Financial Commandment #4: Avoid a Paycheck to Paycheck Lifestyle

Have you ever seen those pictures or videos of people walking on a tightrope between two very tall buildings?  All those pictures are from a long time ago and it seems not many people do that as a thrill anymore (I wonder why??).  Besides that, they are also extremely scary to watch.  Walking on what seems like a razor thin piece of rope where one false move or breath will send you hurtling to your doom.  Very stressful stuff.

Steady now…

Yet, this is how a lot of Americans are going about their financial lives nowadays.  One unfortunate move or event, and their whole financial lives will come crashing down.  This is a very stressful way to live, exhibited by the large increase in anti depressant and anti anxiety medications being used nowadays.  But it’s not a simple pill that will take people off the financial tightrope.  It’s a dedication to get off the paycheck to paycheck lifestyle that is all too common nowadays.  Having some financial breathing room can make all the difference in the world, especially when the big monthly bills come due.  Here are some immediate steps to take in order to get off the tightrope of financial ruin:

Take stock of your current situation:  You have to know where you stand first before you start towards your goal.  Start tracking your monthly income and expenses.  You don’t have to do a budget or anything like that since budgets are not for everyone.  But it is important to know what your income minus your expenses are.  If your expenses are greater or pretty close to your income, you are living paycheck to paycheck.  This is pretty easy to do especially if you use credit cards for most things.  But if you don’t, a simple pen and paper will do.

Cut as many expenses as you’re comfortable with.  Then cut some more:  Living a step away from financial ruin is no way to live.  It’s not worth cable TV.  It’s not worth having a smartphone.  And it’s not worth paying more than you have to for anything.  Cut out non essential expenses, especially those you don’t use much.  This includes the aforementioned cable TV and smartphones, but can also include gym memberships, subscriptions, and excess eating out.  Also, try to minimize those those things you need like car insurance, groceries and clothing.  Many people pay way too much for these things without even knowing it.

Make more money:  Sounds simple enough.  But it’s tough to implement unless you’re motivated to do it.  And getting out of the paycheck to paycheck rut should be enough motivation.  While you’re minimizing your expenses, it’s important to work on the other side of the equation as well by maximizing your income.  Even something like working one extra day a month can make a difference.  You need to do whatever you can to get out of this situation, and once you do you can resume working as many hours as you’re comfortable with.  But find ways to make more money, be it working more hours, selling stuff or using some of your existing skills as some side income.

Build up a reserve:  By cutting expenses or making some more money (or, ideally, both), you are increasing the amount of money you have leftover for the month.  This “gap” between income and expenses is what creates real wealth and will save you from the paycheck to paycheck predicament.  Now it’s important to build up some sort of cash reserve in your checking account or a savings account.  This money should be relatively easy to access as it should be used for “emergency” situations that inevitably happen such as car trouble or surprises at the dentist.

Such unexpected events would be enough to derail a person walking a tightrope and cause them to plummet, either by forcing them to incur credit card debt or even something as drastic as declaring bankruptcy.  This is the importance of a having a reserve or “emergency” fund.

Make it grow:  By optimizing your expenses and income and having a healthy amount of reserve money, you are ahead of 95% of Americans financially.  I don’t have any figures to back that up, but it’s probably true since the vast majority of Americans are in credit card debt.  At this point, it’s wise to give your money the opportunity to grow over time.  This can be done in many ways such as increasing your 401k contribution, investing in mutual funds, buying rental property or starting that business you’ve always dreamed of.  This is the path to real wealth, and what a steady and glorious path it is.


Financial Commandment #3: Avoid credit card debt

Put these on ice if you are in debt!

Put these on ice if you are in debt!

In the third installment of the sacred Financial Commandments, we talk about the biggest thing to avoid.  This is in contrast to the more proactive Financial Commandment we mentioned previously, Pay Yourself First.  Just like a winning football team needs a good offense along with a good defense, a great financial plan needs to proactively go out there and make you more money, while at the same time preventing big money blunders from ever happening.  Commandment #3 is to avoid one of the biggest financial holes you can get yourself into:  credit card debt.

It is known that not ALL debt is bad.  Student loans can help you get an education which you can hopefully leverage into greater income potential for the rest of your life.  A home mortgage will allow you to own a home that hopefully appreciates in value when you sell.  If not at least it gives a roof over your head.  A car loan, though tied to a product which will almost always depreciate in value, lets you drive a car, which you can use to get to work or wherever you would like to go.  These types of debt are not always the best to get into, but AT LEAST you have something of potential value to show for it.  This is known as leverage, as you can use your debt to potentially multiply your money in the future.  Interest rates on these types of loans are usually pretty manageable as well.

Credit card debt is a whole other story.  You almost never have any leverage buying consumer goods with your card (unless you can find a black market for Snuggies).  So the chance of you making some money off of your debt is not very good.  Credit card interest rates are also very high compared to most other forms of debt, ranging from anywhere around 10 to 30%!  If you have a revolving balance, meaning you don’t pay off your balance in full and always have some debt incurring interest, you are really getting hosed.  You are probably paying a very high amount in interest payments, payments that were easily avoidable and with money that could be used for much better purposes.

If you do find yourself in deep credit card debt, start praying to your Lord of choice for help.  When you’re done, it’s really time to buckle down and pay off the debt.  Another reason credit card debt is so dangerous is that it’s so easy to accumulate.  Credit cards are widely available and banks love giving them out because they are a very profitable item for them.  So if you do find yourself in debt, the absolute first step is to stop using the cards!  Sounds simple enough but it can be hard to implement for some people.

