Stop Living Paycheck-to-Paycheck in 5 Easy Steps
The official rate of unemployment in the U.S. plunged to a remarkably low 3.7% last year. The Federal Reserve forecasts that the unemployment rate will reach 3.5% by the end of this year.
However the official rate hides some troubling realities: 1 out of 4 college grads is overqualified for their jobs, there are more contract workers than ever with no job security, and an army of part-time workers desperate for full-time jobs.
It’s no wonder almost 80% of Americans say they live paycheck to paycheck.
Living paycheck-to-paycheck means you’re always one bill away from being without something you desperately need, like:
- Gas money
- Mortgage or rent payment
Breaking out of this dangerous cycle requires more than just tightening up your belt for a few months. You need a plan to break the bad money habits you’ve built.
The good news is I have a five step plan to break you free from paycheck-to-paycheck hell once and for all.
Step 1: Take Stock of What’s Coming In and What’s Going Out
To have money left over at the end of the month, you need to know how much you’re taking home and how much is going out, with the goal being to spend less than you make each month.
To stop the cycle, give yourself an audit. Comb through your last six months of bank statements, credit card statements, and receipts and calculate how much you spend each month.
As a general rule of thumb, you should be spending around 50% of your after-tax income on needs: groceries, housing, utilities, insurance, car payments, etc. 30% of your income should go toward wants: gym membership, subscription services, clothing, eating out, etc. And the remaining 20% goes toward savings and paying off debt.
Don’t worry about the 50/30/20 categories right now. First, figure out how much you’re spending in total each month.
Once you have this number, compare it with your take-home pay. The amount you’re spending every month might be equal to what you bring home, or more than what you bring home. If the latter is the case, you need to take a closer look at where your money goes.
Break down your total monthly expenses into three categories: needs, wants, savings and debt. Your wants should be the obvious low hanging fruit to cut but I want you to take a different approach.
Step 2: Reduce Your Big Needs First
The reason why you should tackle your big expenses/needs first is because they’re most likely going to be fixed costs and if you can reduce your fixed costs once, you’ll reap the savings every month.
For example, say your rent is costing you $1,000 per month not including utilities. If you can negotiate a $100 decrease in exchange for shoveling the driveway or taking out the trash each week, you’ll save $1,200 per year on rent.
Another example is your car. The average car payment is over $500 per month. Because a car is a depreciating asset, there is no reason you should be car poor if your goal is break out of living paycheck-to-paycheck. Like housing, you have options to reduce your car payment, you can:
- Refinance your loan
- Sell your car and buy a more reasonable one
- Become a one-car family
- Sell your car and take public transportation
Big car payments are not worth it if you’re barely making ends meet. Do this exercise for your two biggest expenses, housing and transportation, and you’ll start to build slack into your budget without much willpower or doing a lot more work each month.
Step 3: Cut the Fat A.K.A Your Wants
Now that you’ve taken care of your big expenses, it’s time to look at your smaller expenses that add up.
Don’t listen to people who say living paycheck-to-paycheck is normal. It’s not. It’s this type of reasoning that keeps people stuck.
Start by evaluating your list of wants you categorized in step one. Look at that list and decide what you can do without or if there’s a cheaper alternative.
For instance, do you really need that fancy gym membership? Is there a less expensive no-frills gym you could go to instead? How hard is it to make coffee in the morning versus stopping at Starbucks every day? Can you go every other month without Netflix? What would that do to your productivity?
You’ll find a lot of your wants are tied to convenience. You sign up for recurring monthly memberships because you don’t have to worry about forgetting to pay each month. But what if you don’t use that membership that month? You still pay. This is why small expenses add up fast.
Getting rid of non-essential expenses is critical if you want to break the cycle. But you should also make it harder on yourself to pay for some of these wants because it will show you what you really want versus what you only sometimes want.
Step 4: Start Building Savings
Savings is often overlooked when it comes to breaking the paycheck-to-paycheck cycle. After all, how can you think about building savings when you barely have enough to get by?
I’ve talked about reverse budgets before — where you decide each month where your money goes before it actually goes there. The reason I like reverse budgets is because it forces you to prioritize without much effort since the majority of the work is automated.
When your paycheck comes in, 20% should be automatically transferred to savings and paying down debt before that money even hits your checking account. You do this so you only spend what’s left.
To start, set up monthly or bi-weekly recurring savings transfers. Choose an amount you want to save each month and make sure that amounts gets pulled out of your paycheck first before you start spending on other expenses.
Step 5: Get Real with Yourself About Breaking the Cycle
In order to break the paycheck-to-paycheck cycle, you need to recognize it’s a problem. Just because you haven’t had any disasters strike that left you unable to pay necessary expenses, doesn’t mean it won’t happen tomorrow.
If you think this problem only affects people making low incomes, you’re wrong. 25% of Americans earning $100,000 per year live paycheck-to-paycheck and 33% of those making $75,000 are in the same boat.
To break the cycle, you need to learn how to live below your means. Follow these five steps and you’ll start to break the chains of habit keeping you stuck.
To a richer life,
— Nilus Mattive
Editor, The Rich Life Roadmap