying “ugh, I’m doing this so I can retire earlier…and it sucks.” This kind of “active” expense reduction is not sustainable. Why? Because every reduction of expenses requires a decision (an action). I would get tired of always takin’ the cheap way out.

Don’t get me wrong. I’m all about a Simple Living mindset and avoiding consumerism, but I believe the true key to cutting expenses is to make expense reduction a passive activity.

How To Do It

Passive expense optimization is the easiest way to go as far as cutting expenses. But, let me first say that it’s not the only way to go—we do try to shop for cheaper groceries, fly economy class, get our diapers through Amazon Mom, order less expensive items at restaurants, or walk instead of take a taxi. But like I said, I’m lazy, so if I can reduce my monthly expenses without any decisions, well then, I’m all for it.

Passive expense optimization is just like passive income, but with “payment” changed to “savings.”

image010 (2)

Passive expense optimization means that you take one action now and then reap the savings into perpetuity. You replace a single incandescent bulb with a CFL or LED bulb today, and without doing anything else, you save $6-$8 per year for the next five years—probably with yearly increases (since electricity costs go up over time, savings go up over time).

CFL bulbs are just the start, obviously—there are so many other ways to passively reduce your expenses:

Passive Expense Optimization can be applied to what I call “mindless” expenses—or expenses that get paid periodically (usually every month) without any thought or decision by you. These are sucker’s expenses. These are expenses that have been structured into your life. These are the expenses that, when reduced, have some huge and positive compounding effects. These are expenses we commonly refer to as “bills.”

These expenses normally fall into one of five categories:

image011

These expenses treat your checking account like a sailor on shore leave. You probably don’t even look at the actual bill—it just goes. This is where taking some small actions now can reap big, perpetual rewards for years to come.

Here are some examples within these categories on where you can easily trim some fat. (Note: several items in this list are items I use, and as such are accompanied with some shameless Amazon affiliate links)

Subscriptions & Memberships:

  • Eliminate your Cable Bill and go for Netflix/Amazon Prime
    and an HD Antenna (we’ve done this, and it’s amazing)
  • Do you have a gym membership? If so, read this article by Mr. Money Mustache
  • Sell that Goddamn timeshare (those maintenance fees ain’t free)
  • Monthly/Annual fees for so much other crap: dating websites, magazines, country clubs, AAA, iCloud storage, and it goes on and on…

Utilities & Services:

  • Add  some insulation to your attic
  • Replace incandescent bulbs with CFL Bulbs
  • Get a Programmable Thermostat
  • Weather Strip/Caulk your Windows and Doors
  • Get the Conserve Power Strip for your television and entertainment center
  • Get some solar panels
  • Put a Ziploc full of rocks in your toilet’s water tank (otherwise known as a cistern)
  • Get a Low-Flow Showerhead
  • Turn down the temperature on your hot water heater and wrap it in a Water Heater Blanket
  • Get off that crazy cell phone plan and on to any one of the hundreds of MVNOs (we use Ting)

Debt Interest:

  • Consolidate your high interest debt onto a low interest credit card (like Chase Slate, Balance Transfers have 0% APR and no transfer fee if transferred in the first 30 days)
  • Refinance your mortgage (rates today are insane and at historical lows)
  • Pay off your debt 🙂

Insurance & Warranties:

  • Cancel your home warranty, laptop warranty, phone warranty, and on and on. First, your credit card probably has a built-in warranty for most products you purchase with it. Second, these warranties are only in place because they’re huge profit drivers for the company that is selling them—you’re a sucker if you have them. If you “need” them, then you probably couldn’t have afforded the item in the first place.
  • Cancel your collision and comprehensive coverage on vehicles with a value less than 5x your deductible (or reduce that coverage to whatever your state law allows)
  • Increase your deductibles to a level that you could reasonably afford (remember, insurance companies remain in business because they make more money from your premiums than they’ll ever pay out to you)
  • Shop around for all your insurance plans (home, auto, life, etc.)
  • Consolidate your insurance plans under one provider (in most cases, this will result in some meaningful discounts)

Taxes

  • Max out your 401(k) and Traditional IRAs
  • Start a business to use as a tax shelter (within the laws) for a lot of expenses you incur for profitable hobbies
  • Harvest capital losses at the end of each year for a capital loss deduction
  • Combine personal trips with business trips

All of the above are just examples; certainly only a few may apply to each individual. But, the premise remains the same. The most effective way of reducing your expenses is not “skip the morning coffee,” “buy your eggs in bulk,” “cook your meals at home,” or “get your DVDs from the library.” Those are all smart things to do, no doubt, but the easiest and most effective means of reducing your expenses is to set those expense reductions on auto-pilot.

Make one change today, and see the benefits forever.

Good luck to you!

Eric

 

2 Comments

  1. Great article. Raising insurance deductibles and cutting coverage for cars is huge. The key is not to have cars so expensive (or on a lease) that any small piece of cosmetic damage needs to be fixed. Another good one is maximizing cash back credit cards. Buy the exact same stuff, get a fixed % off every time.

    • I’ll definitely come out with a credit cards article about how many cards somebody actually needs to cover a standard life of expensing. Credit card cash back is truly the most passive form of expense optimization that can exist–literally zero effort.

Leave a Reply

Your email address will not be published.




CommentLuv badge