The fact that almost 65% of Americans are living paycheck to paycheck violates one of my first principles of personal finance; spend less than you make.
It’s also a perfect example of the behavior gap. Meaning, having an intellectual understanding of something, but doing the opposite. I was a perfect example of this in my 20s.
I knew I should be budgeting and living below my means, but I didn’t. Credit cards gave me the option to continue spending, even after I had spent all my money, and I gladly took it.
So, how to close the gap?
Perhaps more financial literacy? But I think we need to dig deeper than that if we’re actually going to solve the problem. I think we need to get to the root cause.
It’s important I share what was keeping me from addressing it in my life. Some of it was getting older and growing up, but a lot of it was shame and fear.
I was ashamed because I knew my behavior was wrong. I knew I should have been a better steward of my money, and that I needed to make better choices. It was easier to put my head in the sand and to not address or think about it.
I was afraid of what other people would think of me if I cut back on my lifestyle choices.
These two powerful emotions kept me trapped in the very vicious and real cycle of living paycheck to paycheck. It’s a bad place to be, and if you find yourself there, I want to help you escape.
Here’s what we’ll cover:
- Addressing shame and fear
- Mastering your cash flow
- Creating your budget
Let’s get started.
Addressing shame and fear
When I lead with shame and fear in personal finance talks, it can take a little while for people to grasp the importance of it. If we don’t address the role these emotions play, no budget or investment can overcome their impact on your finances.
I want to share an 8 step framework that can help address them in your life and get past them. While today’s focus is on how to stop living paycheck to paycheck, you can apply it to anything in your life you’re worried about.
- What change do you want to make?
Today, we’re talking about breaking the cycle of living paycheck to paycheck. There are two ways to go about that; making more money, or living on less. We’ll focus on living on living on less money and reducing our overhead and spending.
- What do you think might happen if you made the change?
When answering this, think about everything that could happen if you cut back on your lifestyle. What might happen if you downsized your car or house? What might happen if you stopped going out to happy hour and or dinner?
- What is the worst thing that could happen to you if you made the change?
When thinking about making those changes, what’s the worst that could happen? Would you lose friends? Would people talk about you behind your back and pass judgment on you?
- How likely is that to happen?
Are those things really going to happen?
- What is the worst that has happened to others in this situation? How often did it happen? How did they deal with it?
Have you ever known anyone who made the changes we’re talking about? What happened to them?
- What is likely to happen based on your experience and the experience of others? How would you respond?
Based on the worst thing that could happen and what you’ve seen happen to others, what’s likely going to happen? How will you respond?
- If the worst did happen, then what would you do?
If the worst-case scenario did offur, what would you do? Keeping in mind you’re considering making the decision to take a step back so you can take many more steps forward in the future.
- Based on this discussion, what do you need to do to put this worry behind you?
Taking everything into consideration, what needs to happen to overcome your shame and fear?
I find this framework helpful in thinking through anything I’m worried about. I also find I spend too much time worrying about what other people are going to think about me, when in reality, other people have their own problems to worry about.
You and I have enough time to do almost anything we want. But we don’t have time to waste. We’re talking about your life and it’s both too short and too long to continue living paycheck to paycheck.
Mastering your cash flow
Cash flow is one of the most fundamental parts of your financial life. It’s easy to manage, and easy to ignore. I was in the habit of ignoring mine for most of my 20s, and therefore a lot fell through the cracks.
A positive habit is monitoring your cash flow on a quarterly basis. If you’ve not been in the habit of doing that, I would recommend a cash flow audit.
Cash flow audit
I recommend you go through the last 12 month’s worth of your spending.
To make the most of this exercise, it’s important to get as detailed as possible, which means really digging into expenses line by line.
Looking at credit card and bank statements as well as going back through online accounts, such as Amazon, can help us recognize charges that we’ve forgotten about and find ways to reduce monthly expenses.
Look at everything you’ve spent money on and determine if there are any expenditures you can reduce or eliminate all together.
Once you identify unnecessary expenses, cancel those subscriptions or create ways to curtail those buying behaviors.
If you’re unsure whether you need something or not, try cutting it from your spending for a week or month. If you don’t miss it, it’s probably a good sign you don’t need it.
When you’re getting started, go through your spending on a monthly basis. When you’re on top of your cash flow, you can move to quarterly checkups.
Creating your budget
Along with cash flow, your budget is an essential component to a healthy financial life. You’re not going to be surprised by this, but I didn’t start budgeting until I met my wife. It was her positive influence that helped us to get our budget together.
In the spirit of helping you get started, here are 10 key categories to help you set up your budget.
10 General Categories
Putting together your personal budget will be specific to you and your situation.
- Housing (25 to 35%) Every expense related to your living arrangements will fall into this category
- Utilities (5 to 10%) Electricity, water and other services such as internet and phone will fall into this category. You could also combine utilities with housing
- Transportation (10 to 15%) Every expense related to getting you from point A to point B will fall into this category, including registration fees
- Food (10 to 15%) All money spent on food, either at home or eating out will fall into this category
- Insurance (10 to 25%) All of your insurance premiums will fall into this category. Some people will choose to include car insurance under transportation, and homeowner’s insurance under housing
- Healthcare (5 to 10%) Every expense related to your healthcare will fall into this category. Should you choose to include insurances in their specific categories, health insurance premiums will fall into this category
- Debt repayment/Saving and investing (10 to 20%) All money dedicated to the repayment of debt, proactive saving and investing will fall into this category
- Lifestyle (5 to 10%) Every expense related to personal care, such as clothing and shoes, and gym memberships will fall into this category
- Fun (5 to 10%) Every expense related to hobbies, concerts and events, streaming services and gaming will fall into this category
- Pot-pourri (5 to 10%) A “catch-all” category, all additional expenses will fall into this category
As you embark on your budgeting journey, you’ll discover many items that don’t fit neatly in a specific category. Shampoo, dishwasher detergent and personal training sessions are some that come to mind. As this is your budget, you’ll need to make the last call on where these items belong.
Conclusion and resources
If you’re ready to take control of your financial life, check out our DIY Financial Plan course.
Connect with one of our Certified Partners to get any question answered.
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Check out the LifeBlood podcast.
If you’d like help getting on the same page with your partner, check out our Same $ Page Course.
If you’d like to help your kids get good with money, check out our Teaching Kids about Money course.
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