Financial Freedom
Getting your finances to behave…maybe for the first time.
When it was finally divorce I looked at my finances. I realized that any emergency would be a catastrophe as there was nothing for an emergency in the bank. My grandmother would call it a rainy day fund. My parents didn’t talk much about money when I was younger but, like most Americans, I had been living paycheck to paycheck for most of my married life. There were also legal bills from my attorney and a few thousand dollars’ worth of medical bills to deal with. Starting a new life for yourself means you have the opportunity to start taking steps in cleaning up financial life too.
Luckily there is no lack of good information from many experts on how to get about doing that. From the Bible to anyone of a dozen good financial advisors, the steps are very simple and only very slightly from one from one guru to another.
Our in game to have no credit payments and a nest egg to handle emergency costs. Ranging from the odd $350 car steering pump to losing a job and having to cover several months expenses until you replace your paycheck. If you have followed recommendations from previous chapters, you already have a basic budget for your new life. Now that you’re living that new life, you have real figures and can put a finer point on it. Your first step is to create a revised budget so that you have plans for each dollar that you make.
Most Americans live paycheck to paycheck and have no money for emergencies. Additionally they are not putting any money into a retirement plan. It has been getting worse and worse since the marketing of free money in the form of consumer credit got started 50s and 60s with the DinersCard, BankAmercard, DiscoverCard and buying autos on credit. It continued to get even worse with payday loans and 90 days same as cash.
The key to not living paycheck to paycheck is simple, spend less than you make. Easier said than done. We can’t address all of the issues that caused you to handle your money the way that you do, though at some point you will want to consider looking at where you got your values regarding money and sort them out. Maybe your family and background told you men handle money a certain way, or that money and people who have it are evil, maybe you learned to buy stuff you can’t afford to impress people you don’t even like or know, like Dave Ramsey says. Whatever emotions you have attached to money, the fact is that money is money is an inanimate object. It is neither good nor bad. It is like a concrete block or brick. It could be used to build a school or crackhouse, to smash a window or as a weapon. It is just a tool and any emotional connection we have with money is something that we are going to have to overcome eventually. For now though we need to act as if we’ve already overcome it and just take the right steps. Steps that have proven themselves out for millions of people. Try and focus on following them and not trying to second-guess them.
Use the cash flow forms in the appendix, a computer program, spreadsheet or your own budget.
One concept that is ancient is that you have to pay yourself first in order to ever make any financial headway. You may balk at this but please trust me it is critical to your getting anywhere. Let’s start with saving 10% of your pay. Because most folks have a very difficult time making this happen, we’re going to have to simplify it by setting up an automatic transfer on each paycheck to our savings account. You will likely find that you will have more money available on one check versus another. That’s not a problem. Let’s say you make $3000 a month as an example. $1500 on the 1st of the month and $1500 on the 15th month. You can put $150 each paycheck into your savings account. But if your expenses are not evenly distributed, there’s no problem with putting different amounts in savings on each paycheck, so long as they total up to being 10%. You can set this up to happen with your bank. This can be done at the physical office or even more simply with a telephone APP. If you’re not tech savvy you’ll be able to accomplish much the same thing visiting your payroll, bank or credit union. Just find something that works for you. Again the easiest path to successful savings is with your current bank and setting up automatic future transfers into your savings account.
Go through your budget and start by plugging in what you need to live on. Groceries, gasoline, rent etc. When it comes to your debts find out what the minimum payments are and insert those. Don’t expect smooth sailing from the beginning but do expect gradual improvement. Your past with money may cause you some difficulty. You may find yourself transferring your savings back to pay for gasoline and groceries at the end of the month. Don’t beat yourself up, it takes a few months to get this budget thing really working.
Two areas that I have found are especially difficult are groceries and entertainment. I have found that these can easily get completely out of hand. I started off planning $100 per week cash for groceries in 100 per week for entertainment. I find using cash for these two items makes you aware of your spending. This helps to encourage you to make a grocery list and actually forces you to pay attention to food and entertainment prices. With an entertainment (dating) budget you will be more willing to cut off a date at the coffee, wine or drinks stage, if the one you’re with doesn’t show signs of attraction. Saving your money in favor of a relationship of mutual attraction.
