How to Break the Paycheck-to-Paycheck Cycle

Guest Post by Daniela Baker

One study by MetLife in 2009 showed that almost 60% of households in America – lots of those with minor children in the family and many close to retirement age – are living paycheck to paycheck. That is, these families depend on each paycheck to pay the expenses that are at hand, without having any financial cushion at all. This is a problem that affects all income levels, as well, since the survey showed that about 30% of individuals earning over $75,000 per year – well over the national income average – still live from paycheck to paycheck.
If you're in this vicious cycle that has you missing bills and lying awake at night worrying about things like cash flow and car repairs – not to mention saving for retirement! – it's time to break the cycle. Here's the step-by-step process you can take to stop living paycheck to paycheck:
Track Your Spending
It's important – vital, actually – that you make a budget so you can get out of the paycheck-to-paycheck cycle. But before you can take that all-important step, you need to actually figure out what you're already spending. Chances are likely that you know your major expenses – insurance, rent or mortgage, car payment, etc. – but you may not have a clue how much you spend on groceries, gas, eating out and other variable expenses. It's time to find out!
Action Step: Starting today, track all your expenses for an entire month. Include every single penny that you spend – cash, credit or debit. Once you've tracked a month's expenses, write them down in an organized fashion by category.
Make a Budget
Once you know where your money is going, it's time to create a budget that will tell you where to put your money before you actually spend it. Your goal here is to create a budget where you're spending what you bring in – and only what you bring in! – within a month. Unless you're living at poverty level, that is most likely possible with some self-discipline. If you absolutely can't figure out how to spend what you make or less, it may be time to meet with a financial advisor to determine your next step.
Action Step: Create a budget that will allow you to track spending and allocate all your money before it's spent. If you're new to budgeting, programs like You Need a Budget and Mint are great options to help you see where your money is going and to more easily track expenses.
Cut Unnecessary Expenses
Some unnecessary expenses are easy to cut out. Sell your car if the payment eats up half your paycheck, and stop eating out all the time if you can't afford it. Other expenses will take time to cut back on. If you spend $600 on groceries last month, don't budget for $300 next month. With couponing and creativity and learning, you may be able to get your grocery spending down to $300 a month, but expecting it to automatically get there in a matter of a month is unrealistic. Trimming expenses can take time, learning, and planning, and you'll get better at it as you go.
Action Step: Find at least one or two places in your budget where you could trim your spending – even if you're already living within your means. Work to cut a little bit from your budget each month for the next few months until you find a good balance where you're spending less than you make but also enjoying life a little.
Build an Emergency Fund
One of the primary ways that people get into a paycheck-to-paycheck cycle is by spending any reserve they have on emergencies, or by relying on credit to cover emergencies. Having an emergency fund of just $1,000 can make a huge difference, because you won't have to go into debt – and take on more monthly payments – every time something breaks down or another type of emergency arises.
Action Step: Take that extra money you're trimming from your budget, and put it in an emergency fund. Don't link your emergency fund account with your checking account, or you'll be tempted to transfer it over to your spending money every time a minor emergency arises. Only use this money when you absolutely must, and then replenish it as soon as possible.
Reduce Your Credit Usage
You don't have to completely cut credit out of your life if you want to stop living paycheck to paycheck, but you should reduce your use of credit.
If you're dealing with high credit-card payments that are stealing too much of your paycheck and going nowhere, consider transferring your balances to low-interest credit cards. Visit our updated comparison chart at http://www.creditdonkey.com/low-interest.html. This can lower your monthly payment and free up some cash for other things – like your emergency fund. Also, start being disciplined about when and where you use credit, since overspending and relying on credit is probably one of the things that got you in this mess in the first place.
Action Step: Make a plan for your credit cards. Pay down the highest-interest, highest-balance cards, or look into balance transfers. Then, determine ahead of time when you'll use credit. The goal is to use credit for major purchases where you need to spread out the cost a little, or to use rewards cards for everyday purchases that you pay back immediately in order to avoid paying interest charges.
Live on Last Month's Paycheck
As you're budgeting, cutting expenses, and being wiser with using credit, your goal is now to start living on last month's paycheck. Basically, you horde a month's worth of living expenses in your checking account, and then start to live on what's already in there, rather than spending directly out of your paycheck as it comes in.
For instance, let's say you need, at bare minimum, $3,500 to meet your monthly expenses. In April, May, June and July, you successfully slash your expenses and save $875 each month. By the end of July, you have enough money saved up to pay for everything that you'll spend in August, as long as you only budget for minimum expenses in August. (Note: This may mean totally cutting out extra expenses like eating out for a month, but it will be worthwhile!)
Now, you can sit down at the beginning and middle of the month in August and pay all your bills without having to worry if you're going to overdraft your checking account because you know that every dollar you've budgeted for in August is already there!
Then, let's say in August your paychecks total $4,000. Now you can create your budget for September with an extra $500 for whatever – whether that's retirement savings, paying off debt, extra spending money or a combination of the three. In September, you spend August's money, and in October, you budget out of whatever you actually made in September.
Living on last month's income is particularly helpful if you have a variable income, like if your job involves contract work or commission. You'll always know exactly what you have to spend when you're spending last month's money instead of scrambling to meet this month's expenses with this month's money.
Also, living on last month's income is helpful in emergencies. Let's say that in September, you've got a budget made out based on the $4,000 you made in August. But then your car breaks down, and it will take $300 to repair it. Instead of scrambling around to scrape together extra cash or using credit to pay for the problem, what do you do? You pay for the emergency out of the money you're getting in September, and then when you're spending September's money in October, you figure out where to cut back so you can budget – in retrospect – for the car breakdown. Make sense?
Living on last month's income is incredibly freeing and is a great way to build financial security!
Action Step: Start cutting back on your budget for the next few months until you get to where you can live on last month's income. You'll be amazed at how much peace this alone will bring to your finances!
Stay Disciplined
Once you're living on last month's income and have an emergency fund saved up for the big emergencies, it can be really tempting to start living beyond your means again. You need to stay disciplined, though. Remember that your cushion from the last month and your emergency fund will only stretch so far if you start spending them, and continue living within your means!
Action Step: Once you've reached these financial goals, set other goals for yourself, including paying off debt, saving for retirement, putting money away for a child's college education or buying a home. But continue to budget and live off of last month's income so that you remain financially secure for the rest of your life.
Daniela Baker at CreditDonkey says breaking the cycle of living paycheck to paycheck can be difficult, and it will take work and discipline. However, if you follow these steps, you'll slowly but surely get your feet under you financially and have some financial cushion, which can translate into more security and better decision-making in the rest of your life.



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