3 Things I Wish I’d Known Earlier
Did you know that as Americans:
*About 66% of us would struggle to scrape up $1000 in the event of an emergency
*About 44% of us don’t have the cash to cover a $400 emergency
*Only about 32% of us maintain a household budget
*Most shockingly, a whopping 43% of us spend more than we earn monthly, causing us to rely on debt to fill in the gap.
Let me say that again, 43% spend more than we earn monthly. It’s no wonder we on average have $38,000 in personal debt, not including mortgage debt!
The 3 things I wish I’d known as a young adult are:
- Avoid consumer debt.
- Live on way less than you make.
- Invest.
1. Avoid consumer debt. I’m talking credit card debt, personal loan debt, student loan debt, auto loan debt. Debt is a thief. It robs you of your present and even more so, it robs you of your future, also known as opportunity cost. When you accumulate debt, you lose twice due to compound interest.
When you take on debt, it comes at a high price. Creditors do not lend money for free. There’s usually a penalty attached (interest), which ends up inflating the price of the item. This is the first way you lose with debt: overpaying for an item.
The second way you lose when taking on debt is opportunity cost. While your dollars are being tied up in paying off the debt plus the interest, they are missing the opportunity to work for you by earning interest. All those dollars you’re spending towards the debt could have been re-assigned to invest with growth potential.
This loss hurts the most because you can imagine how much further you’d be on your financial journey if you just hadn’t spent money financing those clothes, or that furniture, or (fill in the blank).
There are ways to get around debt. Start with the good, old-fashioned way — save up and pay cash. Yes, it will take longer for you to get the items you may want, but you’ll better understand the value of spending.
If you can’t save up the total amount (think big ticket items such as a home, car, education), be creative. Can you move to a smaller, more affordable home in a more affordable location? Are you willing to live with a roommate? Can you survive without the car of your dreams? Will a more affordable car do? Can you save half of the price for that car, and pay off the financing in 2-3 years? Have you searched high and low for alternate education funding, such as scholarships and grants?
So re-asses and start today. Do not take on any more debt. Commit yourself to paying off all of your consumer debt and to never sink into the debt quicksand trap again.
2. Live on way less than you make. Sounds simple enough, right? Well, remember the numbers at the beginning of this post? This proves that simple does not equal easy. Now you can come to this conclusion one of two ways: proactively or reactively.
The proactive way to live on way less than you make is to avoid lifestyle creep. Remember when you first started your working career and your expenses weren’t as high? You had to make do with what you were making. You couldn’t afford the high car payment, the expensive apartment, or the fancy restaurants.
But once you start making more money, your expenses increase right along with it. Before you know it, you’re still living paycheck to paycheck, even though your paycheck has grown significantly. That’s lifestyle creep. Avoid this at all costs.
Keeping your expenses low despite income increases allows you to avoid the lifestyle creep.
If you’ve already become victim to the lifestyle creep (like I had), then the reactive way to live on way less than you make is by dialing back your expenses. Start making cuts by eliminating non-essential items. Cut the cable. Cut the gym membership. Cook at home and cut eating out. Pick up a 2nd & 3rd job if necessary.
This will create as large a gap as possible between your expenses and your income, which will not only make you much more comfortable and less stressed, but also set you up for building a great financial future.
3. Invest. For me, investing sounded like such a foreign concept, completely out of reach. I’d heard the word investing before, but had absolutely no clue what it was. What I thought was risky, or only for people with tons of money, is actually designed for future stability and is available for everyone.
The investing I’m talking about is low cost, broad based index funds. It’s a mouthful, but actually very simple. Something like a total stock market index fund or an index fund that mimics the S&P 500 is ideal. These index funds contain multiple companies within them, allowing for a diverse portfolio.
Diversity is essential because it allows your investment to still succeed, even if there is one company within the fund that is not doing well. For example, if there are 1,000 companies within the fund, and 200 of them are performing poorly, the other 800 are there to offset those poor performers. If you’re investing in single stocks only, then all of the pressure is on those individual companies to perform well, and if they don’t, you have nothing to offset them. This is why index fund investing is an exceptional option.
