How many of us live paycheck to paycheck? Not surprisingly, 95% of all salaried people live like that. Salary income is considered very assured. But on downside it makes people complacent about their financial security. Salary income is assured till one’s doing a job. If one leaves job today, salary will stop from the next day.
But till then (until one has a job) people feel safe. They become absolutely casual about their dependency on monthly paychecks from job. But this situation dramatically changes if job security is threatened. That is the moment when one realize the disadvantages of their dependency on job.
This realization that how dangerous it is to continue living paycheck to paycheck ignites fear. Just for hypothesis, consider the job is lost. From next month school fees of your child cannot be paid. How dreadful that situation will be.
Job loss will reduce ones ability to pay EMI’s to zero. After job loss, even buying groceries and vegetables will become difficult. Is there a way out? How one can reduce the dependency on paychecks?
What it means by living paycheck to paycheck?
I once read; low-salaried people live paycheck to paycheck and high salaried people don’t. This is not a correct analysis.
Correct understanding is related to all three: Income, Savings & Expenses. People who do not save in proportion to their expenses are living paycheck to paycheck. A typical paycheck to paycheck life is one where person spends everything he/she earns.
People who maintain and grows their savings are the ones who are breaking this jinks. People who are not dependent on their salary to manage day to day expense are financially independent people.
The first essential step to stop living paycheck to paycheck is to start saving money. The next step is to make the accumulated savings grow month after month. The faster the savings grows the better.
Not many can realize early in their life that they are actually living paycheck to paycheck. And by the time they realize, its late.
Wise men say that saving money is toughest for people.
People are born as natural spenders of money. But with maturity and experience they start saving and investing more.
Why saving money is so tough?
People find it hard to delay gratifications. Suppose your child wants to eat a pastry. He/she will make huge hue and cry to have that one bite. They want their gratification to happen immediately.
Grownup’s also crave for immediate gratifications. They may not want pastries and ice-creams, instead their wants are bigger. To fulfill their wants they can spend everything they have earned.
A stage comes when people even start spending beyond their means. This is where people start living paycheck to paycheck.
Their wants become bigger than their income. For such people, even their monthly paycheck is not enough.
How to stop living paycheck to paycheck?
Its actually not as difficult as one might imagine. If one can only start saving gradually, financially independence will soon become reality.
Important is to first VISUALIZE that, what it means by ‘not living paycheck to paycheck’?
There can be several stages of this. Let me show this to you pictorially.
Its important to start visualizing the concept of financial independence. Visualization can happen when one establishes a link between savings > Asset > Income from asset > Monthly Expense.
This visualization will highlight the importance of ‘saving money’. Savings are essential for financial independence. They are the starting point from where person buys his FIRST ASSET.
But saving alone is not sufficient. Saved money must be invested to buy income generating assets.
More will be the asset base, higher will be the income. When ones income from asset (passive income) is equal to expense requirement, he/she becomes financially independent.
Financially independent person does not live paycheck to paycheck.
Why majority middle class are not financially independent?
Important is to save money and accumulate income generating assets.
But middle class has net-income-from-asset in negative. People buy asset with help of bank loans. This is where net-income-from-asset becomes negative.
Point is, it is not sufficient to buy assets with loans. Minimizing loan component, and maximizing self-contribution is essential. This is where accumulated savings plays its part.
Substantial Asset Accumulation Takes Time…
There is one big problem with the concept of ‘asset accumulation’ & passive income generation.
Income generating assets can help one to stop living paycheck to paycheck. But it takes long time for asset portfolio to grow in size.
Small size asset portfolio may not generate sufficient income.
To earn decent income from asset, size of asset-portfolio must be expanded. This activity takes time.
In our example, $270,000 worth of asset generates income of $1,800/month. It takes time to build asset portfolio worth $270,000. It cannot happen in couple of years.
A typical salaried man can take 15-20 odd years to build asset portfolio worth $270,000.
This is a problem as 15-20 years is too long a waiting time.
There is no ‘other’ way to stop living paycheck to paycheck? One has to always wait for 20 odd years to negate paycheck to paycheck dependency?
Lets face the fact, middle class cannot reduce the asset accumulation time.
But there is an alternative to asset accumulation. Its more of a short term solution. Using it, partial reduction of dependency on paycheck is possible.
Effect of alternative solution can be visible every month. This acts as a big motivation.
What is this alternative solution?
Our first concept talks about ‘accumulate assets’. The second alternative solution talks about building an emergency fund.
Instead of buying assets, here people keep cash stacked in ones savings account. This is our emergency fund (in cash).
Idea is to build this emergency fund sufficiently big. The emergency fund should be big enough to support basic necessities of life. At least 3 month worth of savings should be in store. Emergency fund can be pure cash parked in high interest generating savings account.
Lets see how to build emergency fund. First categorize expenses into Basic, Comfort, Luxury and Investment necessities. A typical example:
Once we are ready with the categorization of all expense, first target the basic necessities.
