September 2019

8 Tips for Living on a Fixed Income

Author: Kent Thune

Living on a fixed income isn’t just for the retired; it’s a smart way to live. With downsizing, frugality, early retirement, and tiny homes increasing in popularity, the fixed income lifestyle is definitely not the one your parents lived. Here are some simple tips for mastering the fixed income life:

Spend less, save more.
Mastering a fixed income lifestyle is not about perfecting the art of spending 100 percent of your income; it’s about spending less than that by maintaining a saving mentality. Some simple strategies for spending less money include cutting coupons (for app lovers, use Groupon.com); buying non-perishable food items in bulk; cooking at home instead of eating out; and walking, riding a bike, or ride-sharing instead of driving a vehicle by yourself.

Understand your income.
Where’s your money coming from? If you’re retired, sources of income may include Social Security, pensions, and investment income. For everyone else, your money is coming from earned income that may include multiple sources, from part-time to full-time work. It’s important that you know precisely the total take-home pay for the entire household before building your spending plan.

Part of understanding your income is understanding your taxes. For example, if you have earned income (you’re not fully retired) and you receive a big tax refund each year, consider reducing your federal tax withholding by increasing the allowances on your W-4. This will put more money in your pocket each pay period, which will help put your money to work now rather than giving the government an interest-free loan every year.

Track your spending.
This tip could have also been titled, list your expenses. But you can’t create a complete list of your expenses without tracking your spending first. To track your spending, write down (or enter on a spreadsheet, if you’re a computer person), every single purchase you make, organized in categories, for three months. This way you’ll capture most of your regular expenses. Also, be sure you don’t miss the irregular expenses that occur randomly or less frequently, such as annual or semi-annual bills. Convert all expenses to a monthly amount on your spreadsheet.

To simplify the process of tracking your spending, and for all of your budgeting needs, consider an app that can be used on a computer or smart phone. The gold standard of budgeting apps is called Mint. According to NerdWallet.com, the app automatically updates and categorizes transactions, creating a picture of spending in real time. Users can add their own categories, track bills, split ATM transactions into the purchases made with that cash, and set budgets that alert them when they start to top out. The service app also comes with a free credit score.

Create a spending plan.
Budgeting is about as fun as dieting. Just the thought of it brings to mind unpleasant words like limitation, restriction and starvation. And this is why we’ll use the term spending plan instead! Another reason that “spending plan” is an apt term in this regard is that the greatest determining factor of success in living on a fixed income is allocating your financial resources. In different words, you need to have a smart plan for spending your money.

After you’ve tracked your spending (see above), start your spending plan by separating your wants from needs. Financial planners refer to these basic types of costs as discretionary and non-discretionary, respectively. Discretionary expenses are those that can be eliminated (or at least reduced). These are your wants. Non-discretionary expenses cover the costs of things you can’t live without. These are your needs. Once you’ve separated your wants from needs, focus on cutting costs in the discretionary column.
When creating your spending plan, don’t get too extreme. If you cut out all of your discretionary spending, you’ll end up frustrated and unhappy, which can lead to failure. As an alternative to eliminating discretionary expenses, consider reducing them. For example, instead of completely cutting out your favorite snack or beverage, try limiting it to once per week rather than several times weekly.

Avoid variable costs.
When your income is fixed, your expenses will ideally be fixed. This means you’ll want to avoid variable costs whenever possible. For example, one of the largest expenses for most people is housing. If you are renting or leasing, your housing expense is bound to go up in the future. However, the principal and interest portion of a conventional mortgage payment remains fixed for the entire term of the loan.

Be aware of inflation.
The biggest enemy of fixed income is the rising costs of goods and services, otherwise known as inflation. Although the rising cost of living has been relatively tame in recent years, inflation has historically averaged about three percent. Therefore, in theory but not always in practice, you can maintain your spending power if your income rises by an average of three percent per year. But if your income is fixed in the absolute sense (it never goes up), how can you stay ahead of inflation?

Although inflation is not within your control, there is one key component of your cost of living that is within your control—lifestyle inflation. If you can avoid the temptation to consistently and gradually increase your lifestyle with the bigger, better, newer stuff, you can also keep a lid on your cost of living and even reduce it.
For retirees living on Social Security and investments, you’ll need to factor inflation into your planning. Social Security income does get an annual cost of living adjustment (COLA), but your investments do not unless you’ve already planned for this.

For retirees: invest appropriately!
If you’re retired, investing for a fixed income can be challenging, to say the least. Not only are you fighting inflation, but you also face the challenge of balancing your life expectancy and tolerance for risk. Begin by expecting to live a long time. Statistically, almost two-thirds of 70-year old men and nearly three-fourths of 70-year old women can expect to live another ten years. About one-fifth of men and one-third of women can expect to live another 20 years (to age 90).

A good general rule for investing with inflation and life expectancy in mind is to assume you will need at least 80 percent of your pre-retirement income and you will live to age 90. If you want to make your investment portfolio last for at least 30 years, you can safely withdraw four percent of your account balance every year, assuming a three percent annual increase for inflation. This rule assumes an average rate of return on a moderate investment portfolio consisting of roughly two-thirds stocks and one-third bonds.

Don’t worry, be happy.
Living on a fixed income is not necessarily a stressful way to live. Cutting costs and finding ways to enjoy life on a budget can be fun and liberating at the same time. Most of our worries about money are programmed into our minds from popular culture and social media. You don’t have to save millions of dollars to retire comfortably, and you don’t have to go into debt up to your eyeballs to enjoy life before then. Just get good at spending less than you make, find joy in the small things, and happiness will find you. 

Kent Thune is a Certified Financial Planner® and is the owner of a Hilton Head Island investment advisory firm, Atlantic Capital Investments, LLC. He also provides financial counseling to Marines and other service members on Parris Island. Thune’s financial guidance has been published at The Motley Fool, Yahoo Finance, Kiplinger.com, MarketWatch.com, Nasdaq.com, InvestorPlace.com, and his own blog at TheFinancialPhilosopher.com.

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