A student who earned a few thousand dollars over the summer working remarked to me yesterday, "I don't know how I'm going to spend the money if I don't use it to travel over the holidays."

At first, this statement seemed quite innocuous, in line with what I have come to expect in our work-and-spend, consumer-oriented society. People earn money working and then, quite predictably, spend the bulk of their earnings soon thereafter, buying all types of consumer goods and services with whatever remains after paying for life's essentials.

Three Personal Financial Management Philosophies

Upon further consideration, I became struck with just how one-sided the student's attitude on what to do with his money is. On the spectrum of personal money management philosophies, he is at the consumerist end of the two extremes:

Consumerist Philosophy: Earn and spend; earn and spend; earn and spend. In short, spend all of today's earnings on consumer items, because another paycheck will always come "tomorrow." Examples of this type of philosophy include people who live paycheck-to-paycheck more by choice than circumstance, the young woman from England who won a multi-million dollar lottery six years ago at the age of 16 and now regrets having spent all of the money so frivolously, and highly successful, high-income celebrities like photographer, Annie Leibovitz, and singer, Michael Jackson, who, despite their millions in earnings, have ended up "awash in debt" due to their personal financial management, or lack thereof.

Wealth Accumulator's Philosophy: What's important is accumulating as much wealth as possible during one's lifetime. Be frugal, even to the point of being miserly. Save as much as possible from one's earnings, prudently invest one's savings, and reinvest as much as possible of one's investment earnings. An example of this type of thinking is self-made billionaire, Warren Buffett, who not only is worth some $40 billion but is rumored to have once stooped down to pick up a penny in an elevator, remarking to those around him, "This is the start of my next billion."

My opinion is that most of us will be best off following neither of the above extremes but, instead, adopting a middle-of-the-road philosophy, which emphasizes neither consumer spending nor wealth accumulation:

Perpetual Income Generation: Use one's "excess" earnings (i.e., whatever is not needed to pay for basic necessities) from work and investments to build an investment portfolio that will reliably generate long-term income to cover all of life's expenses. The focus here is neither on spending all of one's earnings, just because one has money currently available to spend, nor on stockpiling cash without limit, primarily to see how much wealth one can accumulate. Rather, the core of this philosophy is to accumulate enough wealth to reach an ongoing state of financial independence, which means that the income generated from one's investment portfolio should over time be enough to support one's lifestyle without relying on external employment.

Historical Analogies

I'm now reading Jared Diamond's insightful work, Guns, Germs, and Steel, which discusses how and why some societies developed farming and technologies and came to dominate societies that remained hunter-gatherers throughout the millennia since the most recent ice age some 13,000 years ago. We can draw a simplistic analogy between hunter-gatherer societies and the consumerist philosophy mentioned above, since both emphasize current consumption without any significant savings component. Similarly, agricultural societies may be compared to the wealth accumulator's philosophy, since any excess harvest can be stored or sold for income, allowing for investment in technology development, which in turn can be used to promote further wealth accumulation.

As Diamond mentions, the recurring pattern throughout history has been that agriculture-based societies have not only developed better technology but have also deployed it to exploit societies having more primitive technology. A striking 19th century example is how, in December 1835, a group of 900 Maoris from New Zealand's North Island sailed 500 miles east to the Chatham Islands and conquered a peaceful society of 2,000 Moriori hunter-gatherers, brutally and indiscriminately killing men, women and children who refused to become their slaves. Apparently, what induced the Maoris to attack the Morioris en masse was news from a seal-hunting ship that visited the Chathams, revealing islands rich in shellfish, eels and berries, with inhabitants who "do not understand how to fight, and have no weapons."

Such are the tragic consequences of the collision of societies. Other well-known examples range from the probable driving of the Neanderthals into extinction by Cro-Magnons some 40,000 years ago, to Cortes's and Pizarro's 16th century conquests of the Aztec and Inca empires, respectively, to the so-called Manifest Destiny of European settlers in the 19th century to expand across North America, decimating native Indian tribes in their path.

I mention these historical analogies because of the perspective they bring to personal financial management. As history shows, societies that have had a "savings" component in their culture have inexorably won an upper hand over societies with more purely consumption-oriented habits. If taken to the extreme, this might seem to indicate that pure wealth accumulation should be, at least from a survival point of view, our preferred personal financial management strategy. Hence, my advice to the student I mentioned at the outset could be to save all of his summer earnings in order to maximize wealth accumulation, but is this really best?

Goal: Perpetual Income

Pure consumers live for the present, much as hunter-gatherer societies have throughout history. On the other hand, pure wealth accumulators emphasize the future, based on a "stockpiling" mentality that always favors acquiring more, no matter how much one already has. Rather than simply consuming or saving, it is, in my judgment, critical to forecast one's future financial needs and reach the right balance between consumption and savings that will best optimize one's overall life satisfaction.

So, my advice to the student is: Instead of focussing on how to spend your earnings, or saving all of it for the future, ask yourself how best to utilize your earnings to begin to create a perpetual income stream that will allow you to gain financial independence and support your future lifestyle. Your focus should be neither on consumption nor on wealth accumulation, but on how best to employ your earnings, consumption, savings and investments to one day to replace your own labor as the primary source of income in your life. (Note: Some people call it "retirement," but for me it's closer to financial "rebirth.")