Jack and Lee-Ann* are careful with their money. They pay all their bills on time, make more than the minimum credit card payments every month, and they have a few dollars left over, which they keep in a savings account. Are they living within their means?
I would argue they’re not.
To be financially secure, you do need to spend less than you earn. That’s a necessary condition, but it’s not a sufficient condition. You also need to ensure that your outflow covers key areas. If these aren’t nailed down, financial stability is an illusion.
Four areas to consider:
#1 – Corrosive debt
It doesn’t matter if you’re making the minimum payment or a larger payment on your credit cards; if you carry a credit card balance at all, you are not living within your means. Why? Because credit cards should solely be tools of convenience, not cash flow tools. When you treat them like a bank account – that is, a place where you can access money for purchases – you are relying on them to fund your life. You’re using them to bridge a cash flow gap. Ask yourself this: If I only had cash at my disposal with no recourse to credit, could I have purchased every item that is currently on my credit card statement?
It’s an illusion to think you’re living within your means simply because you cover off necessary debt payments every month. If we’re talking about paying a mortgage for an appreciating asset, that’s different (we’ll talk more about mortgages in a moment). What I’m referring to in this section is debt payments for Lines of Credit, credit cards, and any other loans for consumer items (e.g. the furniture set you bought on credit, the large-screen TV you purchased on a payment plan, and so on).
I’ve written about the difference between corrosive debt and good debt in past posts, but it boils down to this: debt for an item that takes money out of your jeans (liability) without putting it back in (asset) is corrosive debt, particularly if it comes with interest costs in the range of 18% to 24%. Any way you slice it, credit card debt is evil. Think Voldemort here.
#2 – Planned Expenditures
If, like me, you’re a homeowner and you live in a location where February comes with nasty weather, then you know this is precisely when your furnace will fail. Or your stove will give up the ghost the night before you’re due to host the entire family. You get the idea. These are the sorts of things that catch us off-guard and cost many more dollars than we’re happy to part with. These are often referred to as surprises or unplanned expenditures, but are they really?
Gail Vaz-Oxlade, formerly a personal finance writer in Canada, is fairly blunt in her assessment of people who are surprised by any system that fails in their home. Her point is that when you own something like a house or a car – things that break down – you should expect them to fail and you should plan for their repair or replacement. The way to do that is to set up a savings account for planned expenditures and put money into it every month. When something goes wrong in your house, or if your dog chews a kid’s toy and needs a trip to the vet, you have money ready to go.
Let’s say that you have no credit card debt, all of your expenses are covered and you have a few dollars left over but you don’t have a planned expenditures account. Are you now living within your means? Not if a sudden repair causes you to go into credit card or line of credit debt.
Note that I’m not talking about suddenly discovering that your spouse has a serious disease and you now face significant costs. That’s genuinely an emergency, and a shock. Hopefully you’ve got critical care insurance, and life insurance, to deal with some of life’s most unpleasant surprises. But the other stuff – the stove, the furnace, the car? Predictable. It’s just a matter of when.
#3 – Saving and Growing
The more I research issues related to women and money, the more it becomes clear to me that we are not saving enough. Hence the Wealth Gap. The reason I’m being so picky about the issue of living within your means is because I want people to think about the results that they want. If the goal is not to incur debt for consumer items, then that’s one level of living within your means. But if you’re really after financial security, as most women are, then it involves much more than ensuring you don’t amass credit card debt and setting money aside for planned expenditures. It means setting aside funds and growing them to develop greater wealth, for the ultimate purpose of creating more, and better, options for yourself and your family.
Wealth means you have choices.
Wealth means you have options when life happens.
Wealth does not happen by accident or by winning the lottery. It happens by systematically – or better yet, automatically – saving money and investing it in vehicles that will make it grow. This means setting aside enough money on a monthly basis for the express purpose of growing your wealth. Even if you have credit card debt, I recommend setting up automated savings – just a small amount to start until your debt is paid off. Mathematically, the wiser choice is to pay off corrosive debt, but saving money is a habit that requires practice. Think of it as a muscle and start working it right away so that it can grow big and strong while you tackle the other areas of your life.
#4 – Mortgage Madness
“How much of a mortgage can I afford?” That’s pretty much the way the conversation goes with most brokers when clients reach out to them before shopping for a house. In nearly ten years of evaluating Rent to Own files, I can tell you this leads to a lot of minimum down payments and house-poor families. Yes, they bought a home that the bank says they can afford, but now they have little cash left over for anything else. Forget about saving!
In his entertaining book The Wealthy Barber Returns, David Chilton suggests that a wiser approach would be to live in a house that is well beneath your means. He, for example, is living in a small, modest house that he has owned for years despite being a wealthy author and investor.
If your housing choices don’t leave you with enough money left over to pay off your credit cards in full every month, set money aside for planned expenditures and invest money on a regular basis, then this is an area that you might want to reconsider.
How to do it
So how do you pull this all off, you might ask? Alan MacDonald and Paul LaBarge, co-authors of The Copperjar System, suggest the following approach: First, make a list of all your expenditures. Then:
“Look at all the expenditures you’ve listed, and rank them on a scale of 1 to 10 – “1” being absolutely necessary for your survival, and “10” being a complete luxury. When you’ve got them all tagged, look at all the “10” items, and no matter how much you may be attached to them, cut them mercilessly out of your budget and your life. (We warned you this part might hurt.) If that doesn’t balance the books, move on down the list to the “9” items, then the “8”s, and so on.
Keep doing this until you reach the point where your budget breaks even. Then go a bit further, and you’ll find you’re now at the stage where you can finally put aside some savings.”
If it sounds impossible, read Tahani’s story. She’s a single mom who had little money and virtually no income when she left her marriage. She was merciless about controlling expenditures in order to support her kids and pay off her first mortgage. Today, she’s a hugely successful real estate developer.
Whether or not you want to end up owning real estate is immaterial. The point is that controlling expenses and growing your wealth is doable by anyone. Is it painful? Sometimes, but it’s definitely worth it.
And it all starts by truly living within your means.