How Do I Escape the Middle Class Trap and Become Financially Secure?
If you’ve found yourself stuck in the middle class trap, and aren’t sure how to escape, then know you aren’t alone. I (and many others) have been in your shoes. The bad news is your situation currently sucks, but you already know that. The good news is that there is a way out. We’re going to review an action plan for how to get out of this trap and become financially secure. It won’t be easy. It might require some sacrifice or some hard work, but I promise you it will be worth it.
We will review the below key areas during this marathon of a post.
- Educate Yourself on the Basics
- Diagnose Your Problems
- Formulate an Action Plan
- Take Consistent Action
If this isn’t the first blog post you’ve read in the personal finance space, you’re probably used to choice overload. This is where the writer provides you with 10 different steps you need to execute, with each step consisting of 15 different options. You can save your money with online bank A, B, C, or D! I hated those articles when I was deep in throes of my personal finance self-education. Just tell me what to do, and don’t provide me with a never-ending list of options that I’ll never review and never cross-compare. Just tell me what you did.
Luckily for you, my hatred for choice overload runs deep. I will not be providing you with a list of never-ending options. I’ll just tell you what I did, and you can take it or leave it. If you feel strongly about an option I didn’t provide, then change my mind – leave a comment.
Without further delay, let’s get to it. First thing’s first, to escape the middle class trap and become financially secure, you need to:
1. Educate Yourself on the Basics
There is no getting around it. You have to educate yourself on personal finance basics if you are going to escape the middle class trap. This isn’t something that somebody else can do for you. You will need to put in the work. You will need to read books, listen to podcasts, and do some online research. The good news is that you don’t need to become the next Warren Buffet. You just need to have a baseline understanding of the below topics.
Budgeting
In a nutshell, budgeting is simply controlling your expenses so you have enough money left over each month to work towards your financial goals (e.g., retirement, building emergency fund, paying off debt, saving for a house, building real estate investing empire). Everyone hates budgeting and maybe you hate me for telling you that this is a required activity. However that doesn’t change the fact that it’s needed to become financially secure.
Would you be surprised if someone’s business failed because they weren’t tracking their income and expenses so they could make sure they turned a profit? No! Then why do you think you can run your personal finances without a budget and still accomplish your goals?
Budgeting doesn’t have to be a soul crushing exercise. Instead of thinking of budgeting as a burden, shift your mindset. Think of it as an empowering activity you can do to set yourself up for success in escaping the middle class trap and achieving your financial dreams. Does that help? No? Oh well, do it anyways.
Now that you’re super excited to start budgeting, we need talk about some general guidelines you should implement for your budget (i.e., how much of your paycheck should be spent on certain items). While there are a lot out different approaches out there, a very popular budgeting approach is the 50-30-20 budget.
The 50-30-20 Budget
This budgeting strategy says:
- At most 50% of your paycheck should go towards needs
- At most 30% of your paycheck should go towards wants
- At least 20% of your paycheck should go towards financial goals (debt payoff, savings, and/or investing)
This is a great place to start in establishing a budget. The beautiful thing is that it doesn’t require you to micromanage every single expense category. Once you have a firm understanding of your monthly income and expenses, you can adjust these percentages as needed. Then you can prioritize your financial goals and the speed in which you want to achieve them. If you have a mountain of debt you need to pay off quickly, then maybe you modify the percentages to 50% needs, 20% wants, and 30% towards debt)
As stated earlier, the financial goals portion of your budget is where you can prioritize paying off debt, building your cash savings, or investing. Let’s talk about these different goals.
Debt Payoff
In the world of personal finance, there are typically just two methods of paying down debt: snowball and avalanche. Both of these methods come with the assumption that you have more than one outstanding loan balance, because both provide guidance on the order in which you should pay down your debts.
If you only have one credit card that has a large balance then you don’t seed to get fancy. Just get aggressive in paying it down. Of course, people sometimes get a debt consolidation loan as well. This lets them make payments towards one debt amount instead of several different accounts. If you got a debt consolidation loan, then the snowball and avalanche debt pay down methods don’t apply to you either.
Snowball Method
Under the snowball approach of paying off debt, you arrange your debt in order from the lowest balance to the highest. You put all of your focus towards paying off the lowest debt first, while continuing to make the minimum payments on the rest. Once the lowest debt is paid off, you move onto the second lowest debt, while continuing to make the minimum payments on the rest.
