The Mother of all Financial Musts

7/6/2014 8:15:35 PM

We’ve all heard the age-old saying that money will never truly make you happy. However, mismanaging your money and making poor financial decisions can be a life wrecker!
Believe it or not, money problems are among the top reasons for divorce, alcoholism, and suicide in the United States. Therefore, it is crucial to become a wise manager of your financial resources. Financial literacy should be one of your greatest learning priorities, and it should be a core requirement for our nation’s educational institutions.
Fortunately, having a positive (and growing) net worth is not rocket science. If you follow this one tip, you will be on the path to responsibly managing your finances and avoiding major financial pitfalls. Are you ready for it?
Live within your means by spending less than you earn—no matter what your income level. It’s that simple!
In order to generate positive cash flow, you must spend less than you make. This means conservatively estimating your income and ensuring you have funds leftover after all of your spending. Major trouble can set in when you overestimate your income (common in careers with cyclical earnings), underestimate your spending, or charge more stuff on credit cards that you can’t afford to pay off each month.
When determining how much you earn (and therefore the limit of what you can spend), here is where some people run into trouble. You will want to avoid these mistakes at all costs to enable you to live within your means:
  1. They forget that their take-home pay is roughly 60 percent of their gross salary (after taking into account deductions like federal and state income taxes and Social Security)
  2. They assume that a spike in their income is the new “normal” level of earnings and ratchet up their spending accordingly.
  3. They assume their strong investment returns in the recent past will persist.
It’s important to recognize whether your career provides a steady or volatile income. Generally speaking, the more your income is tied to sales (e.g., real estate agents, commission-based retail sales) or project work (e.g., writers, architects, actors) the more it will fluctuate over time. This income pattern presents unique challenges in your financial planning because you can’t forecast the next few years based on the recent past. Therefore it pays to average peak and trough earnings to calculate “normal” earnings more conservatively.
Consequently, people often overestimate their future income when they just had a great year. Then, they increase their spending just when their income falls back to normal. Not good!
Another helpful rule of thumb is to earmark your income first to charitable giving and investments and then to spending. It adds discipline when you force yourself to save 15+ percent of each paycheck. By thinking of your spending as the “leftovers” rather than your savings, you’ll avoid the trap of living paycheck to paycheck.
Plan your income conservatively and spend accordingly—it’s far better to be positively surprised than disappointed!