Saturday, June 20, 2015
Two Problem Children
Amber Light: If you are living on 90% or less of your take home pay
Red Light: If you are spending more than 90% of your take home pay If this simple exercise produces an amber or a red light, you need to consider stronger medicine. Richard Jenkins proposes the 60% solution as a sound method of budgeting that is actually easy to practice. The goal is to live on 60% of your gross income. This money covers the basics food, clothing, essential household expenses, insurance, charity, all bills (including nonessentials like music lessons for the kids or cable TV), and taxes. The remaining 40% is divided up in priority order as follows: 1) 10% Retirement. In the author’s case, this all went into his 401K. 2) 10% Long term savings. This amount should be automatically deducted from your pay. You should never see it. It should be relatively illiquid. If it takes a little work and a couple of days to get at this money you are less likely to use it. 3) 10% Short term savings for irregular but somewhat predictable expenses such as Christmas, vacations, car repair, and new appliances. This money should be held is something like a money market fund that makes it easy to spend when it is needed. 4) 10% Fun money. This money can be wasted on whatever suits your fancy. Maybe you might want to think about a pink checkbook for the wife and a blue checkbook for the husband for this one. The author admits that this method will not work in every case because sometimes more than 60% of your gross income is already spent at the beginning of the month. Unless you are rich enough that your accountants perform this service for you on a quarterly basis, calculate your liquid net worth on the first day of every month. There is nothing that can tell you so much about the direction and magnitude of your financial vector with so little effort. Just add up all your liquid assets, bank accounts, brokerage accounts, retirement accounts and such. Don’t include the value of any physical possessions, such as cars, furniture, appliances, or your house in this calculation. Even though your stuff is worth something, everything but the house is a depreciating asset that you are currently using. If you sell something then you can add that money to your liquid assets. Then subtract the balance on all your loans and credit card balances except for the mortgage. The resulting number is your liquid net worth. If it is getting more positive on a regular basis, you are probably doing OK. If this number is headed in a negative direction, especially if you don’t know why, chances are you need to live on a formal monthly zero sum budget. Once you know where all your account user names and passwords are located this process should not take longer than 30 minutes a month. Treat the question your mortgage (remaining interest and principal) and the equity in your home as a separate calculation. Then there is always the envelope system (physical envelopes containing cash or digital envelopes containing digital money). This system has proven itself for about 100 years. An actual factual envelope containing cash is particularly good for problem areas like restaurants or cigarettes. No money in the envelope? No smokes. Your excuses don’t matter. They are not going to make your world a better place. If you believe you have to have credit card balances, you won’t solve your problems. If you believe you have to have a new car even if you can’t pay cash, you won’t solve your problems. If you believe you have to borrow $100,000 in order to have a life, say goodbye to the first ten years of your adult life, even if you are lucky enough to find a good job. Don’t tell yourself you don’t earn enough to budget. If you can’t learn how to budget $20,000 a year, you won’t do any better on $40,000 a year. There are people living paycheck to paycheck who earn $100,000 a year or more. Don’t tell yourself you can’t budget because you live on an irregular income. The budget forms for irregular income exist. Learn how to use them. “They” want debt slaves and tax donkeys. They want victims. Instead of taking the easy path that leads to destruction, wake up and become free.