This approach is recommended by some financial gurus because it gives people some wins. They can see progress towards their debt payoff goals. If someone tried to pay down a massive balance first, then they may get discouraged when they aren’t paying that debt off quickly and give up. Unfortunately, this method isn’t the most financially sound because you may end up taking longer to pay off your high interest debt, which will cost you more in the long run.
Avalanche Method
Under the avalanche approach of paying off debt, you arrange your debt in order from the highest interest rate to the lowest. You put all of your focus towards paying off the highest interest rate debt first, while continuing to make the minimum payments on the rest. Once the highest interest rate debt is paid off, you move onto the second highest interest rate debt, while continuing to make the minimum payments on the rest.
This approach will minimize the amount you pay in interest (i.e., the cost of your debt) because you are prioritizing paying off the highest interest debt. Financial gurus know that this approach makes the most sense financially, but they tout the snowball method because they know that the debt payoff journey is an emotional one, and it’s important to get some early wins.
Bonus (My Approach) – The Snowlanche Method
I had multiple loans and I didn’t want to get a debt consolidation, so I needed to choose between the two different debt pay down methods. Instead of choosing one, I decided to go with a hybrid approach. I believe this approach provides the best of both debt pay down methods.
Under the snowlanche method, you pay off your lowest balance loans to gain momentum and a feeling of accomplishment. Ideally, you’re able to pay these loans off in 1-3 months so you can get some quick wins and then shift focus to the highest interest rate debt next. This allows you to get some early wins but also minimize the amount of interest you pay during the whole process.
Saving
Look, I get it. Saving is one of the most boring things you can do with money. Spending money is super fun. Investing money and watching it grow is super fun. Squirreling away money into a savings account and having it just sit there isn’t super sexy, but it’s needed. If you aren’t good at saving and you don’t have some funds set aside for emergencies, or future financial goals, then you will have to take on debt to cover them. You don’t want to do that.
For the longest time, I thought saving was silly. I had a good job, and steady income. Why would I need to save? Then I had a family and I realized how truly important savings are.
Before we get into what it’s important to save for, let’s talk about where these savings can be placed. I understand that it’s hard to get behind saving when the savings accounts your bank provides only give you a .25% annual return on your money. This is garbage. Why would anyone put money into a savings account that is going to do significantly worse than inflation?
High-Yield Savings Accounts
In my personal finance journey I learned about high-yield savings accounts. These are savings accounts that actually pay a decent interest rate return on your money. Most banks that provide solid returns through these types of accounts are online banks, because they don’t have all the overheard that your typical brick-and-mortar bank does. This doesn’t mean the banks are less reliable. Your money is still insured by the FDIC.
I decided to use Ally because it showed up on just about every blog when I searched for “best high yield saving account banks”. Also, it came with a 4+% annual return. On top of the great return, Ally has a very cool feature where you can break down the money in your savings account into buckets that have specific labels, such as “Emergency Fund”, or “Home Down Payment”.
Now that you know a great options for where to place your savings, let’s talk about some key areas of focus for saving.
Emergency Fund
Typical personal finance advice says that you should have 3-6 months of living expenses saved in an emergency fund. The more sporadic your income or the less stable your job, the larger your emergency fund should be. If your income is super hit or miss, then you should exceed the 3-6 month rule of thumb. Instead strive to have 12 months worth of living expenses saved up.
If you have a low savings rate (i.e., you don’t have a lot of money left over at the end of the month), then saving up 3-months worth of living expenses might seem impossible. I felt the exact same way, and that is why I decided to build my emergency fund in phases.
- Phase 1 – Save 1 month of living expenses for emergency fund
- Phase 2 – Save an additional month of living expenses for a total of 2 month emergency fund
- Phase 3 – Save an additional month of living expenses for a total of 3 month emergency fund
- Phase 4 – Build emergency savings to six months of living expenses
You might be thinking that these phases seem pretty obvious. Of course you have to save one month worth of living expenses before you get to two. You’re right, it isn’t super creative. However, where I get creative is when I carry out each phase, and where it falls in my personal finance roadmap.
Future Opportunities
Once you have a base emergency fund saved up, then you need to take a look at your goals for the next 2-3 years. This helps identify if you should keep aggressively stockpiling cash, or if you should start investing some of your money. Given that the stock market isn’t guaranteed to provide you positive returns over a short-term investing period, it isn’t super smart to put all of your short-term cash (e.g., cash that is to be used on a major purchase in the next 2-3 years) in the stock market.
