In my last article, I introduced the concept of the financial speedometer to provide a simple framework on how to evaluate the extent of spending in your household. To extend the analogy, so long as a car engine is running, a car will consume some power and fuel even when the car is not moving. Some big and typically highly inefficient engines burn fuel at high rates even when idling. This makes sense for a complicated machine like a semi tractor which is geared for towing and hauling very heavy loads up and down mountains. For a semi, high power comes at a cost of lower efficiency, but it is a fair tradeoff, because that additional power can be brought to bear to pull the load in times of need.
A high idle, however, is much less appropriate for a small economy car. Unfortunately, too many households have the financial engine of an economy car that idles in the red. When I say that a household budget is idling in the red, I mean that many families have arranged their financial affairs so that their committed expenses every month almost equal their entire income. Through the choices they have made and circumstances they have endured, they have eroded almost all the financial operating room they have. Unlike the semi which can draw upon additional power when needed, households idling red are unable to use their budget or discipline to change their financial situation.
Many people overspend on clothes, entertainment and food. In most cases, instilling fiscal discipline and refusing to spend opens up financial capacity that can very quickly help a family improve its position. But a family that has overcommitted to rent/housing expenses, insurance, taxes, utilities, gym memberships, contractual obligations and most of all debt cannot simply choose to stop spending. These expenses are commitments and breaking commitments carries much larger repercussions in practical, philosophical and often moral terms.
- Image by Brajeshwar via Flickr
I, therefore, advise people to carefully monitor what percentage of their spending is composed of committed expenses. The percentage of income that is spent on committed expenses is called your financial idle. I urge people to never allow your idle to exceed more than 55 to 60 percent of your take home pay, (45 to 50 percent if you have irregular income). If, at any time, your financial idle exceeds 80 percent of your income, you are more likely than not, bankrupt. Even if you can somehow stave off bankruptcy in the current arrangement, you will end up endlessly treading water with no hope of improving your situation. To escape this exhausting physical and mental grind, you have only 2 options: upgrade your financial engine by seeking either more lucrative work or additional work, or you will need to make draconian cuts in your lifestyle when you do have opportunities to exit some expenses. By draconian, I recall advising someone to move within a couple of blocks of work, sell the car and give up driving altogether. Some folks have moved a family of four from a 3 bedroom house to a 2 bedroom apartment.
Keep in mind the concept of financial idle. It is one of the key concepts that will help you avoid ending up in a situation where the only escape is via the path of pain. It’s best not to walk that road at all.
