More Money, Same Problems: Breaking the Debt Cycle

Do not save what is left after spending, but spend what is left after saving. – Warren Buffett

In the quote above Warren Buffett, easily one of the most famous and successful investors of our time, reframes how we should think about saving.  It is this concept that identifies why income level only explains about one-third of the net worth differential among U.S. families.  Your ability to generate wealth will certainly be related to your income level, but the primary driver of your wealth generation is whether you can live well within your means, and maintain that low cost of living as you get raises or windfalls.  It is time to break the debt cycle and achieve financial security!

More money, same problems

Data suggests that as income levels rise, so do debt loads and interest rates.  Lending Club, a large peer-to-peer loan provider, had over 80,000 debt consolidation and credit card payoff loans outstanding at the end of 2016.  These loans are for people who are feeling overly burdened by multiple debt balances and high interest and need to consolidate into one loan to lower their interest cost or extend their time to pay back their debts.  63% of Lending Club’s outstanding loans of this type were for people with incomes over the national median ($57,827), and 13% of the loans were for individuals with income over $120,000!  There were many more families that earned six-figure incomes and applied for consolidation loans but were rejected due to poor credit scores or a debt-to-income ratio that was too high.

For the average family, a higher income means a bigger mortgage, more expensive colleges for their children, and higher credit card limits.  NerdWallet analyzed data from a variety of sources, including the Federal Reserve and U.S. Census Bureau, and found that as income increased families leaned more heavily on credit cards, utilizing their higher limits but still getting sucked in by high-interest rates.

Income level also isn’t a big determinant of whether families will be living paycheck to paycheck.  While about 33% of all U.S. households live paycheck to paycheck, a 2015 survey by SunTrust found that 25% of households making more than $100,000 a year were also living paycheck to paycheck.  Meanwhile, a 2015 study by LendingTree found that 44% of Millennials (age 24-35) who made between $100,000 and $149,000 reported living paycheck to paycheck; even higher than the 33.5% of Millennials who made between $50,000 and $75,000 a year.

Why is such a high percentage of U.S. households living paycheck to paycheck, when we are one of the richest countries in the world?  How do we break the cycle?

Habits Define Our Wealth

The best way to ensure financial independence and health is to play good defense.  If your only focus is on earning a higher income, all that higher income will get you is grander expenses or a higher debt balance.  We need to change our priorities so that we consistently and happily live within our means at our current income level, so that if we get a raise that extra money goes to building wealth or saving for goals.

We have to learn to think of budgeting as caring about our future and appreciating a low-stress lifestyle, not as deprivation.  We have to learn to brag about value over dollar price.  We have to racquetball that it is perfectly alright to tell our friends “I can’t afford it right now,” and that if they tease you for it, they (a) probably aren’t very good friends, and (b) are likely behind on one or more of their financial goals.  We have to cut expenses that we have because we think we should have them, and only focus on expenses that we need to have.

A good way to start practicing this is by creating false scarcity.  False scarcity is effectively pretending you make less money than you do.  If you are particularly disciplined, you can allocate your target savings in your savings category in YNAB, or whatever budget system you use, and then use the remaining money for your spending.  If your spending and living expense money gets tight, you have to tell yourself your savings category does not exist and find a place to cut in your other areas.  For the less disciplined among us, you can speak to your employer’s payroll department about splitting your checks into two direct deposits (almost all companies can do this), and have them put only your living and spending money in your checking account and have the rest auto-deposited into your savings.  While this will feel painful for a few months, human beings are incredibly adaptable, and soon your brain will adjust to the idea that this is just what you make.

If you think false scarcity is impossible, think about the last time your employer raised your health insurance.  How long did it take you before that extra $50, $100, $200 a month didn’t feel like it was missing from your check?  Three or four pay cycles?

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My Experience with  Scarcity

I work in the perfect industry for generating false scarcity.  Almost 2/3 of my income is paid in bonus form at the end of each year.  I’m not yet senior enough for the bonus level to be extremely variable with fund performance, but there is a range and Daddy Fish, and I pretend that at any moment there could be a market crash, or issue with the firm, and my bonus could be zero.  We try to put all our living expenses into my base salary and think about any major expenses only within that base.

False scarcity experiences – Fish Family

• Buying our first house:  When we were purchasing our first house, we were given a very high pre-approval value.  Daddy Fish was still working, and our mortgage provider included my bonus in our income.  We used a Zillow mortgage calculator to determine what we thought we could afford on just my base salary, as we expected Daddy Fish to stay home when we had kids, and limited ourselves to that price range.
  • Win. Our first year of home ownership was rough.  Our AC units needed to be replaced ($10K), an ice dam caused leaking through 3 rooms in the house ($1K deductible), and we found out our deck was structurally unsound ($14K).  Because we carefully limited our housing expenses and had Daddy Fish’s whole income to work with, we were able to cover our extra expenses from our emergency fund without slowing our retirement savings.
• New car: About a year and a half before we had Fuss Fish, we decided to buy a second car.  I wanted, as Daddy Fish calls it, my “dream car,” a 4WD Subaru Outback.  Reliable, durable, low cost of ownership and great for dogs, kids, and snow.  (Sorry, not a Subaru ad).  Daddy Fish would keep driving our Nissan.  Well, when Fuss Fish was born, Daddy Fish didn’t feel safe driving him in our 2WD Nissan in Massachusetts winters, and he took over the Subaru.  After bonus season this year, we discussed trading in our Nissan for a 4WD car for Daddy Fish that he enjoyed driving so I could get my Subaru back.  After a few weeks of discussion, we decided I am fine driving the Nissan.
  • Win. A little over a week ago I heard from a successful local business owner that they may be looking for an investor to expand.  It is a business we love, and that has excellent growth potential.  I will be meeting with them in the next few weeks, but we wouldn’t be able to even take the meeting if we had traded in our perfectly driveable Nissan.
• Groceries; We are picky about groceries.  I have a food allergy; we prefer grass fed and free range meats and local produce.  This doesn’t exactly lend itself to low food expenses.  We signed up for a local meat CSA to lower the cost modestly versus Whole Foods and talk about where our grocery spending stands throughout the month.
  • Fail, but working on it. Groceries are our kryptonite. We go over our budget for food and move it from somewhere else almost every month.  The meat CSA was a great concept, but the meat comes frozen* so we inevitably forget to take it out of the freezer on time and end up making extra runs to the store.  We recently turned off the meat CSA for a few months until we work through our stockpile in the freezer and are actively looking for ideas to reduce our food waste.  Setting notifications on our shared Wunderlist to-do lists to take out meat two days before we are making a meal seems to help, but now we have to get into the rhythm of using the list.
    *My mom is still shocked that the fresh, local meat comes frozen.  I’ve given up on that particular argument.
• Gym membership:  We spend $286/mo on our gym membership.  It has two pools, racquet ball courts, a climbing wall, and tennis courts in addition to all the normal gym stuff.  This would be excellent; if we ever went…
  • Fail. Once upon a time, I worked out most days of the week.  There is a not insignificant part of my brain that wants to get back into that habit.  The problem is, with a full-time job, a baby boy I love seeing, a wonderful husband I value and now this website I barely have time to sleep, never mind exercise.  I’m not even going to pretend we are trying to fix this one.  Daddy Fish takes Fuss Fish about once a week to play in the children’s gym and once to swim and says he will swim more when Fuss Fish drops to one nap a day, and he has more hours to get out and about.  I still pretend we are going to get over there on the weekends to drop Fuss Fish at the daycare and play racquetball.  Maybe I’ll go tomorrow…

What is your plan to break the cycle?  What is an expense you don’t value but keep making anyway?