It will always be a good idea to have some additional money sitting around for future opportunities. If your neighbor knows you are into real estate investing and they ask if you want to buy their house for a fantastic price, you don’t want to miss out on this opportunity because you put every dime you had into the stock market and it’s down 20% on the year.
Have some additional money sitting around (and earning interest in a high-yield savings account). The amount heavily depends on your interests and goals. If you aspire to invest in real estate, then you should probably have a good amount of cash saved and earmarked for future opportunities. That way you can jump on a great opportunity when it presents itself. If you just want to invest in the stock market, then you can probably get by with your future opportunity cash pile being a little smaller.
Investing
Getting to this stage should be the primary goal of your personal finances. We budget so we have left over money to invest; we pay off debt so we are able to invest; we save an emergency fund so we can invest without taking on the risk of not being able to pay our bills if our investment loses value, we lose our job, or have a large unexpected expense. Investing is how you get wealthy. You cannot save yourself to wealth.
Some people have a fear of investing. They don’t want to lose it all. I agree with the sentiment of not wanting to lose it all, but investing doesn’t have to be scary. In fact, it can be quite simple. The secret is to not “invest” (read as gamble) in unproven methods. I keep it simple and invest in the low cost index funds provided by Vanguard.
There are book written and studies performed by people much smarter than me that have proven this is the best way for the average joe schmo investor to become wealthy with the least possible effort. Don’t believe me? Read The Little Book of Common Sense Investing by John C. Bogle, or The Simple Path to Wealth by JL Collins and then get back to me.
If you want an investment that you can physically touch, and don’t trust the stock market with your financial future, then get your hands dirty in real estate investing. This is certainly my long term goal. If you’re looking for a one-stop shop for all things real estate investing, then check out the real estate investing books, podcasts, blog, forums, and community over at BiggerPockets.
2. Diagnose Your Problems
After you’ve educated yourself on some basic finance best practices and rules of thumb, then the next step is to diagnose where your finances are currently going wrong. When it comes to problems in personal finance, the root cause of your issues likely lies in one or both of the following areas:
- You overspend (i.e., live outside your means)
- You don’t make enough money
If you read my origin story or my most atrocious money mistakes, then you’ll know that the majority of my problems came from overspending. Spoiler alert: If you have over $100k in non-mortgage debt and you’re throwing $2500 towards consumer spending debt payments every month, then you likely also have a spending problem too. Welcome to the party!
Sure, I would’ve loved to earn more money, but like Puff Daddy/P. Diddy/Diddy/err Sean Combs said, that would likely have just led to mo’ problems if I didn’t get my spending under control beforehand. However, I’m getting ahead of myself. Maybe your problem isn’t overspending and maybe your problem isn’t so glaring. Let’s dive into how you can diagnose the root cause of your financial woes.
Create Mint Account and Gather Last 90 Days of Income and Spending
This doesn’t need to be hard, but it will take some time. Luckily, there is software out there that makes this significantly easier than it would have been 20 years ago. I used Mint for this exercise. Sure, there are a lot of other options out there if you are so inclined to do your own research. However, Mint is incredibly well known and run by Intuit. This is the same company that runs the highly successful Quickbooks and TurboTax. This was good enough for me.
If you have never used Mint before, then you will need to create an account and link your various financial accounts (e.g., bank accounts – checking and saving, investment accounts – brokerage and retirement, credit cards, buy now pay later accounts, mortgage account, and property). Once your accounts are linked, it will import your current balances along with the last 90 days worth of transactional activity.
It is very straight-forward and INTUITive, but here is the Mint quick start guide if you have questions along the way. Could I have wasted page space, provided you with the same exact steps that are listed on Mint’s website, and pretended like I knew how to set up a Mint account more than Intuit? Sure, but I’d rather save my time and pass you over to the experts.
Use Mint to Compare Your Expenses to 50-30-20 Rule
Once you have your Mint account and you’ve imported your transactions from your various financial accounts, now would be a good time to see how your current spending habits measure up against the 50-30-20 rule that we reviewed earlier.
