This is a series of posts from Constant Rich: Personal Finance, a book written by the author of this post.
In the modern societies (as well as ancient ones), every individual requires an amount of money to live. Ideally, every individual has enough money to live comfortably and meets all of his or her needs. However, in reality, many people do not earn enough money to be living in that ideal world.
Traditionally, we used to categorize people as poor and rich. Those who seemed to possess many items and live in comfort were rich while the rest, who did not possess many things were poor. This traditional system is, until today, the dominating system of appraisal among the people. The guy who drives a Mercedes is richer than the guy who drives a Toyota.
But as any back-of-the-envelope system, the rich and poor method is flawed to its core. The system that many governments and financial institutions use is based on the monthly income. They assign a minimum wage and anyone who has an income below that of the minimum wage is below the poverty line and hence struggling. But there's a catch here. Many of the times, the minimum wage is unrealistically low and even those who earn significantly more than the minimum wage are far from a thriving life.
This gap requires us to use a more comprehensive (and yet simple) approach to see whether we are in a good shape or financially struggling. This system and many more are described in detail in my book but I assume here that you have not read the book (something that I suggest) hence I won't be using any of the specific phrases.
There are 5 criteria to financial struggle and if you meet any of them, you are sadly in a bad shape.
Your income is too low. You are able to survive till the end of the month, but are living below the standards and may have to cut some corners on the essentials such as food and clothing to be able to pay all the bills.
Your primary source of income is lost and you either don’t have any income or your income is significantly reduced. Obviously, you will be forced to spend from your savings and/or create debt by using your credit card, take a loan or borrow from a friend.
Negative cash flow: Your primary source of income is not lost but you have had a negative cash flow for the past two or three months (had more outflow than inflow, for any reason other than investments) and had to balance the difference from your savings or by creating more debt.
You have a primary source of income, have a positive cash flow (more inflow than outflow) and are able to live within the standards. However, you are not able to save at least 10% of your income to invest in the future and an attempt to do so will result in failure to pay your bills, debts, or covering your basic needs. This part of your income is critical to a thriving financial life. This part is meant to be used for investments that produce further income or capital gain and not to be used for buying an expensive item.
You have a primary source of income, have a positive cash flow and are able to live within the standards. However, you are not able to save at least 5% for a rainy day (which we call “emergency fund”), separate from the money you have saved for investments and an attempt to save 5% will result in failure to pay your bills, debts, or basic needs. This part, also, is an essential part of your finances, since an unexpected expense (for medical or legal reasons as an example) can really disturb the balance of your entire financial system.
The first three criteria are kind of obvious for the majority of people and almost anyone in the first three groups knows that they are in financial struggle.
The problem is with the people who are in the 4th or 5th group since many of them consider themselves to be financially strong and I can prove to you that they are not.
First, if you are not able to save at least 10% of your income and invest it continuously, your finances will never grow, it remains the same. It also makes your dependent on your primary source of income. However, you have to realize that 10% is the bare minimum and you should save even more. The more you save, the more you invest and the more you invest, the more u invest. The more you invest, the more extra income you will have and the cycle goes on with a snowball effect, with each cycle bigger than the last.
Second, life is full of unpredictable events. You should cushion your finances from unforeseen expenses. These expenses can put a dent in your finances and collapse the whole thing. If you cannot have a cash reserve for the rainy day, you are walking on the edge of the knife.
So, if any of the above criteria is true in your case, you are financially struggling. But what is the point of knowing that? Well, the way that you can overcome the struggle is different in each case, depending on the nature of your problem.
For example, those in the 4th and 5th category, usually have some hidden, extra and unnecessary costs which, after careful investigation can find and eliminate. On the other hand, the people in the 1st category, need to look for a higher primary job or get a second job, which is easier said than done.