What is important to me? How do my values influence my financial decisions? These are some of the key questions I’ve begun to ask as I move deeper into the “third stage” of personal finance. Now that my debt has been eliminated and I’ve developed the discipline to save for retirement, I’m ready to explore my financial priorities.
Over at Fiscal Fizzle, Wojciech has an excellent article about finding your financial heart. He lists seven activities — thought experiments, really — that you can use to obtain a clearer understanding of your financial values.
In the first exercise, for example, he asks readers what they’d do if their income were cut in half:
To enter the scarcity mindset, imagine that your total household income has just been reduced to half of today’s levels. It’s not so far-fetched, as both two- and one-income families are finding themselves partially or totally unemployed.
Create a theoretical budget based on the new income level. Unless the space between your current income and expenses is wide, you’ll really have to focus and trim down.
What would you do if you suddenly had half your normal monthly income? That’s a fantastic question, one that can help you become more attuned to your financial priorities — your actual priorities, not just the theoretical ones. Wojciech offers six additional exercises that force readers to ask questions like:
- What if your income increased by 50%?
- What are your Financial Defaults?
- What’s your Most Important Charity?
Wojciech’s article very much reminds me of George Kinder’s three questions about life planning. They both seem to be saying something that I’m just beginning to understand: When you understand what you want to do with your life, you can make financial choices that reflect your values.
This article is about Planning, Psychology
Still a difficult question regarding the “third stage.” I’m still having difficulty in determining how much is enough. I guess I’ll have to read some of those books you recommend J.D.
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If my income were cut in half probably manage. If the household income were cut in half probably bankruptcy.
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To me, this is what personal finance is all about–aligning your usage of money with your goals, values, dreams, etc.
And that applies to both spending and investing.
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These are some great, thought provoking questions. Personally, I cringe at the idea of a 50% household pay cut right now. While we are debt free and doing well after following your advice and that of Dave Ramsey, we are still totally dependent on linear income sources.
This is one reason I’ve really been looking into legitimate methods for forming multiple streams of income, especially passive income. That would provide a whole different layer of financial security for our family.
Dustin
EngagedMarriage.com
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My income just doubled – my living expenses hardly changed.
Being single, and living in the Midwest, I found my previous (extremely modest) income enough to support a very simple but comfortable lifestyle (including no debt, modest savings, and modest giving.) Still being single, and still living in the Midwest, I don’t see a need to drastically change my lifestyle “just because I can.” I was content then, and I can be content now.
I have made substantial increases (in both value and percentage) to 3 line-items of my budget: giving, savings and taxes. In the event of an income decrease, all of these can/will be reduced.
I have three smaller “splurges” in my budget – I now pay 10% more in rent (for an apartment 150% the size of my old one!), have high-speed internet, and have increased my entertainment budget slightly (although this is mostly because I’m no longer a student, so I can’t take advantage of steep discounts on tickets to campus acts.) Both internet and entertainment can be eliminated or cut if I were back to my old salary.
In other words – cut my income in half now? No problem – I’ve been very wary of “lifestyle” creep. Had you cut my income in half before, though, I would have had to made substantial changes – getting a roommate, and forgetting about giving and saving, at a bare minimum. And yet I still would have been able to get by, somehow. I like living like this – knowing that I can take financial punches (like losing six weeks of income to spend time with an ailing family member) that won’t knock me out. For now, young and single, this is what “financial freedom” looks like to me.
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This is a very relevant question in my life right now… One that I have actually been thinking about the past week or so. I fear that my job is in jeopardy. My fiance and I both make roughly the same salary, so if I were to lose my job, our household income would be cut 50%. We stopped paying down the mortgage and have been beefing up the emergency fund (Because of this fear as well as other reasons). Fortunately, we were able to refinance a few months ago at a great rate (4.875% from 6.25%) and switch to a non-escrow mortgage, which lowered our monthly MANDATORY payments by about $710/month. Our self-escrow account is already fully funded, so no worries there. So with the refinance and emergency savings, we’ll be able to manage on one income for well over a year. But hopefully it wouldn’t take me that long to find suitable employment!
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I recently voluntarily cut my income by a little over one-half. I’m actually pretty proud of myself–I didn’t have to change my lifestyle radically, which means I was doing a reasonable job of avoiding lifestyle inflation. Still hurt, though.
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My general expenditure has fallen drastically, but I’ve now got a mortgage that’s over half my take-home pay, so… it wouldn’t be pretty.
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Thanks for the link, JD. I hope people get a lot of mileage out of my post. I’ve been thinking more and more about where my own priorities lie and life’s purpose (although I’m still young).
It’s interesting to me that those I know are fairly good at setting general life goals, and maybe some financial milestones, but rarely examine what they really want.
One of the best things I learned at a young age is that how you spend your money is just as good of an indicator of your priorities as how you spend your time.
Excited to see what your readers think!
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I think the question of what you would do if your money was cut by 50% or whatever %, can be used to find ways to live below your means. If you find that you cannot manage with a 50% cut, but may be a 10% cut, that finding should be interpreted to mean that you can NOW starting saving or investing the 10% (assuming that you were previously spending it).
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If my income were cut by 50% I would not be able to meet basic needs. Right now I am spending 30% of my monthly income on rent. That would become 60%, and the rest would likely not cover utilities and groceries.
Looking at the hierarchy, I guess I would buy groceries and diapers and not pay rent. When evicted, I would move into a homeless shelter with my husband and baby daughter. Or perhaps I would use my emergency fund to move back to my home country and move in with my sister or grandmother. Though currently my emergency fund only contains half the amount to buy short-notice tickets for the 3 of us.
