I hear this all the time from clients: we make a lot of money, why do we feel like we cannot get ahead or save. Of course, there can be a lot reasons for this issue, but one that I frequently is that your fixed costs each month are too high.
What does that mean? Well, you have certain expenses each month that have to be paid or dire things will happen. Those costs recur every month and there is no end in sight. I call them Contractual Obligations and here are some examples:
- Car Payment
- Childcare (e.g. Nanny or Daycare)
- Home Equity Line of Credit
- Student Loan Payment
- Private School
When your payments to your contractual obligations exceed about 40% of your TAKE-HOME income, you will find it hard to EVER get ahead of the game. If your contractual obligations are around 50% of your take-home pay you will feel a lot stress and there may be spousal arguments and tension. You may feel like you’re choking.
Here’s why: when you spend 40% or more each month on contractual obligations, there’s not enough for full discretionary money or for savings after other recurring monthly items like groceries, gas, medical, pets, landscapers and utilities.
Discretionary money and savings make you feel calmer and more in control. When you do not have any full discretionary money or a Rainy Day Savings account, you CHARGE THINGS. We all need some full discretionary money, to buy a shirt, go out for a drink/coffee, and take the kids to the movies. We need Rainy Day Savings for when the boiler breaks.
Generally, I do not see people consistently able to manage below $300/adult/month. Most families of four in an urban area are looking at $1,000-$3,000/month in full discretionary money.
Let’s see what I mean with numbers. Let’s say our sample family of 4 has $10,000/month TAKE-HOME pay:
- Mortgage $3,500
- Car Payment $400
- After-care $500
- Student Loans $600
- Total Contractual Obligations = $5,000
- Contractual Obligations as a percent of Take –home pay = $5,000/10,000 = 50%
Remember, if you are taking home $10k/month your household is making about $180-220k per year pre-tax. That’s a good income, but yet you still feel like your choking. I know it seems like having $5k left to pay for everything else, should be plenty. It’s not. It’s not enough to save, AND consistently spend less than you earn.
The critical thing to remember is you want to keep those fixed payments under 40% and for most people the issue is with housing. Yes, that house is beautiful and yes, the bank will let you borrow enough, but the reality is very stressful. Same with the car.
Student loans have fewer options, but before you buy that new car or house, do your math and keep your fixed obligations under 40% of your take home pay to keep your sanity.