A Series of Unfortunate Events… or Fortunate Ones

This is kind of a “Personal Finance 101” article in response to some things I’ve read on social media in the last few days. If you’ve ever had anyone ask you “why save?”… well, here’s my answer to that.

Our lives are a mix of fortunate and unfortunate events. Sometimes things go well. Really well. And sometimes things go poorly. Really poorly.

This creates an interesting dynamic in people based on how many good things and how many bad things have happened to them, as well as what their personality is wired like.

Some people live for the moment and don’t worry about long term planning. They simply assume everything will turn out. Often, these people have had an abundance of fortunate events in their lives or else they simply have a strong optimistic personality.

Others are on the opposite end, as they scrimp and save and plan for every contingency due to their fear of and experience with unfortunate events.

The rest of us? We’re somewhere in the middle. That’s where I’d put myself – somewhere in the middle, perhaps slightly in the direction of the careful planner. I have a huge emergency fund and lots of insurance, but in 2008 I walked away from a great job to live my dream as a freelance writer. (In truth, I try to have both opportunity and risk prevention in my life… but we’ll get back to that in a bit.)

The intuitive understanding that most of have come to over the years is that there is great value in protecting yourself from risks, but there is also great value in being able to take advantage of opportunities. It’s finding a balance between the two that’s the real trick.

The One Solution That Provides the Best of Both Worlds

The one way to simultaneously have access to lots of opportunities as well as having protection against many of life’s problems is to simply have a lot of money saved and invested. I firmly believe that there’s nothing in this world that can give you opportunities while also keeping you safe like having money in the bank.

Choosing not to save and invest for the future naturally pushes you toward the riskier end of the equation. You’re much more susceptible to having bad things happen in your life that you simply cannot deal with. Of course, without money in the bank, you’re also going to find yourself unable to take advantage of a lot of opportunities, too.

For example, a person who decides not to save at all for the future might have more money in their pocket to spend right now on things they enjoy, but they’re also in a situation where they need a steady and likely a fairly high income stream and with no money in the bank, that has to come from a job. They’re not avoiding risk at all, but they also don’t have the resources to take on opportunities that might come their way.

On the flipside, let’s look at a person who saves a significant chunk of their income. Not only can that person handle unfortunate events like a car breakdown or an illness in the family with relative ease, that person can also switch jobs or even careers without going into panic mode, too. That person has opportunity and protection from risk.

That’s where I strive to be, too.

The problem is that whole “saves a significant chunk of their income” part of the equation. Most people simply don’t do that. In fact, 76% of Americans live paycheck to paycheck, putting them firmly in the camp of people who have risk but lack much opportunity.

How do you escape that? It’s simple: live like the other 24%.

Live Like the Other 24%

The 24% of Americans who aren’t living paycheck to paycheck live by a simple creed. They spend less than they earn.

Usually, they achieve this by saving before they do anything else with their paycheck. They then live on whatever they have left.

I’ll use a rounded-off example of a friend of mine. He earns about $50,000 per year, which is a healthy income. He ends up paying about $10,000 in taxes, so he’s left with about $40,000 a year to take home.

He’s paid twice a month, so twice a month, a day or two after payday, he has $500 withdrawn directly from his checking account. He never has to lift a finger to do anything – it just happens. That money is transferred to an investment firm (I think he uses Edward Jones, but I’m not 100% sure), of which a portion of it ($200) goes into retirement savings and the rest ($300) goes into various investments, including the stock market. Again, all that happens automatically – he never lifts a finger.

However, that means that he has to live on $28,000 a year instead of $40,000 a year. For him, that means simple choices like not driving a brand new car all of the time and not living in a huge house. He drives a fairly old car – still in good shape, but nowhere near new – and he lives in a fairly small house.

In addition, he avoids debt like the plague. He had some student loan debt after college but made it a priority to pay it off. He took out a small mortgage for his home loan, which he paid off in a handful of years. And that’s it – no credit cards, no nothing else. He doesn’t pay a ton of interest to have something now when he could have it without paying that interest in a month or a year or two.

What does that sacrifice give him? If he doesn’t change a thing, he can stop working at about age 52 and never work another day in his life while living just like he lives right now. If his car gives up the ghost or the transmission fails, he doesn’t skip a beat. He usually has enough cash to pay for it right now and, if not, he can just go tap his long term savings. If he were to lose his job, he would have plenty of time to find a new one as he could live off of his long term savings for a long time. Similarly, if he got fed up with his job, he could switch jobs at his own leisure.

He has a ton of opportunities on the table in front of him and he’s protected from most of the risks that modern life could throw his way. All he does in exchange for that is save some of his income before he ever sees it.

Getting There

So, how do you get from the typical financial state of an American to that kind of situation? You basically use the same principle of spending less than you earn to put yourself in a situation where your monthly expenses are really low, then you put a healthy amount of savings on complete autopilot.

The best way to do that is to put a healthy chunk of your next paycheck into savings, don’t touch it again, and try to make it through the pay period without going into any debt. Learn what you can cut back on by actually doing it. You’ll find that it’s not as hard as you think and that most of the stuff you’re giving up is pretty forgettable and unimportant. Then, do it a few more times. Boom – you have yourself an emergency fund, ready to handle any life emergencies that pop up.

Next, start making a large interest payment on your highest interest debt first and then make it through the rest of the month without getting into any more debt. Keep making minimum payments on all of your debts, of course, but knock that highest interest debt down hard. The key, though, is to get used to going through the month living on less than you’re actually earning. That should define your new normal.

Here’s the real truth: people have a tendency to let their spending expand and expand until it eats up all of their paycheck. When that happens, a mis-step or a major expense of any kind forces you into debt.

However, that expanded spending mostly is used on things that are pretty unimportant – entertainment and expensive food options and snacks and “going out” (meaning being social with a bunch of additional expenses tacked on). When your spending expands to eat up your whole paycheck and these things become regular expenses, they begin to seem like the norm, but in truth they become forgettable and wasteful. You remember the occasional treat, but you don’t think twice about the thing you do every day or every weekend. That’s kind of sad in its own way, as something that was once special becomes boring and normal and unappreciated but you’re saddled with that regular expense.

It’s Simple…

The route to having a life that’s full of option but isn’t derailed by a nasty unexpected event is to spend less than you earn and do it with automatic consistency. Do that for a while and your debts melt away, you have money in the bank, and suddenly you’re not cuffed to that terrible job and you aren’t in disaster mode if there’s a bit of water in your basement. All that you have to give up is the most frivolous and unimportant and forgotten bits of your spending, not the stuff you immediately think about and value.

Good luck!

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