By Mark Henricks
If you want to be wealthy, or just financially secure, you first have to learn how not to live beyond your means.
“Living within one’s means is the secret to wealth and success,” said Barry Korb, a certified financial planner with Lighthouse Financial Planning in Potomac, Maryland.
Not living beyond your means doesn’t mean having no luxuries, Korb cautioned. The goal is balance.
A Simple Tool for Living within Your Means
Tim Hewitt, a certified financial planner with Wiley Group in Conshohocken, Pennsylvania, recommends following a 50-30-20 budget or spending plan. This budget calls for spending half your income – 50 percent – on needs such as rent or mortgage, car payments and credit card minimums.
Thirty percent – roughly a third – is for wants including eating out, travel and entertainment. The final 20 percent – a fifth – is for saving and debt reduction.
One thing to keep in mind when crafting a 50-30-20 budget is that you should consider only your after-tax income when calculating how much to spend on needs, wants and savings/debt reduction. For employees that number is take-home pay, not pay before taxes and the other items withheld. For self-employed people, it’s total revenues after expenses including taxes.
Going Beyond Living within Your Means
Once you have crafted a spending plan that lets you pay your basic bills every month, keep looking for additional ways to save and budget. That’s because it’s important to spend significantly less than your income instead of spending an amount equal to your income.
“It’s not just living within your means, it’s living below your means,” Hewitt explains. “If you’re just living within your means, you can get behind.”
Building a Fund for a Rainy Day
When you are spending a meaningful amount less than you make every month, you’ll be able to build savings and reduce debt. Your first goal should be to build an emergency or rainy day savings fund. Only after you have an adequate rainy day fund should your attention turn to reducing debt.
Your emergency fund should be large enough to pay for three to six months of essential bills. Once you have the emergency fund filled with cash, you’ll be better able to handle the occasional unexpected expenses such as car repairs, doctor visits and the like.
Using Automation to Live Within Your Means
Along with basic budgeting, consider using automatic drafts to pay your regularly recurring bills and fund your savings account. “If you can automate that, you’re not going to feel it as much,” Hewitt said.
You can use automatic drafts to pay essential bills like rent and utilities. This can save money by avoiding late fees. Also consider using automatic drafts to pay credit card minimums and make loan payments.
If you set up your savings contribution as an automatic draft on or near your regular pay day, before long you’ll hardly notice the money coming out of your pay. You’ll grow accustomed to getting by with the lower, after-contribution amount and living within your means will become less difficult.
The Reverse Budget Approach
If budgeting seems too unpleasant, consider what Scott Stratton, a certified financial planner at Good Life Wealth Management in Dallas, calls “reverse budgeting.” This approach involves paying yourself first – setting aside money from each paycheck for an emergency fund, retirement savings and auto, health, disability and homeowner’s or renter’s insurance.
“Then you can spend the rest of your money and don’t have to worry about where you spend it,” Stratton said. This is much simpler than trying to track every expenditure, he said, but can be equally effective at helping you live within your means.
“I don’t know that it’s important to know how much you’re spending on dog food every month,” Stratton said. “Most people don‘t need to know that. You just need to know you’re ending each month with more than when you started.”
The Long View
If you want to avoid living beyond your means, it’s especially important to consider long-term consequences of all major spending decisions, said Scot Hanson, a certified financial planner in Shoreview, Minnesota. “There’s often not a lot of money left over after the big things – rent, car, school loan,” Hanson said.
Deciding now to attend a less costly college, live in a less expensive place and drive a more modest car can decide whether you are able to comfortably live within your means for years into the future, Hanson said. “Most people don’t factor in all those things,” he said.
Building in Some Slack
Living within your means can be compared to eating within a diet plan. It’s not always easy and even a relatively minor slip can seemingly undo days or weeks of dedicated effort. For that reason, money management experts suggest recognizing and rewarding yourself for your successes.
Seek to trim your essential monthly expenses like rent and food enough that you are able to you set aside a meaningful portion of your income for non-essential expenses, such as movie tickets, tasty treats and modest impulse purchases. If you give yourself small rewards from time to time, it may make it easier to achieve your bigger goals over the long term.
“It’s very difficult to stick with a diet without a cheat day,” Hewitt said. “Same thing with a budget. You need to have some fun and live your life and not have it be too restrictive.”