After forbidding yourself from using your cards for a while, a credit card repayment plan is very simple:  Use cash only, pay the minimum on all of your balances, and pay whatever you can on your balance with the highest interest rate.  Once that balance is gone, move to the next highest interest rate.  Rinse, lather and repeat.  This is the most efficient way to pay back your debt, despite what those “credit counseling” companies say.  They will essentially set up a similar plan for you, and charge you for it.  Bypass the middle man and follow the formula above to pay off credit cards quickly.


Financial Commandment #2: Pay yourself first…and automate it!

Paying yourself first is probably the most powerful and under utilized method to building real wealth.  The idea behind it is very simple.  Instead of paying all of your monthly bills and expenses and then putting the rest into savings, paying yourself first means you put some money into savings first and then pay whatever bills you have after.  This method just plain works because of two main reasons.  First, YOU decide how much money you want to save and then you adjust your expenses after that.  It can be empowering to decide your own savings rate and it is in sharp contrast to the first method where your bills and expenses dictate how much money you set aside.

The second reason paying yourself first works is related to Financial Commandment #1.  It literally forces you to live within your means because setting aside money for yourself as your first step ensures that money is not being used on something you may not need.  This is a surefire way to get out of debt and build real savings and wealth.  People can be very fickle creatures so the best way to make a habit out of spending less than you earn is to make it impossible to spend more in the first place.

Paying yourself first is an amazingly effective financial practice, but again humans can tend to revert back to old habits.  If paying yourself first is a relatively new practice, it can be tempting after the initial excitement to cut back a little bit on your savings rate.  The best way to avoid this is to pay yourself automatically.  This is very easy nowadays and here a a few ways to do just that:

Online savings accounts:  Most big banks will offer you a savings account in addition to their checking account.  You should avoid this because the interest rates on savings accounts from big banks are usually atrociously low and more importantly, it still makes your money easy to access.  Using an online savings account separate from your checking account is a much better idea because their interest rates are usually much higher (though not incredibly high as most online accounts pay around 1%), but also it creates an extra barrier against you from withdrawing that money on a whim.  Some great online savings accounts include Capital One 360, Ally, and American Express.

IRA:  Opening an IRA is easier than ever.  You can open one if you’re employed or self-employed.  I have had my Roth IRA with Vanguard for a few years now and it has been great.  They allow you to automatically contribute as much as you want and as often as you want.  They also have a very good selection of mutual funds which have very low fees.  It takes about 5 minutes to sign up and connect your bank account.  They also offer very good guidance as far as which mutual funds would be best for your situation.  Of course nothing is guaranteed with stocks or mutual funds, and there are key differences between traditional and Roth IRA’s which will be a subject of later posts, but for long term growth, it’s tough to beat a monthly IRA contribution.

401k:  A 401k can be a great way to automatically pay yourself.  Most 401k’s allow employers to take a pre-determined, and pre-tax, amount from your paycheck and put it into your account.  This is a great deal because it lowers your taxable income and since that money is automatically deducted from your paycheck, you’re not going to spend it.  There are some things to watch out for in 401k plans such as higher than normal fees and the fact that you have a limited selection of funds to choose from.  However, many companies offer a match on your contributions.  They vary among companies, but if you contribute 5% of your paycheck and your company matches the full 5%, that’s like getting a 100% return for free.  Not a bad deal at all.

These are the more popular ways to automatically pay yourself.  While you can just go and change your contribution amount even if you are doing monthly contributions, this extra step makes it a little tougher to do.  Automatic contributions are the best way to pay yourself first and grow your wealth.

Leave a comment below and share your favorite way to pay yourself first. 


Financial Commandment #1: Spend less than you earn

There are certain rules and sayings that are priceless and will withstand the test of time.  Two plus two equals four.  Don’t buy vacuums form a guy selling them door to door.  Michael Jordan is the greatest basketball player ever (please there is no argument here LeBron and Kobe fans).  The list can go on.  In my personal finance journey, I have come across some timeless and time tested ideas as well.  I have tried to make these ideas the foundation of my personal finance strategy.  The first of these “Financial Commandments” is one that everyone has heard but not everyone implements: Spend less than you earn.

The first personal finance book I ever read was The Richest Man in Babylon.  I thoroughly enjoyed this book because it was short, it was simple enough being a personal finance newbie, and it also imparted the strongest message for me regarding personal finance: spend less than you earn.  The books use of parables about the “virtue” of not spending all that you have in your pocket versus spending everything that you get was really refreshing and was easy to apply to my life.

Not spending your entire paycheck right away doesn’t inherently give you any rewards.  It just leaves some extra money in your bank account.  In fact, you immediately receive less because you don’t use all that money to buy whatever you want.  But what that unspent money represents is very powerful.  It gives you the freedom to use it in any way you want.  If you want to use it as a buffer in your checking account, that is fine since some people feel more comfortable with that.  If you want to eventually transfer it to a savings account, that’s great too (this will lead to a future Financial Commandment).  If you just want to give it to your favorite charity, that is wonderful also.  The bottom line is, that money you set aside can be used for whatever you wish.  It represents financial freedom.  And the more financial freedom you have, the more potential you have for a happy financial life.

It’s also worth noting that before the age of credit cards, car loans and home mortgages being the norm, it was actually a lot tougher to spend more than you earn.  The cash that you had in your pocket or your basic checking account was all you had.  Those were simpler times, and most probably less stressful times finance wise.  People had to live within their means because that’s all they could spend.  Give someone a tool such as a credit card, and living beyond your means suddenly becomes a lot easier.  We can use this as a lesson for us to try our best to live within our means and to only use financial tools such as credit cards and loans in reasonable and affordable ways.

Feel free to comment below on this Financial Commandment and how it has shaped your financial journey.