Let me ask you… who is better off… The young couple who makes $85,000 a year or the family of four who bring in about $50,000 a year?
Well..with such little information..one would conclude that the couple making $85,000 would be the one’s better off, after all.. they MAKE more money! But perhaps more information might paint a different picture.
What if.. the family of four was living well below their means. Spending $2000 of their $3000 net monthly income on bills and food..giving $300 to their church and saving $700 each and every month and has no debt. And what if the young couple spent $4000 of their $5000 net monthly income on debt payments, bills and food, didn’t save, and spent the other $1000 on buying stuff and eating out and having parties.
Maybe on the surface.. it might STILL appear that the young couple is better off (i.e. they have more stuff, and more FUN) But what happens if BOTH families continue doing what they are CURRENTLY doing for the next 10 years?
Lets assume that both couple still live in the same house, and both households’ income increased by 50%.
In 10 years time.. the young couple will STILL be spending 100% of their net income on Debt Payments, Bills, Food, Eating Out, buying STUFF, and entertaining. They’ll have no savings, and their debt balances and expenses are higher (not lower) than they were 10 years ago. The family of four on the other hand, STILL have no debt, STILL tithe 10% to their church, and STILL invest a good portion of their income. In fact.. their expenses didn’t increase at all.. since they have no debt.. all they are paying for is their monthly necessities, which hasn’t changed much at all in the last 10 years. The only thing that changed for them was the GAP between their INCOME and their EXPENSES. With a wide gap, this allows the family of four to put away more than $1000 a month for a rainy day and for their future. The young couple has no increase in their gap.
Then a layoff hits… The young couple and the family of four lose their jobs. Who is better off now?
The family of four, who was prepared to weather out the storm, is much better off than the young couple, because they can live off their savings and investments for at least 6 months while he looks for another job. The young couple..who have been living paycheck to paycheck despite their high income.. will soon be having collectors calling them at best.. and at worst.. having to face bankruptcy.
So the lesson for you is… Do you know what your GAP is? What is the difference between your INCOME and your EXPENSES? Do you need to take steps to WIDEN the GAP?
Agreed. financial success = income – expenses. Now there’s 2 ways to improve your financial success either increase your income or decrease your spending. Most people thing that they need to focus on the former it’s all about how much you earn however Couple 2 have done the latter focused on cutting expenses. The most important thing in an ecconomic down turn is having a low burn rate (ie low expenses).
Thanks for posting,
If someone wants to take steps to “widen the gap”, they can increase income (which is hard) or decrease expenses (which may require swallowing some pride). Either way.. make good USE of the gap, and further your financial goals, by paying down debt or saving.
I have a GAP of about $200 a month. It’s not a lot.. but I’m going to take steps to increase my income AND decrease my expenses. Should I pay down my debt… or save?
Jason,
It all depends on what kind of debt you have and whether or not you have a liquid emergency fund.
If you have a lot of consumer debt (credit cards, auto loans) but you have no savings at all… then I’d suggest you start by building up a $1000 savings account to be used for emergencies only. Then I’d start working on the debt.
If you intend to save.. focus on saving…
If you intend to pay down debt… focus solely on that…
Good luck widening that gap Jason!
My GAP’s been hard to figure since I started freelancing. In the last 10 months, I was paid 15 times of widely varying amounts. Of course, the bills still appear like clockwork each month.
Hi Andrew,
When your income is variable then an emergency fund would then be your best safeguard. Having $1000 stashed away in a saving account can really protect you in case you have a month when the income didn’t meet the expenses for the month.
Otherwise, if on a monthly basis your income is ALWAYS higher than your expenses.. then you’re in great shape and you have a variable gap. USE that gap to pay down debt.. or save… and have a little fun while doing it to!
At the moment I’m not sure what my GAP is, I know that we normally have about $1000 left for ourselves but we are also putting just over $500 per month in savings. I think it is harder to increase your income (ie. overtime, etc..) cutting your expenses can be easy. I’m sure some of us could live with out certain items (ie. internet, cell phones, digital cable…)
CDW,
Thanks for the comment! Keep building that savings until you reach your target number.
I agree that we pay for things that we probably don’t need.. like digital cable and satellite radio.
I for one can’t live without my internet.. can’t WORK without it either!
Reducing expenses is easier. My last raise was about 1.5% and that doesn’t cover the increase in benefits. I’d leave my job but I’ve been there for 9 years and I’m not getting any better offers.
Hang in there Indra,
There are lots of ways you can reduce expenses. Small tweaks here and there.. like putting your TV on a power strip and turning it off at night. We do that for our TV’s and Computers.. and it saves us about $20/month off the electric bill.
Other changes include reviewing your auto insurance.. getting new quotes might save you money.
Enough small tweaks might even make up the difference in your benefits. You might even be able to give yourself a RAISE!