Now that you have your budget you may find you have more money at the end of your month. If you have more that’s great! You can add it to your savings. The idea is a zero-based budget with a minimum of 10% savings. What if you’re short? Look at the debt payments. Are any of them ones that you haven’t been paying in the past? If they are already past due and are in collections, you can leave them out for now with little effect until you’re ready to negotiate them. Do you have medical bills you’re making large payments on that you could lower to say $25 a month? Can you lose cable TV or house phone? Now that you’re divorced, can the adult children start paying for their own cell phones or car insurance? If none of these are working for you may be able to lower your grocery expense. If you are careful getting as low as $200 a month or even $100 a month is possible if you get really serious. There are plenty of YouTube videos on how to do.
Be careful about cutting your entertainment/fun budget though. Remember you replaced food with people and activities and you don’t want to become a hermit to cut costs as that will set you up for failure. If you still can’t get traction on your budget and get your budget to behave, you may need to make some more drastic steps. If you already have an automatic deposit to a retirement program this might be the time to stop it temporarily until you get your debts paid off. Then you can restart it when your more under control. You might want to take a look at a cheaper apartment, or a two bedroom apartment with a roommate situation or even a shared room for a while until you get debt free. But this is a last resort, your independence and freedom has been hard won and taking a woman to an apartment with a roommate will definitely cramp your style. The freedom of your own place has a significant positive effect on your well-being.
Now that we have our budget set up what are we saving for? First, our rainy day fund or emergency fund. There is no perfect amount but most experts put it around $1000 to start. This fund will give you some breathing room and will cover most emergencies. A blown tire, speeding ticket, airline flight to a dying relative and the like. Getting to $1000 is the first step, as emergencies occur you will return to this step until the fund rises above $1000.
Now we are ready for the next step which is becoming free of all debt; except for your home mortgage if you have one. Just think what a great feeling it will be when you’re no longer a slave to the lender. Start by making a list of all your debts, the current payment amounts you make and their minimum payment amounts. Then put the list in order from smallest to largest debt.
Example
Balance What I Pay Minimum Payment
Citibank $275 $100 $30
Medical bill $375 $200 $25
Personal loan $1250 $150 $80
Attorney $1500 zero Due in full
Car $4800 $240 $240
Next Steps
Let’s say you have $1400 in your savings. That means that you have $1000 in your emergency fund and $400 allocated to pay off debt. You will pay off the $275 Citibank debt, since it is the smallest and then each month increase your savings budget by the $30 Citibank payment you no longer have to pay. So with our example of a $3000 per month income, that means you will be putting $300 per month into savings plus the additional $30 payment or $330 per month. Anything extra you have above the $1000 emergency fund, you will use to pay off the next largest debt. Each time you pay off a debt it increases the amount you are savings each month. In football it’s called momentum. Dave Ramsey, the popular money coach, calls it a “debt snowball” because it gets bigger and bigger as you pay off your debts faster and faster. It works great! Dave also warns us not to be tempted to pay off the larger debts first because they have a lower interest. He says it is a mental game and the paying off of the smaller one’s first will get us psyched up and prepared for the larger ones. Additionally, he says you have more money available to knock them out quicker after you’ve eliminated the other minimum payments. To put it more metaphorically, at the beginning it’s like cutting down a tree with a buck knife, by starting off with cutting down a sapling, your smallest debt, it is pretty easy and by the time you get to the trees, your biggest debts, your wielding a chainsaw.
You can screwed up quickly if you don’t follow these simple instructions. Part of why it works so well is that takes the human psychology and emotion of poor money relationships into account. Do not change the steps using your own logic. As an example you decide that it makes much more sense to pay off your car loan because it’s at 13% APR while your Citi Card is only 9%. Now if you had a math problem, that might be true and it might be a wise decision. But we have emotional problems with money and not a math problem. If it were just a math problem you would’ve never gotten CitiCard in the first place, and if you had gotten one for some logical reason you would have never carried a balance on it, nor would you have bought the car for anything but cash. Math was certainly not my problem math and it’s probably not yours. The value of getting those first smaller debts paid off quickly and building momentum so you’re ready to attack that $4500 card cannot be overstated!
