Live Within Your Means

Live Within Your Means

February 12, 2024

*This post highlights Chapter 2 from Mike’s book, Achieving Financial Fulfillment.

We all have to start somewhere. Our childhood and upbringing have a significant impact on who we become as individuals and how we view the world around us. What is your earliest financial memory? I’ll never forget being in 5th grade and a teacher asking the class if anyone had a bank account. A few kids raised their hands, but I didn’t because I didn’t have one. I remember going home that day and declaring to my parents that I wanted one. It wasn’t long before I got my first savings account, and my interest in finance started to really grow. Financial principles are no different from other behaviors: we learn them by watching others, practicing, and repeating over time.

No matter how high or low your income is, some portion needs to be set aside for unexpected expenses and saving for the future. Whether you are just starting out or are later in your career, a good target is to save 10% of your income. You first need to establish a cushion for one-time expenses such as car maintenance, vacations, and unplanned costs such as medical bills. Once you have a basic emergency fund of a few hundred to a few thousand dollars, unplanned expenses will no longer feel like an emergency situation. This money can be kept in a checking, savings, or money market account for easy access.

Next, a common strategy is to divide your income into different categories based on how the money will be used. The percentages used for each can be customized, but the categories are typically the same: Needs, Wants, and Savings/Debt.

Here is a breakdown of how you can allocate your income:

50% of your income: Needs - This portion of your budget should cover costs such as housing, food, transportation, utilities, insurance and minimum payments on loans. Anything beyond the minimum payment should go into the Savings/Debt repayment category.

30% of your income: Wants - Distinguishing between Needs and Wants isn’t always easy and can vary from one budget to another. Generally, Wants are the extras that aren’t essential to living and working costs. They’re often just for fun and include meals out, entertainment, and travel.

20% of your income: Savings/Debt Needs – This is the amount you put away to prepare for the future. You can start by creating a comfortable cash cushion to avoid taking on future debt. Further, you will need to devote your savings to paying down existing debt (including beyond the minimum payments). How to use this part of your budget depends on your situation, and it likely will include saving for retirement through accounts such as a 401(k), IRA or Roth IRA.

In this example, 10% of the $5,000 take-home pay (or $500/month) is contributed to a Roth IRA (Savings/Debt). Setting aside even small amounts of money is critical no matter your stage in life. Out of sight is out of mind! You will thank yourself later when the savings start to really add up. You should also always try to take advantage of any company matching or retirement benefits provided by your employer. The most important thing is to automate your savings every month (or every paycheck) so it happens without having to think about it.

In review, the first priority is to build a cash reserve, and the second priority is to pay down debts. The third priority is investing. Some debts are better than others, such as a home mortgage or a car loan. However, investing should begin only after credit card debts are paid-off in full. Make a plan for your budget and then make it happen!