How close to the edge of your finances are you living?

Last week, while visiting my mother, there was a segment on TV about the impact on federal workers of the recent government shutdown. A lady being interviewed said that with the first missed paycheck, she had had to miss her car payment. If she missed her second paycheck, she would be missing her house payment. Hearing this story, and realizing that this person is not alone in this situation, I wondered how close we are to running out of money, if our current sources dried up.

Robert Kiyosaki defines how rich a person is, by the length of time their financial resources will last if their income stopped coming in. If you stopped getting a paycheck tomorrow, how many weeks, months, or years rich would you be?

While the solution to this problem is neither new nor difficult, most Americans don’t practice it. If you happen to be one of those not living by a financial model such as this, I invite you to give it a try.

Live on less than you make

A few decades ago, as I got my first career position out of college, I thought I was making more money than I would be able to spend. It was $35,000 annually. (We were raised on much less than this as a family of 6). Little did I know how easily it is to spend what you make. The good news is that I started getting raises, and increasing my income through other job opportunities. Within a few years I was making more than $50,000 a year. What happened to us, is what happens to most people, and best summarized by George Clason in the book, “The Richest Man in Babylon” sums it up best:

“That what each of us calls our ‘necessary expenses’ will always grow to equal our incomes unless we protest to the contrary.”

In that book, the character Bansir, a chariot builder seeks advice from Arkad, a wealthy resident of Babylon. Arkad teaches those that want to know how to duplicate his success, what they need to do become wealthy. The first rule is to live on less than you make. In the language of Arkad, “For each ten coins I put in (my purse, I) spend but nine.”

Using this ratio, we should be saving 10% of all we make. If we had that practice, and we earned an annual income of $50,000, and applied this principle we would be setting aside $5,000 a year. If we just did this, at zero percent interest, we could lengthen our financial runway to over a month in a years time. (Based on data from 2015 of the average mortgage payment of $1,030, and that amount to be 30% of total monthly expenses).

Jim Rohn gave a formula beyond just saving 10% of your income. It was this:

  • Give 10% to charity
  • Save (he called it passively invest) 10%
  • Actively invest 10%
  • Live on the remaining 70%

In this budgeting model we would be saving 10% as already noted, but we would also be employing another 10% towards active investments. Even if our active investments only broke even, it would still double our financial runway as compared to only saving 10%.

In the land of wildest dreams, (or extreme wealth) we could say, why not live on 10% and put 90% to savings, investing and charity? There has to be some reality to the ratios, and that reality will be different for every person, but the principle is the same.

It’s like getting optimum gas mileage from your car. If you start your car and let it idle for hours in your drive way, you are getting zero miles to the gallon. On the opposite end of the spectrum, if you drive your car, pedal-to-the-metal, you are not going to get your best possible gas mileage either.

If you can’t afford to live a 70/10/10/10 spending plan model, how much can you begin to put towards those categories? Maybe you can start at 91/3/3/3 model or a 97/1/1/1.

For most of us, if we don’t recognize the truth of the George Clason quote above, no matter how much we make, we will find ways to spend it, and consider those to be necessities.

If you are not already, I invite you to begin consistently directing a portion of all you earn to savings and to active investing. For more about the differences between active and passive investing, see this previous article.

Take this 10-question survey to see how you’re doing overall with your financial habits.