Another caveat, do not go ahead and dip into your emergency fund to pay off a debt early. Let’s say you get hit with an emergency of $600 for a car repair and your emergency fund has now dropped under $1000. You been looking forward to paying off the next debt and in your mind will be tempted to just pay it off anyway taking your funds still further below a thousand dollars. But trust me Murphy will come to see you. He goes door-to-door knocking. If you tell him, “Piss off! I got a $1000 emergency fund!” he’ll sadly beat it and head to the next guy’s door. But if you only got $180 in your emergency fund, he will hit you with a $300 emergency forcing you to do something you shouldn’t like sticking a spare tire on your car for a month instead a pair of new tires, spending your food and entertainment cash on the emergency or something really stupid like taking out a payday loan. Don’t do it Murphy’s just waiting. You must take the time needed to rebuild and replace your emergency fund before continuing to pay off debt. As time goes on you will find Murphy will become more and more of a stranger and emergencies will come less and less.
You might end up with a special situation from your divorce, the attorney’s fees. If you’re like most guys you gave your attorney an initial retainer upfront. They are aware how scarce money can be after divorce. However many times there are additional retainers, charges or fees that are added on. You’ll need to talk to your attorney and see if you can make payments until you pay it off as part of the debt snowball or not. Remember, attorneys can make your life hell, so don’t piss them off. You may have to pay them off first and immediately. So you will have to let your emergency fund and debt snowball wait. Try to get your attorney to allow you enough time to at least get a $500 emergency fund in place. Then do the scorched earth, living on beans and rice thing and pay them off as soon as possible.
Once you are rolling along your target is to be debt-free except for your mortgage in less than two years preferably closer to one. If the numbers show this is not possible try to identify why not. Do you have too much car? You might think of selling it and getting something more reasonable for your situation. If the Kelly blue book for private sale your vehicle is more than half of what you making per year, the answer is probably yes, you have too much car. An example would be a teacher making $50,000 a year driving a $40,000 pickup. Sell the truck and get a decent $5000 car. When your debt is all paid off you can save the amount you would normally make for a cars monthly payment, then you can upgrade to a better vehicle for cash in the future.
The other problem you might have is owning a car that is very expensive to maintain. Examples would include a Jeep, BMW, Volvo, Jaguar, Land Rover, Mercedes and all supercars. These vehicles cost several times more to maintain than Toyotas, Hondas and Nissans. So even though you may have a late-model BMW that’s all paid off. You could be in a position where you’re afraid to drive it because it seems like every time you do it needs $1,000 in repair shop work. If this is your situation, you might be better off selling the car and buying something practical for your debt snowball.
Celebrate each debt being paid off and make note of it. Put a list of those paid off debts on the refrigerator or the back of the kitchen or bathroom cabinet door. Make it part of your daily meditation of what you’re grateful for. It’s easy to feel like you’re getting nowhere, even if you have an emergency fund and have paid off $3000 in debt, if you dwell on the $5000 of debt remaining and an unexpected $300 medical claim that showed up the mail. You need to remind yourself of $3000 you paid off. Otherwise you’ll get disheartened that the $5000 is now $5300. Like paying off debts from smallest to largest, it’s a mental game.
Finally the day will come, your debt free! Possibly for the first time in decades. Celebrate!
Enjoy it, enjoy the freedom you feel. You no longer are slaves to the lender. The giant credit and banking marketers no longer have a piece of you. Let that sink into your mind and stay that way.
Our next goal is a true emergency fund. Our initial fund covered the most likely little emergencies that occur frequently but not anything major. The loss of a job, blown car engine or a surgery with a $7000 deductible, will put you right back to where you were drowning in debt. Life is good debt-free and we want to keep it that way.
