If Your Out-go Exceeds Your Income, Your Upkeep Will Be Your Downfall! This is a mantra that I have written about before. In this post, I will go deeper into some fundamentals and practices that will help you maintain that critical balance.
As long as you continue to spend more than you earn, you will continually fall further and further behind. Eventually leading to a financial crash and burn. This practice will lead you deeper and deeper in debt. At some point you will eventually not be able to pay the interest on the debt you owe causing you to fall into bankruptcy.
Bankruptcy is a major personal setback and brings with it consequences that have a long lasting effect. Credit becomes harder to acquire. Its impact is felt by more than the individual who filed for bankruptcy. Those debtors that did not get paid in the settlement now have to deal with the loss to their business as well. The increase in bankruptcies and foreclosures took a toll on our nation’s economy over the past decade. The trend had snowball effect that hurt us all.
How much have you spent on interest charges this year? What does that add up to over your lifetime till now? How much do you hate budgeting and how much would you be willing to pay to avoid making and living on a budget?
We’ll group the fundamentals into two groups; things to avoid and things to move toward.
- Easy credit offers
- The trap of indebtedness
- Immediate Gratification
- Move toward:
- Improve financial literacy
- Desire to grow wealth rather than overspend
- Commit to a New Pattern of Saving before Spending
- Prioritize Spending – control your out-go
- Reduce Amount of Out-go to Finance Charges
- Improve Income Potential
Three Pitfalls to Avoid
Falling prey to offers from credit card companies, continued indebtedness and the desire for instant gratification are traps that threaten to sabotage our efforts toward achieving our desired outcome. By identifying them and setting guards against them, you will have a safer road to achieving financial independence.
Easy Credit Offers
Today more than ever before, young American consumers who have yet to recognize the trap of indebtedness are being enticed by easy credit offers. Why do credit card companies make it so easy to get a credit card? Why do they offer to pay you to use it with cash back incentives and airline and hotel points? It’s because they make money from you as well as from the companies where you use the card. The credit card company wins coming and going. A small commission to you is no loss to them. They are betting that you will pay them more than the incentive they seduce you with. And they are winning big time.
Choose credit cards and all forms of debt carefully. It is generally a good idea to close loan accounts that have a zero balance and are not being used. This one step will help to protect you from identity theft and help you control your spending.
A rewards credit card can work in your favor when you use the card regularly and maintain a zero balance each month. That means pay the full balance every billing cycle. If you are giving them more money in the form of fees and finance charges, it is working against you. In that case, I recommend you get rid of it.
The Trap of Indebtedness
Growing debt and prolonging the paying off of existing debt, particularly student loan debt is a trap that leads to a mentality of accepting the condition rather than seeking an improved personal economic state. When your debt balances grow month after month, the amount of money that you give up to finance companies grows with it. The interest that is added each month also gets charged interest. Interest charged on interest is a principle called compounding. Compound interest works both ways. You choose whether it works for or against you. Financial institutions collect compound interest, but they also pay out compound interest.Compound interest works both ways. You choose whether it works for or against you. Click To Tweet
I will address the process to pay down debts and reduce future finance charges in the Objectives to Move Toward section below.
In an earlier post Who is Responsible to Provide Basic Needs of Americans, I told the story of when I was spending more money each month over a three year period and how I turned that pattern around.
The temptation of immediate gratification promises pleasure, but delivers pain. It is the ultimate bait and switch. Let me define what the temptation of immediate gratification means to me. When you are at a store or see something you want to buy online and you feel that urge to buy it immediately, that is the urge for immediate gratification. If you give in to the urge every now and then, it doesn’t seem like a big deal. However, when you still have month left at the end of your money is when you experience the pain. When your money runs out before every payday you are starting to have a problem. Maybe you start to look to credit cards as an enabler to satisfy the urge for immediate gratification. At that point immediate gratification is leading you right to the traps of Easy Credit Offers and Indebtedness.
When you stop and ask yourself why you want that thing right now, the answer often does not stand up to reason. I love what the actor Will Smith said in an interview once, “Too many people spend money they haven’t earned, to buy things they don’t want, to impress people they don’t like.”Too many people spend money they haven’t earned, to buy things they don’t want, to impress people they don’t like. – Will Smith Click To Tweet
A sense of urgency to buy now can be used as a warning sign for you that immediate gratification is raising its head and trying to prey on you. Try to delay a minimum of 48 hours before making a decision to purchase the thing that is calling your name.
To the extent that you are able, plan your purchases in advance based on valid needs rather than urges.
Five Objectives to Move Toward
There is a natural tendency for people to move away from pain and toward pleasure. Sometimes when it comes to financial choices we get confused between what is pain and what is pleasure. It takes a bit of self-discipline to associate pleasure to doing what is right when it comes to managing money. Sometimes good financial decisions seem counter-intuitive to moving toward pleasure. I mean, wouldn’t it feel good to buy what I want when I want? Doing what feels good and moving toward pleasure are not exactly the same thing.
Improve Financial Literacy
There is more information readily available to everyone now more than ever before in history. You can google any financial principle that you can think of and gain a great amount of knowledge about it. YouTube videos are available to explain everything imaginable in a video format. Thousands of blogs are dedicated to the subject. Major financial periodicals post their articles online for free. Nonetheless, a trend toward financial illiteracy continues rather than toward widespread financial literacy.
The tendency to ignore financial knowledge is costing this generation it chance to excel their parents financial accomplishments. Start now searching out and consuming financial knowledge.
We have already discussed compound interest. Gaining an operational understanding of compound interest and applying it to your overall financial plan will help motivate you toward a goal of financial freedom.
