The first step to financial independence is to live within your means. It’s simple. You have to spend less than you make so you can save and invest the difference. I followed this directive as soon as I became an engineer and started making a good income. Before that, I was a student with minimal income and high expenses. I couldn’t save anything no matter how frugal I was. Once I became an engineer, I continue to live modestly and started investing right away. That’s really the prerequisite. You need to make some money first. Luckily, most adults are already there. The unemployment rate is at a historic low. If you want a job, you probably can find it.
Making money is a requirement, but it’s even more important to save. After all, it’s what you keep, not what you earned that count. Many Americans make good money, but can’t save much. They spend it all on things that don’t matter. I did pretty well when I was young, but I probably could have done even better if I had some advice. So I’m writing this one for my son. Once he’s 21 and started making money, he can refer to this post and start investing right away. Time is on your side when you’re young. You have to take advantage of it. Here are my 8 tips to live within your means.
1. Track your income and expenses
When I was in my 20s, I never tracked my income and expenses. I lived modestly so my net worth kept increasing. That was good enough for me back then. Mrs. RB40 was also frugal, so we made a good team. However, I think we would have been better off if we tracked our income and expenses when we were young. It’s not that difficult and you can learn a lot from doing this. Here are some of the benefits of tracking your cash flow.
- You’ll know exactly how much money you’re bringing home every month. This is the baseline for your income. It should grow every year when you’re young. If your income stops growing, there is a problem. You probably need to change job or learn new skills to get back on track. You won’t know there is a problem until much later if you don’t keep track of your income.
- You’ll know what you spend money on. Most people spend a lot of money on stuff they don’t need. If you track your expenses, then you can reduce those unnecessary expenses.
- You’ll can see how much you save every month. You should save at least 15% of your income. If you don’t track your finance, you won’t know how much you’re saving. To reach financial independence sooner, you really need to shoot for a higher saving rate. 50% saving rate is a good target.
- You can see your net worth grow. Seeing your net worth grow is addicting and it will motivate you.
- You will develop good financial habits.
We never spent more than we made, but after we started tracking our expenses, we became even more careful. I stop buying things that don’t add happiness to our lives. Those expenses are easy to miss if you don’t pay attention to them. You can track your expense with a simple spreadsheet or a free website like Personal Capital. There are other apps to help you as well. It can be difficult when you first start, but after a few months, it’ll become second nature.
2. Spend less than you make every month
This is common sense, but it can be difficult to do. If you don’t track your finance, it’s easy to overspend. Buying lunch and eating out a few times per week can add up to hundreds of dollars per month. Everyone charges everything to their credit cards now. It all adds up. That’s why so many people have credit card debt.
One way to make sure you spend less than you make every month is to make a budget and follow it strictly. However, that’s really difficult. Most people can’t follow their budget for long. It’s too much work. Here is what we do. I have an overall monthly budget. So every month, I should spend less than $5,000. At the end of the month, I tally up my spending and see how much we spent. If it’s under $5,000, then we’re good. If we spent more than $5,000, then we’ll be a lot more careful the next month. This works very well for us. Of course, we go over budget sometimes. But that’s mostly due to large emergency expenses. Last month, I sent $2,600 to my dad. That messed up our budget, but it’s not a huge deal. We have an emergency fund to absorb those big hits. At the end of the year, everything should averages out.
3. Avoid consumer debt
If you’re like most American households, then you have some kind of consumer debt. The average household carries $5,700 in credit card debt. Many households have auto and student loan debt too. That’s not good. When you pay those high interest rates, you’re just enriching the banks and derailing your retirement. It’s best to avoid any consumer debt altogether, but life happens and sometimes you can’t avoid it. In that case, pay off your consumer debts as soon as you can and avoid them in the future.
4. Save a sizable portion of your income
The US personal saving rate isn’t bad historically. We’re saving 8% of our income, which is way higher than when I originally wrote this post in 2014. However, 8% is not enough. Every household should save at least 15% of their income. This saving will help you endure various emergencies and build up your retirement accounts. Personally, I think 15% saving rate is still too low. If you’re making a good income (more than $100,000/year), then you should be able to save much more than that. I’d shoot for at least 25%. For people who want to become financially independent and retire early, aim for 50%. Saving and investing more will give you options when you’re older.
5. Boost your income
As mentioned above, I gravitate toward frugality when I try to save more money, but that’s not necessarily the right way. There is only so much you can cut out of your life before you start feeling deprived. Increasing your income is the smarter way to save more.
The main source of income for most people is their fulltime job and it’s best to concentrate on that. Aim for a good raise every year and keep your eyes open for better job opportunities. If your income stagnates, it’s time to move on to a new job. Your employer has no loyalty to you so you have to look out for number one.
An alternative is side hustling. If your career doesn’t pay that well, then side hustling can make a big difference in your income. The right side hustle can even lead to a more lucrative career and/or a more satisfying lifestyle.
6. Minimize lifestyle inflation
Lifestyle inflation is the biggest enemy of living within your means. It’s good to boost your income, but the problem is that most people also spend more every year. Lifestyle inflation is unavoidable, but we really need to minimize it as much as possible. Do you really need that 2,500 sq ft home with 4 bedrooms and 4 bathrooms? How big was your house when you were growing up? 5 of us lived in a 2 bedroom apartment when I was young and it was just fine. My mom had 9 siblings and they lived in a 2 bedrooms townhouse when they were growing up. Okay, that’s too crazy, but you know what I mean. The key is to make sure your income outpaces your lifestyle inflation. Don’t live it up if you can’t pay the bills.
7. Ignore the Joneses
Ignoring the Joneses is very difficult for most people. For me, it’s easy because I don’t really care what other people think. Fortunately, I learned this lesson early in my teens. In junior high, I really wanted a pair of Nike Air. All the cool kids had a pair and I was envious. So I saved up $80 over the summer and finally got a pair before school started. It turned out nobody even cared what shoes I wore. The shoes didn’t help me jump any higher and I was still terrible in PE. The shoes didn’t matter. From that day on, I don’t pay attention to cars, shoes, jewelry, or any other outward signs of wealth. Why spend money trying to impress other people? They really don’t care what car you drive. Unless your job involves impressing the clients, you don’t really need a luxury car.
8. Learn to enjoy free/cheap stuff
Sure, it’s fun to spend money. I love eating out, traveling, and other entertainments as much as anyone. However, I found the secret to spending less money – you don’t need to spend a lot of money to have fun. You can learn to enjoy free/cheap entertainment. These days we spend most of our time enjoying hikes, reading, playing at the playgrounds, cooking, listening to free concerts, and ferreting out free or discount days at the museums around town. There are a ton of free things to do out there. They are just as fun as more expensive entertainment. You don’t have to spend a lot of money to have fun. Spending money once in a while is okay, but don’t look down on free entertainment. They’re great too.
These tips should be helpful for young people who are just starting out and even older folks who need a reminder to live within your means. Ok, I’m going to cut this short. The sound of the symphony has been wafting through the windows all day and we’ll head to the park to see the free show. The 1812 Overture is coming up soon and there will be fireworks afterward. Ahh… Life is good.
Do you have any good tips to help people live within their means?
*Sign up for a free account at Personal Capital to help track your cash flow and manage your investment accounts. I log in almost every day to check on our accounts. It’s a great site for DIY investors. Check it out!
Image credit Bruce Mars