Do Not Spend More Than You Earn
For most people, the money they earn goes to the following categories of spending:
- Living expenses. Food and utilities.
- Mortgage or rent.
- College loans repayment.
- Transportation. Vehicle loan payments, gasoline, maintenance.
- Medical. Doctor bills, medications.
- Taxes. Income taxes, sales tax, property taxes, school taxes.
- Clothing. Clothes for work and daily wear.
- Discretionary spending. Vacations, additional clothes, personal items, hobbies, recreation, entertainment, dining out, etc.
When we say you should not spend more than you earn, it does not mean have no debt. It means that you have a budget, know where the money is going, and your debt is decreasing over time.
Required Spending
From the list above, most of the items fall into what I call required spending or non-discretionary spending. Food, housing, utilities, college, transportation, medical expenses, and taxes are expenses we all incur. While they are required expenses, we can definitely reduce these expenses as much as possible. Being a smart grocery shopper, buying a cheap car, and living in a cheaper house are easy approaches to reducing our required expenses.
Our spending on required expenses should not exceed our income. If it does, then we need to take a hard look at every item and find ways to decrease that expense.
Major Expense Items
We will all have debt from major events in our life:
- Buying cars.
- College loans.
- Buying a home.
It is normal for most people to incur debt from these events. The goal of debt from these sources is to be decreasing over time. And the payments on these forms of debt should not exceed your income. You should be able to afford this kind of debt. If not, you should immediately be looking for a cheaper place to live and a cheaper vehicle. Better yet, try to eliminate this type of debt as quickly as possible. For example, pay off your car and do not buy another car as long as possible.
Discretionary Spending
It is the discretionary spending where most people get into trouble. It is easy to put these items on a credit card and then get over your head. If you have a budget and itemize your expenses, your money should first go to required expenses first. If anything is left over, then you can budget for discretionary items like vacations, dining out, electronics, or other items.
Most importantly if you use credit cards to purchase these items, you should pay off the balance every month. No credit card debt should be your mental mindset. You can easily fall into this hole and never be able to get out.
Another Required Expense
Investing a portion of your income should also be a required expense. It is not actually an expense but instead is an asset. An asset that we want to grow over time. Do it in a way that you never see the money. It should come out of your paycheck automatically. As your debt decreases, the amount you invest should increase. Instead of spending your extra money, you should be investing it. In fact, you should be investing as much as possible early in your life to realize the benefits of compounding.
Phases of Your Life
Most people undergo the following phases in their life:
- Early childhood, where everything is provided for you. You make no money, you spend no money of your own.
- Teens, where you may make money, spend money, but you have no debt.
- College, where you may make money but you are spending large sums of money, usually going into debt.
- First jobs, where pay is low and you incur more debt with cars, a home, kids, and travel.
- Mid-career, where income is increasing but for many people so does the spending.
- Late-career, where income has peaked, and debt is either declining or gone.
- Retirement, where income is less and usually fixed and debt should be gone.
Where the Debt Occurs
For most people, debt starts with college and builds during their first jobs and mid-career. It is mainly early in life and late in life where debt typically does not exist. Definitely by retirement, one should have no debt or very little debt.
Not that debt is bad, because you need to borrow money for college, cars, and a home. But the payments for those debt items should not exceed your income minus your other expenses. You need to manage your debt. Your debt payments must be within your budget.
If you can pay your bills and have money left over, then you can slowly build some excess in your checking account. And once you have some excess, you don’t have to worry as much about when to pay your bills.
Budgeting
Many people create a budget so they do not spend more than they make. Some people create a budget using a spreadsheet. Some people use online sites, desktop tools, or spreadsheets.
I think the most important is to know how much you are spending. This can be simply done with a spreadsheet, and I have an example in my blog post in my blog post, Track Your Bills. Your spending will be a combination of necessities, investments, and discretionary spending.
One tool you can use is You Need A Budget (YNAB). This tool has a YouTube Channel, a web site, and a book.
YouTube Channels
Books
You Need A Budget book is the companion book to the web site.