I like to call this an attitude fund. Our fully funded emergency fund is going to be 3 to 6 months of living expenses. It is not 3 to 6 months of income so take your expense budget, remove the extras you would cut in case of emergency and remove any savings. Now you’re left with how much you need to put away for a rainy day. Decide how many months of savings you want based upon your tolerance for risk and how stable your work is. If you’re in a profession that is stable, your work is secure, you’ve been there for a number of years and have no expectation of being laid off or having to quit, then you can lean towards three months. The midcareer math teacher perhaps would be an example of this. The more precarious your employment the closer to six months you want to be. A salesman, new to the company and possibly even new to sales might be closer to six months. Someone in a boom or bust job like a driller on an oil rig might choose six to even twelve months if they have no mortgage and with a mortgage perhaps two years might be a good emergency fund for them.
Whatever amount you choose; that is your next financial goal. For most people were looking at between $10,000 and $35,000 for their fully funded emergency fund, rainy day fund, attitude fund or whatever you want to call it.
At first just let your savings account grow past the initial thousand dollars, but after you’ve got a few thousand dollars in there, go-ahead and skim off everything over $1000 and open a money market account that includes a debit card and check writing privileges. Future deposits can be made each month or every few months by transferring everything out of savings above the thousand dollar mark and putting it to your money market fund. You may even be able to make arrangements for the bank to do this automatically. I personally enjoy writing the check with the comment,
“emergency fund” on the memo line.
Why money market account? Your emergency fund is really insurance it is not an investment. You might be tempted to put it into something that gives you more interest, but that’s not its purpose. We want it somewhere that is available for emergencies and is completely liquid. That’s why we’re not putting it somewhere to make interest and requires you to sell shares in order to access your cash. You can pay for any emergency or get cash with a debit card a check.
Finally, we have really become weird compared to our friends and family. Unlike most Americans we have no payments, no debt and were not living paycheck to paycheck anymore. Rumors about layoffs at work don’t send us into panic mode longer and we have taught our money to behave.
What’s next is saving for retirement. Again this will be fairly simple from a mathematical standpoint. We will adjust our budget so that we are no longer saving but rather putting away 15% of our income to go to retirement. You decide it’s to be 15% gross or net, that’s up to you, but if you’re over 40, I’d suggest doing gross, especially if you haven’t any retirement savings or pension yet. We want to get the most tax-free benefits we can and we want it to be very safe. As much as possible we will put it into the following, in this order, invested in a diversified selection of mutual funds with a good track record.
1. Employer 401(k) type of retirement pretax where the employer matches
2. 401K type investment where our employer doesn’t match
3. IRAs pretax
4. Roth IRAs.
As an example an accountant makes $50,000 per year after taxes and has decided to save 15% of his net. 15% of $50,000 is $7500 per year. His CPA firm matches the first $5000. He has his human resources/payroll department put $5000 into a mutual fund program automatically. He could put more and without a match, but after looking at the mutual fund choices, he has discovered there aren’t very many choices of funds, so he decides to open an IRA outside of his company with a brokerage firm that has more choices. He puts the remaining $2500 into a traditional IRA pretax account.
Once you decided on how much is going where, you’ll research the mutual funds and find three funds to put your money into. What you’d like to do is split it among three funds. First, a high-growth large-cap fund, second a foreign investment fund and lastly in emerging markets fund.
Find funds with an 8 to 10 year track record and at least 12% per year average return. If you decide this is too much research at this point in your new life, you can either pay a broker to choose funds for you or get a good Standard & Poor’s index fund. Index funds mirror a selection of standard and poor stocks and will perform essentially the same as the actual standard 500 companies.
Remember that any financial advisor who works for free is paid by commissions for what he sells to you; so don’t use the free guy to pick funds, use somebody who charges a fee.
Now you can start having some fun. Do you want to fund a child’s college? Put it in your budget. Do you want to give to others? Be a secret Santa? Buy a car, motorcycle or boat? Save for a vacation or new furniture? Buy a house? Just add it to your budget as part of a new savings plan. Do you want to start a business? Do you still have a mortgage? You may now want to consider paying off your mortgage early. How long do you have left? What amount of savings would that take to cut it down to five or ten years? Is it time to increase some items in your budget. Maybe double or triple your fun and entertainment budget.
The next step is up to you.
Cappy