Many people with six-figure incomes actually end up being poorer than those with $50,000 incomes. The issue is that they end up buying all sorts of things they cannot afford because they feel their incomes entitle them to do so. The first step is usually an over-sized home and expensive cars. Next come expensive vacations and home furnishings. The little stuff, like a regular latte, trips to Target, and even dinners out also enact a toll on financial stability.
Understand that financially “normal” is broke. Every dollar that comes in the door in the paycheck goes out the door in a bill. Often many of those bills are regular payments, which makes it difficult to every gain some traction and pull yourself out when things start to go wrong. Just because others around you are spending like drunken sailors doesn’t mean it is safe to follow their lead.
Let’s say that you have been spending a lot. Where is the border between sustainable spending and that which will result in bankruptcy a few years down the road? Here are some signs that you are living on the financial edge and things could easily go wrong.
1. You home payment is more than 40% of your take home pay. A home payment at this level makes it very difficult to save money to pay for other expenses that will eventually occur, such as car repairs, home maintenance, and medical bills. It also makes it difficult to save for future expenses like college and retirement.
2. You are rolling loans from one car into a new loan for another. If you aren’t at least paying off one car before you buy the next you are always owning cars during the time where they are depreciating by several thousand dollars per year. It is best to buy used cars for cash, but at least own a car long enough to pay it off and drive it for a few years payment free. This is the difference between paying for college and taking out loans.
3. You don’t have enough in savings to pay cash for a major car or home repair (at least $3000 in cash). Things may be going great until they aren’t. If you have a cash cushion saved, you can just pay for various little emergencies and go on with life. If not, you’ll end up taking on expensive debt, either a credit card or a payday loan place. Neither is good.
4. Your free cash flow, defined as money you have left over after all payments, utilities, and food are purchased, is less than $500 per month. If you don’t have money that you can allocate to new things, you’ll never be able to save and build wealth. With inflation, your expenses will eventually overtake you. Look at earning more income or cutting back to free up cash.
5. You often don’t have the cash to cover your bills until your paycheck comes in. If you are waiting for your paycheck to come in before dropping bills in the mail, you are one late paycheck away from some penalties and interest.
6. You are keeping a credit card balance. Credit card balances start out small with good intentions of paying them off quickly, but can easily grow and quickly become unmanageable. If you are putting things on a credit card and don’t have the money to pay them off at the end of the month, you’re spending beyond your means and will eventually get into trouble.
7. You don’t have the money to pay a portion of your taxes. Obviously not being able to pay your taxes is a serious issue that can result in fees and wages being garnished. If you find yourself unable to pay off the IRS, you need to cut back seriously on lifestyle.
8. You are borrowing from your 401k or taking money out outright. If you are taking money out of your 401k or borrowing against it to buy things, you are buying things you cannot afford and stealing from your future. Your 401k is not a piggy bank. You will have hundreds of thousands of dollars less at retirement if you take out a few thousand from your 401k when you are in your twenties or thirties. You are also going to pay huge fines and penalties when you withdraw early. Even if you only take out a loan, you will be hit with fees if you lose your job or change jobs and don’t repay the money quickly.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.