Make a lot but still bad with money? Here's why.
It’s easier for high earners to be bad with money
Even some of the most intelligent and successful people struggle with money. In fact, it’s downright common. One of my favorite movies of all time is “Broke”, the ESPN documentary that shows in epic detail how so many athletes at the top of their game with multi-million dollar salaries end up completely bankrupt. Although this is a totally dramatized angle on the problem, lots of people with high incomes struggle with money.
It may seem counter-intuitive. Theoretically, making more money makes it easier to pay your bills and keep your debts in check. And, if you’ve seen the movie you know that many of the athletes depicted had little to no formal financial education (or, frankly, formal education of any kind). Obviously, doctors and lawyers and successful business people GENERALLY have more of a financial education to lean on. But still, they struggle with their finances.
Why is it so hard for high earners to keep their finances in line?
“I make good money… why am I always broke?”
There are three big reasons that high earners struggle with money: they are ignorant about their financial situation, they maintain a belief that their income will always support their lifestyle, and they make risky decisions because they have only known success.
Financial ignorance is the genesis of money problems
Recently, I have been a little obsessed with the idea that financial fitness is a lot like fitness in general. If you want to be fit, you have to work out, you have to manage what you eat, and you have to monitor your weight. The last part is crucial. If you are working out but you’re eating like a complete pig, you might still be gaining weight. If you never check your weight or look in the mirror, you can’t spot the issue before it becomes hard to handle.
It’s exactly the same with money. You have to work, you have to manage what you spend, and you have to monitor your net worth and cash flow. If you are making a ton of money but spending like crazy (particularly with credit cards), you could very quickly have a debt problem. Or, you might never be able to save.
This problem also shows itself in smaller ways. More often then you might think, high earners have a single checking account that they deposit their income into, pay their bills out of, and use for their discretionary spending. Then, they never really know how much money they have at any given moment; some of it is set aside for bills, some is discretionary, some might be savings but it’s all commingled into a big confusing pot. It looks like this:
As you might imagine, this makes overdrafts much more likely, along with overspending and undersaving. You have GOT to know where you are to get where you want to go.
Then, lifestyle inflation rears its ugly head
If you aren’t really sure how much money you have, it’s pretty easy to overspend. It’s even easier for high earners, because they know they are making a lot of money and that provides a false sense of security that their income will bail them out of any spending or commitments they might get themselves into.
Not to exempt myself from all of this, I’ll give my favorite personal example of how this looks in real life. A couple of years ago, I was looking for a new car. I had recently gotten a big raise and I really wanted to reward myself for all of my hard work. Now, I should mention that even though this raise was big in percentage terms it only amounted to around $800 a month in actual take home income. Here I was, shopping for cars, thinking “I make $xxxx, and I will totally keep on getting raises every year so I can easily spend $700 a month on this car lease.”
Of course, I ended up getting the car and for the next three years EVERY SINGLE MONTH it hurt so much to pay that bill. I loved the car, but in no way was it worth it. Just because I could afford it doesn’t mean I should have bought it. Over the course of the lease, I estimate that I threw away around $15,000 that I could have been saving instead. Stupid.
This also illustrates the other issue that makes this hard for high earners: you can get the financing to make the stupid decision even easier.
The invincibility complex compounds the problem
It isn’t just ignorance and lifestyle inflation that makes it hard for high earners to manage their finances, they also have a nasty habit of making risky or generally bad investments. When you are great in your field and you make a decent amount of money, chances are you have a lot of confidence. Although that is a good thing, it’s a really bad thing when it comes to investing.
In “Broke”, you can see a lot of the athletes pouring money into investments, loans, and businesses that are just plain stupid. “Normal” high earners make some of those same mistakes too, or they throw half of their net worth into high risk tech stocks or maybe their friends startup. They make a lot of money so therefore they must be good with money and logically that means they must be good at investing! All in on the options and TSLA stock! Then, when it inevitably takes a dive, they sell in a panic and lock in their losses.
The invincibility complex is often compounded for those who struggle with money in the first place. If you make a ton of money but you can’t seem to save enough, then taking a big risk on a stock or investment that might take off and clear all of your debts looks pretty attractive.
How to start getting your finances under control
At this point, you might be a little depressed. But, you shouldn’t be. Money is really, really hard, and just like going to the gym it’s something that you have to intentionally focus on to improve at. Here’s my three step process for getting your finances under control.
Set a solid financial foundation and monitoring system
My very first real post, and one of my favorites of all time, is my description of my financial system. Quite simply, instead of having a single checking account where all of my bills and discretionary spending go out of, I have TWO checking accounts. The “operating account” where I get paid in and I pay my bills out of: everything that is consistent and predictable. Out of that account, I pay myself my spending money into my other checking account, so I always know EXACTLY how much I have to spend at any given time.
As you can imagine, I also keep a hawks eye on what is happening in the operating account at any given moment. I also use my free Personal Capital account to keep track of all of my accounts, my house, my mortgage and even my incentive stock options so I know how much I am worth at any given time.
Combating lifestyle inflation with knowledge and budgeting
Keeping lifestyle inflation at bay is a difficult task, and for me it’s honestly the thing that I find the hardest. Of course, knowing where you are and what you have to spend makes it much easier to combat lifestyle inflation. Having a great, realistic budget helps make your decisions for you in the sense that you can easily identify what you really can afford, and what is out of reach. I also recommend simply getting rid of your credit cards if at all possible.
Invest intelligently and consistently
If you know where you are and you are combating lifestyle inflation, it shouldn’t be too hard to start making good investment decisions. You should definitely be prioritizing setting money aside for investing above and beyond your retirement contributions, since even exceptional post-tax retirement savings for high earners will likely not cover their bills in retirement.
Once you are setting some money away, you can use Personal Capital to generate model portfolios based on your risk tolerance for free. The best thing you could possibly do is stick to index funds, and invest a little bit every month over time. Be consistent and over time your balances will grow. If you’re lucky, you might even see some numbers like Jim, below.
Conclusion: Go to the financial gym
Although high earners theoretically have it good financially, that doesn’t mean they have it easy. It takes work to monitor, prioritize savings, and invest intelligently. The more money you make, the more work it takes.