Personal Finance Advice

We all know (or should) that living above your means for the long term is a recipe for financial disaster. Living above your means is spending more than you earn on a consistent basis. When you do it occasionally, as in the case of an emergency or a planned splurge, it’s not detrimental. However, it becomes detrimental when you do it consistently. Most of us know this and try to avoid it, with varying degrees of success.

There is some confusion, however, as to the difference between living within your means versus below your means. Many people assume that they are the same thing, but really they’re very different. I’ve heard many people claim that, “I’m living within my means, therefore we’re all set. We have no financial worries.” When I ask them if they have emergency funds, retirement accounts, or low debt levels, the answer is often no.

“Then how is it possible that you’re all set financially?” I’ll often ask.

“Because we’re able to pay our bills and still have a little bit left over to have some fun with.”

While it’s great to be able to pay your bills, living within your means is not the same as living below your means. People living within their means are able to meet their monthly obligations, but they do not have the ability to save for the future. All of their income is sucked up by bills and payments. What little is left, if any, is often spent on fun and entertainment. People who live within their means often have a large debt load. They usually owe on cars and credit cards, and their mortgage is usually right at the upper limit of what they can afford. Since they can make the payments on all of this, they assume that they are okay. Unlike people who live above their means, people who live within their means aren’t losing ground every month. Their debt load is not increasing and may even be decreasing. They don’t have to juggle bills and due dates to make certain that everything is paid. They are able to pay their obligations fairly easily.

The problem with living within your means is that, while you can meet your obligations month to month, there is no safety net and nothing put away for the future. If an income is lost or reduced, or if there is an unexpected large expense, those living within their means have no way to weather that crisis. Living within your means quickly becomes living above your means as the monthly obligations start to exceed the income. This often leads to big financial problems that can take years from which to recover, if recovery ever happens at all.

Contrast this scenario with people who live below their means. People who live below their means are able to meet all of their monthly obligations, save for the future (both for the near future/emergencies and for retirement), and have some fun, as well. They often have no or very little debt, usually consisting of a mortgage or a small car note. Any debt they do have is very manageable and nowhere near the amount they could technically “afford.” They may use credit cards, but they generally pay the balance in full every month.

The difference between the two groups is that those who live below their means keep their obligations and payments to a level that can be sustained on a much smaller income than they currently earn. This may mean that they don’t have the biggest and greatest home, fancy cars, or a lot of extras, but they make a conscious decision to keep their expenses lower than their income. Perhaps they even live on one income and bank a second income. This means that they have a lot of money left over each month to save. They can put some into an emergency fund and direct some to longer term goals like replacement vehicles, retirement accounts, or a down payment for a home. They spend on fun a frivolity only after all the bills are paid and the savings accounts are funded.

People who live below their means are not as threatened by income loss, emergencies, or other hazards of everyday life. They know that they have room in their budget to cover some extra expenses and they have savings to fall back on if they need it. They may even have a whole extra income to spare. They know how to survive on less and can probably trim their budgets and make frugal adjustments to further reduce their income needs. They can weather a crisis without long term damage.

It is a mistake to think that living within your means is the same thing as living below your means. If you live within your means, you are really only a few missed paychecks away from having to live above your means. When you live below your means, you have many more options for saving and dealing with a crisis. The goal should be to live below your means, not within your means.