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I live in the inexpensive Midwest, but I’m a single mom with 2 kids, divorced a few years ago and with very little savings although I’m in my late 40′s. Fortunately, I have a very good job, a solid emergency fund, and a modest, low-rate fixed mortgage. After re-adjusting our spending last year, I started saving 40% of my take-home after tax income and next year since I paid off my car loan that will go up to near 50%. So, while I could easily live on 50% of my current income, I’d have to stop building my savings for retirement and my children’s education which would seriously impact our future.
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I like the question about charity. I wrote an article a year or so ago about budgeting for donations, and one of the things people tend to do is give spontaneously when asked (when someone comes to the door, etc). Of course, there’s nothing wrong with that, but it can throw off the budget if you haven’t planned for it and it might mean you don’t have the money to later give to charities that are your top priority.
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Ironically enough we (my wife and I) are sort of in that situation now. In May we decided that it was time for her to leave her job and decide if there was a new career path for her or not. We had built up a emergnency fund but had to use a large chunk to pay off part of a sign on bonus. (Yes we could go into how we shouldn’t have taken that bonus or what ever but it is what it is and we’ve learned from it.) My wife decided that we wanted to go back to school and change careers. We knew that we couldn’t live on just my salary so she knew she would need a job of some sort but she’s been able to get a part time job teaching that’s helping her determine what she’ll pursue as she gets back into school.
So we’re not at 50% but let’s say 60-70% when her part time salary starts to kick in. Now if we had to cut down 50% at this point, we’d really have to make some changes. The nice thing would be that our student loan payments could probably get forgiven in 25 years since we’d have to go on some other payment plan. The bad part would be that 25 years seems a long way off (especially when you’re only 25 years old to begin with).
Fortunately we’re young and, while the world isn’t necessarily a forgiving place, so far we’ve been blessed to be able to learn from mistakes and to make mistakes without suffering too much from the consequences.
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I think the “living on half your income” question is interesting, but it really depends on how much you currently earn. For instance, if you earn $80,000 it’s much easier to downsize than if you currently earn $40,000. The higher the percentage of your income that you’re spending on wants rather than needs, the more you can cut back back.
I could live on half my income, but it would mean going back to sharing a house or apartment with three or four other people (like I did when I was a student). Having some freedom and privacy is important to me.
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Cutting my current income in half means I’d be living and paying bills on around $6,000 a year. That’s an instant trip back to either my parent’s house, or a homeless shelter.
Although I’m in your hypothetical situation already: 4 years ago, my current income was cut by about 60%, and has stayed that way ever since. I did end up moving back in with my parents at first, til I paid out what little credit card debt I had (about $3500). Then I built up a bit of savings. Then I moved out on my own again. Had to rent a room from a friend. Cut all unnecessary things from my life. That meant No land line. No TV. I buy my clothing used on eBay or in a thrift store. I drive a truck that’s almost 20 years old. I have to be frugal when food shopping. I do have internet, only because my freelance job requires it. But I’m already at bare-bones expenditures. If my income was cut any more, I’d have to pick an essential to cut: A roof over my head. Electricity. Food. Insurance. I guess the only ‘frivolous’ thing left is my cell phone, which is my ONLY phone. I could cut that (a savings of $32 a month), and rely on the Internet for communication to the outside world (which would include email, AIM and Skype). Thinking about my income being halved yet again is a really depressing topic.
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I did this about 15 years ago (literally not theoretically) and I learned threee things:
1. I liked knowing that I *could* do it so it taught me to avoid lifestyle inflation as my income went back up.
2. I’d rather change my life/job/goals to keep complete independence than ask for help.
3. I can give up beer without a second thought, but I’ll always find a way to keep at least a little bit of wine in my life.
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We went through a cut when my wife went part-time 2 years ago when our son was born and will go through an even bigger cut if she stays home with baby #2. Not 50%, but maybe 25% or so.
In the first instance we “practiced” living on the lower income by putting all her paycheck into savings. We still do this, so losing her income would only lessen the amount we save, not affecting our month to month spending.
If we were to cut another 25%, we would likely be living paycheck to paycheck, but with a health emergency fund in place I wouldn’t be too worried. I would be discouraged since we probably couldn’t add to our savings anymore, so I’d definitely look for a higher paying job or freelance.
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If my income were halved due to job loss, I’d move. People trying to hold onto their existing houses, rather than appropriate downsizing (or going back to renting), has helped cause foreclosures in my area.
Of course, buying a house that you can afford on half your income would be the right way to buy a house in the first place, wouldn’t it?
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My answer is off the scale because I currently live overseas. The cost of living is so much cheaper here (just had breakfast for 37 cents) so I could “survive” even if my income dropped 95%. You might say this is the ultimate step in the downsizing strategy — and I’ve already taken it proactively.
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We live on one income… If it was cut in half, we’d be in deep trouble.
But you know, I think we would still be able to manage. We’d have to remove the entertainment budget, keeping only rent, bills and food. It would be tight but we’ve done it before.
If our income was doubled (most likely because I got a job) we already decided that my income would almost completely go into savings. However, we would use a small portion of it for a “vice fund” we’ve been wanting to create in our budget (basically, beer for him and chocolate for me). We haven’t been buying these items on the food budget because it’s not something we both eat/drink, and we haven’t been using our entertainment money for it either.
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JD, I think you should actually ANSWER these questions! Or at least some of them.
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J.D.,
Thanks a lot for this e-book and also for the wonderful stuff in your website. I am a fan and have been reading and following your writing for the past couple of years. Keep up the good work!
Question: I have a Roth IRA through Charles Schwab. What do you think about them? I haven’t seen you endorse them; rather I have read your endorsements on Vanguard, Fidelity, and TRowePrice. Any comments are appreciated.
Thanks,
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