Accumulate savings for minimum 3 months worth of ‘Basic Necessities’. In our example, basic necessities includes Home Loan EMI/Rent, Grocery, Vegetables, School fees, Medial etc. First target will be to accumulate savings equivalent to 3 months of basic expense.
This way, if one leaves the job, he/she will have at least 3 months to plan the next alternative. Basic necessity will come for next 3 months.
In case one wants double comfort, building savings for comfort-needs is required as well.
I know a friend, who has 6 months worth of savings for Basic + Comfort. He also has 3 months worth of savings for luxury. He is also gradually accumulating assets to attain financial independence.
I once asked him, “How do you feel to own such healthy savings?” His answer was perfect, he said “These days he works fearlessly in his Job”.
He also said, “His boss is liking him more in his new avatar”. This is amazing. Benefits of high savings, big portfolio is beyond just money-gain.
It not only improves financial well being but it also improves ones personality. I will suggest my readers to practice it for few months. The positive effects will be very visible.
Ideas on How to stop living paycheck to paycheck
I earned my first paycheck around 15 years back. Back them I was an avid spender. Probably I used to spend beyond my means.
In next 10 years, I realized that spending is not as fun as it used to be once.
I started reading about ‘effective money management’ and ‘investment techniques’. I realized that saving money is essential.
I started saving 20% of my earnings. But to my surprise these savings were not helping my cause.
I continued to be extremely dependent on my salary. This dependency was only increasing.
My paycheck dependency was making me uncomfortable. I was not able to free myself. My savings were not growing as fast.
Moreover, my savings were also not holding. Ultimately the accumulated savings was getting spent on useless things. I was slowly becoming salve of my employer.
My financial independence was in deep threat. This vicious circle of living from one paycheck to another paycheck needed correction.
Then I took few simple corrective actions. I followed few logical steps. If followed properly, it has potential to change any ones life.
Lets see how to decrease our dependency on paychecks:
Step-1 > I opened High Interest Yielding Savings A/c (HIYSA)
As soon as my paycheck gets credited to salary account, 100% of it is transferred to HIYSA.
These days many banks offers high interest on savings deposits. Earlier, the interest yield was max 4% per annum. But these days, with ‘auto sweep facility’, interest earned on savings deposit could be as high as 8% per annum.
HIYSA works as a big motivator for me. I save money handsomely just for the sake of earning ‘high interest’.
I myself was not aware that high-interest percentages can motivate me to save more. Every quarter, seeing those extra money dripping-in my savings account motivates me to save more.
Forget about spending, you will save more just for high interest income. I realize that I am no longer eager to draw money out of HIYSA.
Instead, I was enjoying to see the savings grow.
Step-2 > I started Recurring Deposit Savings Scheme from HIYSA
First day of every month my salary gets credited to my salary account. On First day itself, 100% of my salary gets transferred to HIYSA.
I have also opened a recurring deposit (RD) account. On first day of each month, 20% of my salary gets debited automatically by RD.
This activity happens every month till next 12 months. After the 12th month, when salary gets revised, I proportionately increase my contribution to RD.
As this happens on first day of each month, this money never comes to my attention. Its safely parked elsewhere, earning higher interest.
Step-3 > I created an Expense Budget
20% of my money goes into recurring deposit. Fortunately I never get to see it.
I have adjusted myself to manage all expense with only 80% income.
But I do not allow myself to spend 80% at free will.
I have set a budget for each & every expense I incur in a month/year.
If I have to buy grocery, I know how much maximum I can spend in week/month.
If I have to dine out, I have a maximum budget allotted to it as well.
Idea of creating a budget is to identify potential money drains. We happen to spend needlessly at times. Budgeting helps us to become aware and curb needless spending’s.
I have also kept a target of saving 1% of all budgeted expenses. This challenge always reminds me that I cannot overspend than my budgeted expense.
Step-4 > Use savings to Buy Assets and Build Emergency Fund
I save 20% of my total salary. 1% of my total monthly expense is also saved.
Buying assets generates income.
Contributing to emergency fund, gives me more financial independence.
I immediately distribute 20%+1% savings between asset and emergency fund. For five years continuously I kept buying assets and also contributed to emergency fund.
Then I bought a real estate property for myself. I had to take home loan to buy that property. Interest payment of home loan was eating up nearly all EMI.
Then I decided to do something opposite. I started diverting all my savings for loan prepayment.
All money that I once used, to buy assets was diverted for loan prepayment.
But contribution to emergency fund continued as before.
Originally I was supposed to pay EMI for 10 years. But because of prepayments, loan got finished in only 5 years.
As soon as home loan was paid 100%, one income generating asset got added to my portfolio (real estate property).
My advice to my readers is to keep buying real estate property using loans. But make it a point that you make regular prepayments. Take loan for 10 years and finish it off in 5 years.
Imaging how much dependency on paycheck will be reduced if after every 5 years, one real estate property gets added to you asset portfolio. This is fantastic.
Its true that I still have a long way to go. But at least, now I know that which path I have to follow.
For me, my goal is to reach a stage in life where I am financially independent. A imaginative view of my goal indicated in the below pictograph:
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