Most of us base our budget on our salary. And that seems to make sense.
The more we make, the more we can spend. And as long as we continue to spend less money than we make, we’ll never run out of cash.
To use an analogy, let’s think of our income as electricity and our bank account as a smartphone battery. In this analogy, our living expenses represent our usage of the phone and the resulting depletion of the battery.
Over the course of the day, we place calls, watch YouTube, read the news. Come night, the phone’s battery is just about empty.
But that’s not a problem because we know that, as long as we keep recharging the phone (i.e., collecting our paycheck), the battery will never go empty.
Salvation is just one electrical socket away.
So again, the idea here is that we spend money knowing our salary will continue to support that level of spending.
Unfortunately, while this approach to spending might sound like a safe strategy, it’s actually very risky. And if you’re not careful, it can get you into a lot of trouble.
Today, we’re going to talk about why it’s a bad idea to base your budget on your salary, and then we’re going to show you a much smarter and more secure way to calculate your monthly spending limits.
So if you are looking for a better way to budget your money, stick around.
The Danger of Spending What You Earn
Now I know I’ve just made a bold claim: your income shouldn’t influence your spending.
But I stand by it. Can you guess why?
Let’s go back to our battery analogy. You happily go about your day, sliding into DMs, swiping right. At some point, the battery warning flashes.
No problem. Let’s just plug it in.
But then something weird happens. You plug it in, and it doesn’t charge. That’s strange. You try a different power cord. No luck.
Now you’re starting to get concerned. You have an important call coming up and you need to get through your email backlog. You need this phone charged.
With a sinking feeling, you head over to the light switch to flick it on. “Click” goes the switch, but alas, no light.
Oh boy, the power’s out. And right on cue, your phone screen goes black.
Sadly, in the world of personal finances, this happens all the time.
We go merrily about our lives, knowing approximately how much money we spend, and how long until we get our next paycheck. We have a system that works.
Until it doesn’t.
People lose their jobs, for any number of reasons, and out of the blue, their income disappears. Now they’re stuck with their expenses, and no way of restoring that proverbial power.
That’s a stressful situation to be in.
A Better Way To Approach Your Spending
What if, rather than relying on our income like a sure thing, the way we rely on the utility company to power our homes, we instead approached things differently.
What if we kept a few portable power banks lying around the house, fully charged and ready to go. That way, if the power went out, we could switch to those temporarily.
That’s kind of like having an emergency fund of savings to get you through a medical emergency or an unexpected transition from one job to the next.
It’s an okay solution, but it’s not really something sustainable that we can rely on for our day-to-day.
We need something that can provide us consistent power, no matter how long the power grid is down. In other words, we need income that can sustain us indefinitely. An emergency fund doesn’t cut it.
In our battery analogy, we need solar panels on our roof, hooked up to a Tesla Powerwall that stores multiple days worth of electricity. The sun provides an infinite source of energy, and on cloudy days, the Powerwall fills the gaps.
In other words, your solar panels render you completely independent from the power grid. How liberating is that?
Believe it or not, such a solution also exists for our personal finances. Something that frees us from our reliance on our employer.
That something is called passive income.
And while there are many ways to earn passive income, the simplest and most reliable source of passive income is to invest your money in diverse, low fee, market tracking index funds.
When you invest your money in that way, it isn’t just sitting there losing value like it would in a savings account. You are instead putting that money to work. As humanity advances, your investments appreciate in value and pay out regular dividends, which also get invested.
The growing value of your investments is your passive income. The more money you invest, the more passive income your investments produce. It’s that simple.
This growing pool of investments results in a beautiful, compounding source of income that eventually covers your entire cost of living.
And if you invest the right way, your returns are surprisingly consistent over longer periods of time, which sure beats an unpredictable employer.
In other words, with a steady stream of passive income, you wouldn’t need to lift a finger to pay the bills. Not a bad setup, eh?
Now if you don’t have a brokerage account yet to set up this kind of passive income generator, no problem.
Pause this video and sign up for either Wealthfront or Betterment.
Both of these platforms make it super easy to get started. They offer a fantastic blend of diversified, low-fee, market-tracking index funds. And they customize your allocation based on your age and financial priorities.
My favorite part is that you can set up a recurring investment that pulls from your bank account every time you get a paycheck or when your bank account balance exceeds a specific threshold you set.
And since it’s automatic, you won’t have that painful psychological battle with yourself about market timing. The money gets invested without you even thinking about it.
I’ve invested with both Wealthfront and Betterment for years and can say they are equally excellent. You can’t go wrong with either. If you’re like me, go with both.
I’ve included links to both platforms in the description box below. You and I get a referral bonus when you sign up, which helps support what we do here at Stake Your Wealth.
Passive Income is Your New North Star
So THAT is what you should base your budget on. Your passive income. Your employer can’t snatch that away from you. It just keeps chugging, regardless of what happens to your job.
And notice how this passive income has nothing to do with your salary. At least not directly.
Because again, your salary is reliant on you having a job. Which you have very limited control over. You could be fired at any time. Or your employer could go bankrupt.
So I’ll say it one more time: when you base your budget on a source of income that you can’t control, you’re in dangerous territory.
That’s why your goal should be to build up a stream of passive income. Something you have much more control over.
Grow that passive income stream as much as you can, and use that as your basis for determining your spending power.
And to be clear, your salary is still important. Don’t go quitting your job just yet.
But your salary is important only insofar as it enables you to grow your pool of investments, which in turn will increase your passive income, which in turn increases your spending power.
So when you get your next paycheck, instead of thinking, “hmmm, how much of this can I spend”, instead dump as much of it as you can straight into your brokerage account, and base your spending on the passive income generated by those investments.
At first, you might be disappointed by how much lower your passive income stream is than your salary.
But that’s the price of true financial freedom. It’s slow to start, but as your pool of investments grow, it becomes incredibly powerful.
And just remind yourself: the more you grow your investments, the more passive income you’ll generate. And that’s income that no one can take away from you.