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Commentary > Everyday Money
The ultimate money challenge
Are you living within your means? It depends what you mean.
November 1, 2004: 3:13 PM EST
By Jeanne Sahadi, CNN/Money senior writer

NEW YORK (CNN/Money) – Ask three people for the definition of a concept and you're likely to get three different answers.

Take the notion of "living within your means." Do you define it as:

a) Not spending more than you earn (as in, you make $100 and can spend up to $100 but not more)?

b) Not spending more than you earn and having no debt (other than "good" debt like a mortgage or student loan)?

c) Spending less than you earn, saving the rest and having no debt (other than "good" debt)?

Judging from an informal questionnaire I sent out, there's no consensus.

Most people would agree that you're not living within your means when you spend more than you make. Some 14.5 percent of Americans do just that, according to the 2001 Survey of Consumer Finances by the Federal Reserve.

Meanwhile, another 26.3 percent said their spending equaled their income. To some, that means they're living within their means.

That may be a fair conclusion for families with very modest incomes, who just make ends meet after paying for necessities.

Ideally, I'd define living within your means as spending less than you earn, saving some of your income and having no debt. The exception being debt that lets you build net worth, such as buying a home, getting a degree or making a home improvement that builds equity.

But how much you spend and save are subjective calls based on your risk tolerance, your values and your location.

"Everyone defines (living within your means) differently because everybody's propensity to take risk is different," said certified financial planner Chris Cooper.

For example, he said, some people are completely debt-averse. For others, "good" debt is okay, so long as their monthly payments are manageable and the loan terms reasonable.

Even "bad" debt like credit card debt might pass muster in limited cases. Say you have a balance that you could pay in full now, but you choose not to because you have a 0 percent interest rate for a limited period of time and you'd rather invest your money elsewhere for a better return.

Or consider housing. Ideally, Cooper said, you wouldn't spend more than 25 percent of your gross income on a home every month. But you may find yourself spending upwards of 50 percent if:

  • Housing costs are exorbitant where you live.
  • You're willing to pay more to live in a neighborhood with good public schools. Or ...
  • Your home is what you value most and you're willing to cut back in other areas.

Living on $75,000 a year

Before recommending a spending plan, financial planners typically will ask you what your priorities and values are.

But I thought it might be interesting to give a planner carte blanche to decide how a married couple earning $75,000 a year could allocate their money so that they live within their means as the planner defines it.

Certified financial planner Kim Dignum worked up a dollar-for-dollar breakdown for a couple who live in a Chicago suburb, have two kids, own their home and live on one income (thereby avoiding childcare costs).

She estimated they'd pay about $14,860 a year in federal, state and local taxes, plus Social Security and Medicare. She further assumed they'd pay $4,821 a year for health insurance, auto insurance and life insurance.

After accounting for those items, here's what Dignum determined the couple could spend every month on:

  • Housing: $1,562.50 (including mortgage principal, interest, property taxes and insurance)
  • Household expenses: $1,655, including food/groceries ($400); utilities, water and telephone ($350); clothing/dry cleaner ($200); recreation/entertainment ($250); and vacation savings ($125).
  • Car loans: $400
  • Transportation (gas, maintenance, parking): $100
  • Retirement savings: $500
  • College savings: $300

It's a tight fit. Ideally, Dignum likes a family to save up to 15 percent of its gross income a year. But as it is she could only allocate about 13 percent for retirement and college savings.

If the couple wanted to set aside more savings, they might reduce spending on variable expenses, such as vacation or entertainment. Or, if they can, they might buy a used car outright instead of paying $400 a month for a new car.

There are also no credit card debt payments in the mix. To accommodate that, the couple again would have to trim variable expenses. But in Dignum's book, incurring balances you can't pay in full is a sign you're not living within your means.

"No one looks after your money like you do," says Jeff Claudio of Crestview, Fla. And few have been so successful at looking after their money as Jeff and wife Leonora.
Email Millionaires in the Making: New York transplants to the Gulf Coast, Jeff and Leonora's retirement strategy pays off early.

A couple in similar circumstances living in a state with no state income tax and/or more affordable housing likely would have more income left to devote to savings.

No matter what your income, if you strive to live within your means, or you are already but would like to save more, you might compare your spending against the ideal budget that Dignum mapped out.

Jeanne Sahadi writes about personal finance for CNN/Money. She also appears regularly on CNNfn's "Your Money," which airs weeknights at 5 p.m. ET. You can e-mail her about this or any other column at  Top of page

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