Back when I didn’t have any money, I thought that when I had a lot of money, I would read the Wall Street Journal, Entrepreneur and Forbes Magazine. But I didn’t. Financial literacy is something that I still need to work on. To that end, I just started following those three financial publications, @WSJ, @Entrepreneur, @Forbes on twitter. I was already following @DaveRamsey and @andharvest which provide some great financial enlightenment.
Some basic terms that have an impact on all of us and we should all have a working knowledge of include:
- Interest rate
- Operating expenses
- Debt to income ratio
- Credit Report
- How to get out of Debt
Use this list to start exploring resources that will improve your Financial Literacy.
Desire to Grow Wealth Rather than Overspend
Watching my money grow is one of my favorite things in the financial realm. When I was nearly $100,000 in debt, I plotted my course to financial freedom and tracked my progress to being debt free. From that time until now, I have made a game of challenging myself to see how much I could increase my wealth year by year. Earning, keeping and growing my wealth is my favorite hobby!
Foster the desire to grow your wealth. Reward yourself for reaching saving goals.
In a previous post entitled How to Replace Consumerism with Proven Wealth Building Strategies, I embedded an excellent video called Don’t Buy Stuff You Cannot Afford that pertains to the topic excessive out-go.
Leasing a car is a good example of very poor use of money, especially if you have any debt. First, the car you are driving does not belong to you. So you have to take care of it and use it in accordance with the wishes of the owner (dealership). The contract sets limits on the distance you can drive. Any overage on mileage will cost you dearly at the end of the lease. Any life decision you make will impact the leaser. Such as relocating to another state for a job.
The only real upside is the ego stroke of driving a class of car above your income level. I would say that make sense if it gains clients that you could not get any other way and thus earn substantially more than if you drove a car commensurate with your current income. But then, I would take that increased earned income and buy a car of my own and stop driving a long term rental.
Commit to a New Pattern of Saving before Spending
One of the great principles taught by financial expert Suze Orman is to develop an appreciation for money that exceeds you appreciation of immediate gratification and the temporary thrill of self-indulgence helps you feel rewarded by building up wealth.
One of the most highly recommended methods of consistently growing your savings is through some sort of payroll deduction. That could be in the form of a 401K, IRA or other employer sponsored savings contribution plan. If the company has a contribution matching plan, that is free money that you can get from the company if you are willing to squirrel away a portion of your paycheck each payday. That can’t be beat!
If they are not matching funds, then there is an argument for putting your money in a different recurring investment plan. The argument is that you are not taxed on the money you invest in a 401K until you spend it and if you end up in a higher tax bracket at retirement eligibility time than you are when you invest, you then pay a higher tax rate. That argument is superseded by a funds matching company benefit.
Your bank is another place to look for incentives to set up an automatic savings plan where a set amount of money is transferred from checking account to savings each month.A budget is telling your money where to go instead of wondering where it went. – Dave Ramsey Click To Tweet
Prioritize Spending – Control your Out-go
Many people are intimidated by the challenge of creating and being confined by a budget, but once the task is done, the reward is well worth the effort. The freedom that you feel, knowing that you are not getting deeper into debt far outweighs the inconvenience of setting it up and following through. Getting your spending under control leads to personal economic sustainability.
Beyond intimidation, budgeting is one financial principle that people really seem to hate with a passion. They are willing to part with a lot of money on fees and finance charges to avoid creating and living on a budget.
Early on in my life, I developed a passion for avoiding paying finance charges! Interest, fees and fines drove me nuts! I quickly saw the benefit of getting out from under the thumb of financial institutions. I’m still not crazy about keeping a budget, but the budget I use now is solely focused on putting surplus money where I want it to go and does not have any basic needs listed in it. Since I lived within my means when I was younger, I now have plenty of surplus. Thank God, my basic needs are easily covered without worry. Had I failed to get those under control earlier, I would be struggling with them still rather than having plenty of surplus now.
I recommend reading Bob Lotichs’ post on controlling your spending habits at seedtime.com: How To Quit Spending More Money Than You Make.
When you make your budget, you can put some money in a category of fun money and use that for compulsive spending. As long as there is money earmarked for it and you don’t exceed that amount you are sailing in safe waters.
Reduce Amount of Out-go to Finance Charges
As you pay down debts, you decrease finance charges on every subsequent month till the debt is eliminated. Start working on a plan to eliminate your debts by paying extra above the required minimum on the debt with the highest interest rate first. Get a downloadable workbook to plan your path to being a debt free graduate from my post Launching A Practical Get Out Of Debt Plan.
If you have been making minimum payments on revolving credit accounts such as credit cards, compound interest has been eating your lunch. Perhaps you have only been looking at the amount due box on your statements and making a payment as late as possible. You will have much more money in the future if you pay a larger amount and pay it sooner than the due date. You see, the daily balance is used to calculate the interest amount. Every day that you wait to pay the bill incurs more interest expense.
The first step in your plan should be to do whatever it takes to stop yourself from spending more than you earn. Your debt reduction plan should attack the debt account with the highest interest rate first. Pay as much as you can afford toward that bill while keeping current with the rest of your debts. Celebrate when the first debt is eliminated! And then combine the amount that was going to that bill and add it to the amount you are paying toward the bill that is left with the highest rate. Continue that snowball effect until they are all gone.
Improve Income Potential
The most effective and immediate way to increase your income is to add more value to production at whatever job you are currently doing. If you give more value to your employer, one of two outcomes will increase your income; either an increase in position within the company or a better opportunity with another company.
There are two factors that position us financially, income and out-go. To improve your position, you need to reduce your out-go and increase your income. I wrote a full post on a variety of ways to increase your income that you can jump to now: 5 Better Solutions Than A More Competitive Minimum Wage.