Living Within Your Means
Living within your means is the number one principle of personal budgeting. If you want to reach your financial goals and see your dreams come to fruition, you must not spend more than your income.
Of course, if your income is less than the cost of a roof over your head, basic food requirements, and other necessities, living within your means may be impossible. But, if you are not in that unfortunate position, you can take a grip on your finances and start living on a budget.
Depending on your income level, living on a budget doesn’t mean you have to do without luxuries. It’s just a question of making a financial plan – including your chosen treats and holidays - and sticking to the plan.
Living With Your Means Definition
For illustration, say your monthly income (take-home pay) is $4,000, taking into account both your wages and any other income source. That’s $48,000 a year. Over the course of the year, you need to spend no more than this $48,000. Your bills may come to more than your income in a month (see the section on big-ticket items below) but they should not exceed your annual income.
Broadly, there are three categories of spending, and each of these contains smaller sub-categories:
- Necessities
- Treats
- Improving your wealth (savings and paying off debt)
In your budget, you'll plan how to allocate your monthly $4,000 between those three categories, and the various sub-categories within each.
Stop Using Credit Cards and Consumer Loans
If you want to maintain a good personal credit score, you may need to maintain some consumer credit, so you can demonstrate that you have a good record of making repayments on time. You’ll need to take advice on this aspect, depending on the country where you live.
Ignoring credit scores, living within your means requires that you should not borrow money (credit cards, personal loans etc) for day-to-day spending.
The point is that, if you buy on credit, you are giving yourself a mechanism to live beyond your means. You are simply ignoring the principle of limiting your spend to your income.
Save for Big-Ticket Items
But if you’re living within your means, and have decided not to buy on credit, how do you pay for big-ticket items such as a holiday, a car, or a house?
For items like holidays, you’ll need to allocate some of your monthly $4,000 to ‘savings pots’, also known as ‘sinking funds’. For example, you could open an interest-bearing deposit account at your bank. If you set a holiday budget of say $3,000, that’s $250 per month ($3,000 divided by 12 months). Each month, you transfer $250 to your sinking fund.
When it comes to buying a house, you will need a mortgage unless you’ve built up very substantial savings or have other valuable possessions to sell. But, even if you take a mortgage, you can still take sensible decisions from a personal budgeting viewpoint. After all, depending on where you live, your monthly mortgage payments may be less than you’d pay in rent.
- Buying a house you can afford and not over-extending yourself.
- Setting and living on a budget for the house move and furnishings
- Paying into a sinking fund to save for future house repair bills
What about a car? Should you take out a car loan? Though we all need to take these decisions for ourselves, the principle of living within your means would say no to a car loan. Just like holidays, you can set up a sinking fund for your car purchase, transferring a budgeted amount each month until you have the means to buy the car you want. And, until then, maybe make do with a cheaper vehicle.
Building Your Emergency Fund
If you are just starting out on your personal budgeting journey, you may not have sinking funds or other savings to fall back on. Until then, what if you have a large bill to pay, one that will inevitably cause you to spend more than your monthly income?
First, it’s probably wise not to cut up your credit cards until have built up your savings. As soon as you can, though, it’s a good idea to open an instant-access account for your emergency saving fund. This is money you can take out when unexpected bills crop up.
How much do you need? Most people say $500-1,000 is enough. This is the money you will use instead of reaching for your credit card.
How to Start Living Within Your Means
Obviously, the higher your income the simpler it should be to start living on a budget. Though this isn’t always the case. Sometimes a high income earner takes on more consumer debt and a more expensive lifestyle.
It can take a while to unwind and reset. The key is to:
- Get started. Take some action today, without delay, to build your momentum and your confidence
- Set some goals as to what you want to achieve - and why
- Make a firm commitment in your mind that you will live within your means
Living within your means requires action. But your mindset is equally important. Believing that’s it’s possible and that it’s the way you want to live your life.