The road to financial health is a journey that can begin with simple, relatively painless steps. One way to get started is to apply a system to how you approach your household budget. Of course, the step before that step is to actually create a household budget, which unfortunately many individuals do not. How to improve your credit score by budgeting is relatively painless.
Americans are inherently optimistic people; we expect tomorrow to be better than today, including the amount of money we earn. This positive expectation has been one of the reasons for our decades of prosperity and economic growth. But when applied to our financial management, this expectation can cause trouble, particularly for individuals whose income is variable. And for most of us, our income does vary from year to year, up and down, even if we don’t remember it that way. Suppose you made $88,000 last year. You could reasonably expect to earn $95,000 this year, perhaps because the company you work for has cost of living increases, and you might get a merit pay raise. So what happens? You begin to spend as though you’re already earning that $95,000, ignoring the possibility that your income could actually drop next year.
In this recession, we’ve seen millions of people fall into this trap. As the economy contracts, so do the earnings for many of us. It doesn’t have to be as drastic as getting laid off. It might be something as minor as our company not being able to afford paying us a bonus. Or we have to offer our customers discounts to keep them buying from us, in the case of a retail store, or even a service provider.
People whose income is variable, such as commission salespeople, or people who work on a contract or project basis, are particularly vulnerable to falling into this trap. The extreme case would be people who, temporarily, earn the most money they possibly can over the course of their lives, such as pro athletes. They might earn $5 million a year for a few years, and unfortunately spend at that rate as well. It can be disastrous for them when their career ends, their income drops, but their spending habits stay the same.
One way to avoid this financial pitfall it to think of your income as a moving average of several years’ earnings; three years might be a good place to start. Maybe our person who made $88,000 last year, for example, earned $58,000 the year before, and $70,000 the year before that. Averaging these three years, we see that number comes out to $72,000. If this person made out his budget with this number being his assumed income level, he would be building up cash surpluses during good years that could carry him through lean years. Perhaps this recession would have been hardly painful at all, in terms of changes he would have to make to his lifestyle.
Improve your credit score by budgeting your expenses.