Wednesday, November 17, 2010

Day 34 - The Salary Myth Part I: Income vs. Debt

November 17, 2010

I have generally been taught all my life that a larger income allows for greater security and more options. While I do believe there is some truth to this, I also feel that this type of thinking can be easily misconstrued by a person - myself included. I think I have realized the key word is "debt" rather than income. I believe a family with $50k of income and very little debt can lead a similar or better lifestyle than a person who makes $80k and relies on debt for most major purchases. Let's test this theory by putting some numbers together for a very simplified example.

Family A makes $50,000 annually while Family B makes $80,000 (gross). Family A has very little debt - just a small student loan. Family B has two car payments and lots of student loans to pay back. All other monthly expenses are the same.


Family A Family B
 $50,000 Gross Income  $80,000
65% Less Taxes, SS 65%
 32,500 Annual Take Home  52,000
/12 /12
 2,708.33 Monthly Take Home  4,333.33
 (1,250) Rent/Home Mtg.  (1,250)
 -   Car Pmts  (800)
 (750) Food  (750)
 (200) Insurance  (200)
 (200) Utilities  (200)
 (100) Student Loan  (1,000)
 (2,500) Total Expenses  (4,200)
 208.33 Net Income  133.33

This is obviously an oversimplified example but hopefully it makes the point. Assuming all expenses are the same - with the exception of anything debt related - you can see that these fictitious families can live similar lifestyles despite the $30,000 difference in income.

The general takeaway here is that more income does not necessarily equate to more money, things, vacations. It also does not ease that "stuck" feeling in your head when disposable income is eaten up by car payments and student loans. Just Google the many "Real Housewives" who have lost everything in the past few years.

Takeaways
1) Spend less than you make: A very simple phrase but for some reason difficult to live by. Americans at every turn are encouraged to be consumers often times even to their detriment.
2) Think twice before taking a loan out for anything, including school: You may end up with a mortgage-sized load of debt to pay off - with no house attached to it.
3) More income is not always the answer: Explore your spending habits. You may be surprised to find ways to cut back even more than you first imagined.

Stay tuned,
Sarah
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