Cutting costs

The Overhang sounds like a mystery novel, doesn’t it? Actually, there’s a Michael Connelly book called The Overlook, but the overhang I’m talking about isn’t a rocky outcropping from which the hero dangles by his fingertips. It’s a principle of personal finance that is about to save me a lot of anguish. (Just like the helicopter that’s about to appear and save our hero right before he loses his grip.)

Personal finance people talk a lot about the savings rate. In theory, the savings rate ought to be one simple number: how much am I saving compared to my income? In reality, it’s a lot more slippery: are we talking about pre-tax or after-tax income? Is debt repayment the same as savings? Should we distinguish between short- and long-term savings?

The overhang is a lot simpler. It looks like this:

The size of your overhang (double entendre intended) is a measure of your ability to withstand a reduction in income. Reductions in income happen all the time, some by nasty surprise and some by choice.

I’ve borrowed this idea from one of my all-time favorite personal finance books, All Your Worth by Elizabeth Warren and Amelia Warren Tyagi. The key insight in their book is what they call the Balanced Money formula: from your take-home pay, 50% should go to necessities, 30% to wants, and 20% to savings.

By: Matthew Amster-Burton

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