- Log into your Mint account
- Select Transactions from the left-hand menu
- Select Edit next to one of your expenses
- Select “Manage Tags” under the Tags section
- Select Edit next to All Tags
- Select Add Tag and enter the Tag Name “Want”
- Add another Tag and enter the Tag Name “Need”
- Review all of your transactions for the last 90 days and assign a tag of Want or Need to each expense. I highly recommend using the “Edit Multiple” feature to assign a Want/Need tag to multiple transactions at once
My Want/Need Breakdown by Category
If you’re wondering what expenses should be considered a Want, and what should be considered a Need, below is what I did.
| Expense Category | Want/Need |
|---|---|
| Mortgage/Rent | Need |
| Day Care | Need |
| Debt Payment Minimums | Need |
| Groceries | Need |
| Auto Insurance | Need |
| Gas | Need |
| Auto Services (Oil Change, Maintenance and Repairs) | Need |
| Cell Phone Bill | Need |
| Utilities (Water, Electric, Gas, Trash, Internet) | Need |
| Entertainment Subscriptions (Netflix, Disney+, etc.) | Want |
| Fitness Memberships (Peloton, Gym) | Want |
| Amazon | Want |
| Vacations/Weekend Getaways | Want |
| Personal Services (Haircuts, etc.) | Want |
| Home Services (Cleaner, Pest Control, Weed Control) | Want |
| Eating Out (includes Coffee Shops) | Want |
Expense Category Breakdown for Want/Need
Feel free to modify the Want/Need categorization as you see fit. Maybe you are skilled in the world of car maintenance and you’re able to do the work yourself. You might consider paying someone else to perform this work for you as a want. You can do it, but you want to pay someone else to do it so you can free up some of your time. I know nothing about car repair (nor do I have the time or desire to learn), so I need to pay someone to do it for me.
Compare Your Wants and Needs Against Your Income
Once you have assigned a tag of Want or Need to each expense, you can look at your Spending Trends by Tag.
- Select the Trends option on the left-hand menu
- Select the By tag option under the Spending graphs option
- Modify the time period as needed
Use these totals and divide your take-home pay by them to come to your want and need percentages (e.g., Want Total / Monthly Take-Home Pay = Want %). How do you compare against the 50-30-20 rule? If you’re like me, then this likely taught you a lot! I learned that my “Needs” were 57% of my take-home pay. Also that my “Wants” were 27%, but much higher than anticipated. All those Amazon orders, Starbucks, eating out, and weekend getaways add up!
Gather a List of All You Debts
Now that you know where your spending falls in terms of wants and needs, it’s time to rip off the band aid. It’s time to take a look at all your debts. If you imported all of your debts into Mint as part of the account setup process, then you should have a consolidated view of your debts. However, Mint will not reflect the interest rate or the minimum monthly payment for each debt. You will want to gather those details from each lender.
Below is a table of my non-mortgage debts as of June 2023. I call this list my “Dumb Debt List” because a dumb financial decision caused the debt to land on my family’s balance sheet. Even if the interest rate on the debt is 0%, I still want to pay off the debt so I can put the dumb financial decision behind me and move on with my life.
| Debt (Interest Rate) | Total Amount | Minimum Monthly Payment |
|---|---|---|
| Affirm Loan #1 (0%) | $1,000.01 | $71.50 |
| Affirm Loan #2 (0%) | $1,021.12 | $113.46 |
| Credit Card (21.24%) | $3,111.03 | $40.00 |
| Sprinter Van (4.9%) | $67,783.55 | $1,376.37 |
| 401K Loan #3 (3.5%) | $4,615.88 | $90.96 |
| 401K Loan #2 (3.25%) | $8,127.68 | $180.80 |
| 401K Loan #1 (3.25%) | $8,758.55 | $180.80 |
| AC/Furnace (0%) | $12,922.00 | $359.94 |
| Total | $107,339.82 | $2,413.83 |
I did not include my mortgage in this table because I do not consider it a dumb debt. If anything, it was a smart financial decision. We bought a house that wasn’t the nicest house we looked at, but we knew we could easily afford it. We do not plan on paying anymore than is required every month for the duration of the 30 year mortgage.
3. Formulate an Action Plan
You’ve educated yourself. You have reviewed your spending habits. You’ve compiled a list of your debts. Now you’re ready to make a plan on how to better your financial situation. The question is, what do you prioritize? Do you pay off debt first, save up an emergency fund, or start investing? Common sense, and most financial gurus out there have you initially prioritize saving and paying down debt. Investing is a necessity. However, it’s also a privilege that is afforded by making smart financial decisions in your life.
