In the circle of personal finance, a lot has been said about the idea of “living within your means” if you want to get ahead economically. Yet, few of us do it. Instead, we overspend and often get into financial trouble as a result of the habit.
What’s preventing us from actually spending less than we make?
One reason could be that most of us are either unwilling or unable to conform to the necessary financial discipline to bring about positive results.
Another likely possibility is that too many of us may not understand what the phrase means, and the confusion is creating delay, procrastination, and indecision.
Assuming the latter is true, I would like to clear up the confusion. The hope is that, if you are struggling with the issue, the illustrations in this piece will serve as guideposts for financial progress in the months ahead.
How Lack of Spending Control Can Lead to Financial Failure
Assuming you and your spouse bring home a combined net income of $5,000 a month, this would amount to $60,000 for the year (see figure 1). The actual amount you bring home may vary, but the concept will be the same.
Whether you create a spending plan or not, visually or mentally, you would allocate portions of the income ahead of time for various financial responsibilities in the home.
The best way to do this, of course, is to create a spending plan—like the one below—so you can track the movement of your money. By putting the information on a spreadsheet, you can eyeball the size of your income and see how your cash flows to various allocations within the family’s interests or concerns.
Again, notice that your income is $5,000 for the month, which is a measured sum of money. This means that regardless of how you choose to spend it, you’ll get no more funds until next month.
In the expense section of your plan, notice that you intend to save 10 percent ($500) of your monthly earnings (see the estimated column). Looking at the rest of the figures in the same column, things appear to be within the range of your income.
However, when we look at the “actual” columns of your budget, we see that things have changed. Lack of good planning or impulsive decisions caused you to deviate from your original estimates.
You increased groceries and dining out expenses; you purchased some furniture on credit; you also made some additional credit card purchases; and you continued spending on miscellaneous items.
Because of these additional financial activities, you were unable to save any money for the entire year. So, not only did you spend close to 5 percent ($2,699) more than you earned, you also left yourself wide open for financial problems because you have no savings.
This scenario depicts a clear example of how easy it is to “live above your means.”
Notice that all the money you earned for the year went right back into the economy. Seemingly, everybody you do business with got to keep some of it, except you.
How unfortunate is that?
Though spending 5 percent above your earnings is financially unhealthy, I’ve seen worse. Most of us habitually spend 20-30 percent more than we make, and we juggle funds to pay the debt until things collapse completely.
In this situation, you’re surviving but not making financial headway. If this pattern continues, you will surely run into financial ruin in the years ahead.
How to Create A Budget that Leads to Financial Success
In figure 2 below, much of the same conditions exist, as in Figure 1: Income, debt, and some fixed expenses are the same.
However, this model is based on the principle that you cannot have everything you want all the time. To gain something important, you must give up something in return, which is true with all things in life.
In this model, since you created additional expenses with debt, you adjusted some things such as groceries, dining out, miscellanies, and a few other things to keep the budget balanced. What’s even more exciting is that you remained committed to your savings.
So, by the end of the year, you accumulated a whopping $6,000 in savings, which is a huge accomplishment. Notice also that you spent $58,800, which is $1,201 less than you earned.
Granted, these numbers are static, meaning that they don’t change in the scenarios. But they would fluctuate slightly in a real situation, depending on what’s going on in the family.
Nevertheless, the pattern would remain the same for someone who is reasonably determined to make something work. All it takes is the will to resist impulse spending and stick to the originally committed funds that are allocated to each category.
This is what it means to “live within your means.”
The illustration in figure 2 shows how you take control of your finances before things get out of hand. In this case, you’re managing the situation instead of allowing conditions or impulses to dictate your financial outcome.
With good planning, you exercised a reasonable degree of self-control to prevent runaway spending.
While doing so, you didn’t starve your family, neither were you terribly uncomfortable with the small changes that were necessary to make things work. More importantly, you made financial headway because of the money you saved.
If you repeat the same or a similar pattern in subsequent years, you will be profitable. Before long, you’ll be seeking professional guidance about investments, so you can continue expanding your wealth.
If you’d like to have a copy of this 12-month Cash flow Plan, you may download it here. This spreadsheet is very flexible. You may change or expand the categories for your convenience. But you should keep things simple as you work with the model.
To learn more about financial management, consider reading my new book: Pennies to Power: How to Use Your 20’s to Gain Financial Independence for Life.
Thanks for reading.
What Are Your Thoughts?
Is it necessary to set boundaries on spending? Why do most people avoid working with a budget? Do you think having access to credit discourages spending limits?