Regardless of your goals, it is important to not let your spending eat into the money you are earmarking for those goals. That is some very common advice is to “pay yourself first.” If you have decided that you want to allocate 25% of your paycheck towards debt pay down, then update your direct deposit settings to automatically deposit 25% of your pay check into a debt pay down account.
My Action Plan
My initial financial goals are to build an emergency fund to provide my family with financial stability, and pay off debt so we’re able to save and invest more aggressively in the future. The below table reflects my roadmap to financial wellness. It is worth noting that during the time it takes to complete these steps, I will continue to contribute to my 401k (up to my employer match, which is 6%). The employer match is free money and I will not turn that down.
| Focus | Detail | Benefit |
|---|---|---|
| Save | Save 1 month of living expenses for emergency fund | Provides my family with some basic financial stability that should prevent us from taking on additional debt throughout our financial reboot |
| Debt | Pay off Affirm Loan #1 (0%) | Frees up $71.50 every month that can be used towards other debt payments |
| Debt | Pay off Affirm Loan #2 (0%) | Frees up an additional $113.46 every month that can be used towards other debt payments |
| Debt | Pay off Credit Card (17.49%) | Frees up at least $40 every month that can be used towards other debt payments, but more importantly, it prevents us from falling into further debt through accumulated credit card interest |
| Debt | Pay off Sprinter Van Loan (4.9%) | Frees up an additional $1,376.37 every month that can be used towards other debt payments |
| Save | Save an additional month of living expenses for a total of 2 month emergency fund | Provides my family with further financial stability |
| Debt | Pay off 401K Loan #3 (3.5%) | Frees up an additional $90.96 every month that can be used towards other debt payments, but more importantly, it gets that money reinvested in my 401k |
| Debt | Pay off 401K Loan #2 (3.25%) | Frees up an additional $180.80 every month that can be used towards other debt payments, but more importantly, it gets that money reinvested in my 401k |
| Debt | Pay off 401K Loan #1 (3.25%) | Frees up an additional $180.80 every month that can be used towards other debt payments, but more importantly, it gets that money reinvested in my 401k |
| Save | Save an additional month of living expenses for a total of 3 month emergency fund | Provides my family with further financial stability and accomplishes a milestone that makes me comfortable to start investing into an after-tax brokerage account |
| Invest & Debt (50-50 Split) | Use after-tax brokerage account to invest in index funds. Pay off AC/Furnace loan | Starts to build my family’s wealth through investing, and eventually frees up $359.94 every month that can towards investing and saving cash for future financial opportunities (e.g., real estate investing) |
| Invest & Save (50-50 Split) | Use after-tax brokerage account to invest in index funds. Save cash for future financial opportunities | Continues to build my family’s wealth through investing, and saves cash for future financial opportunities |
4. Take Consistent Action
Congratulations! You’ve educated yourself on finance basics, taken a look at your finances, diagnosed your problem(s), and put together an action plan for how you can improve your financial position. These are some huge first steps, but they will lead you no where if you don’t put your plan into action.
Be sure to continue to adhere to personal finance best practices, which will include:
- Discussing your financial plan and progress with your partner (at least monthly) – this step is absolutely critical if you are going down this long, difficult path with a partner. You must be on the same page to be successful
- Sticking to your budget – monitor your expenses at least weekly so you can make sure you’re hitting your 50-30-20 (or whatever percentages you came up with) budget
- Checking your debt balances monthly – checking more frequently will do nothing for your psyche (trust me I know). Check in monthly so you can watch your overall debt balance go down over time
- Monitoring progress on your savings goals – are you on track to hit your emergency fund?
- Identifying ways to increase your income – being solely reliant on once source of income is an outdated practice that leaves you vulnerable. Find ways to build additional income streams
- Continuing to educate yourself in the world of personal finance – read a new personal finance book every month. Update your phone’s newsfeed so it shares personal finance articles with you. Listen to podcasts
- Revisiting your financial goals – Do you need to increase your emergency fund because you had a new kid and you need to have additional money set aside for childcare? Do you want to start a business, so you want to boost your emergency fund to 12 months of living expenses? Have you gotten the real estate bug, so you want to switch from investing in low cost index funds to rental property? Review your financial goals to make sure you’re still hiking towards the right financial peak
If you read this entire article, then you’ve proven to yourself that you are dedicated to improving your financial situation. Don’t delay action. Take it now. Your future self thanks you.