When you invest, you’re allowing a magical element to work on your behalf: compound interest. Investing allows you to one day be able to no longer trade your time for money. Your money will be working to make more money for you, allowing you to decide what you want to do with your time.
This opens up lots of freedom with your time and energy. This freedom improves your quality of life and your health and well-being. After doing only what was required of you for so long, once you reach that freedom stage the only question you’ll have to ask yourself at this point is: what do I want to do with my days? With a world of options, what a great dilemma to have!
There are plenty of financial professionals who detail certain steps to follow to get out of debt and secure a financial future into retirement. I like both Dave Ramsey and The Money Guy. Ramsey’s steps are a bit more rigid, making them clear and simple to follow. The Money Guy’s steps are geared towards a more disciplined crowd with more conditional details regarding debt payoff and investing.
No matter who you follow, I believe the steps in improving any basic personal finance situation can be broken down into two categories: Budgeting & Saving and Investing.
Budgeting & Savings begins with the task of tracking your spending. You must know how much your life is costing you and how much you are bringing in to fully understand your current financial situation. This is a task some people don’t want to tackle because once they become fully aware of the situation, it can lead to feelings of guilt, hostility and the pressure of the added responsibility to make some changes in your life.
Let’s face it. You may not want to be told how to live your life or what to do with your money. You may see it as criticism or judgement. You may feel inadequate for not being at a certain level of “success” or “status” that you feel you should be at this point in your life.
Let all of that fall away, understanding that the steps you make today will secure a financial future for you and your family. Keep the ultimate goal of financial independence in mind every step of the way.
Once you have tracked your spending, then compare that number to your income. Is your spending more than your income?
Take charge and start making the necessary changes to streamline your spending and maximize your income. Is your spending more than your income? Can you identify where some changes can be made to the spending to create a gap between what you make and what you spend? Yes!
Make cuts to your expenses. It will feel so good to finally be in control of your finances instead of feeling overwhelmed and defeated. The goal is to create as large a gap as possible between your expenses and your income to save & invest the difference.
Once you start seeing that gap build up between your expenses and your income, your immediate goal is to build an emergency savings of at least $1,000. This will make all the difference in the world when you have the cash to cover an emergency rather than relying on credit cards burying you further and further into debt.
There are additional steps to take between this $1,000 saved step and the investing step. I reference The Money Guys’ Financial Order of Operations because it more closely aligns with my personality and my financial situation. For those looking for a more disciplined plan, check out Dave Ramsey’s 7 Baby Steps.
The first major steps of either plan, with some variance, mainly begin with building an smaller emergency fund, getting out of consumer debt, and building a fully funded emergency fund of 3-6 months worth of expenses. Once you’ve worked through the savings & vanquishing your debt stages, then comes the investing.
Investing is where you set some intention to the future money grown in the gap between income & expenses, once you have your fully funded emergency fund set. This is where you invest in tax advantaged retirement accounts, such as employer-sponsored retirement accounts (401K, 403B, etc), SEP IRA accounts (for the self-employed), Roth and/or traditional IRA accounts, HSA and FSA accounts.
If you followed the link(s) above, you already know about participating in your employer-sponsored retirement accounts (401K, 403B, etc). It’s a must to contribute up to the company match. This is free money that you cannot pass up!
Within all of these investing accounts, make sure your investment selections are smart and simple. Broad based, low cost index funds and ETFs are the best because they provide diversification at a low cost. JL Collins explains this perfectly on Bigger Pockets Money here.
Ignore the noise of the “hottest new stock” or the stock market crashing and losing your investments. You’re not interested in the hottest new stock, your focus is on steady gains over the long haul. With marker fluctuations, be careful not to overreact in a downturn and turn ‘paper’ or ‘perceived’ losses into actual losses.
So with keeping in mind the goal of budgeting & saving and investing, you can take control and turn around your financial situation to one of stability and abundance to secure your future. That is my desire for whoever is dedicated to putting in the time and doing the work. Let’s do this!
“If your goal is FI [Financial Independence], the most powerful thing you can do is increase your savings rate [the percentage of your income that is dedicated to savings]”. — Jim Collins, Bigger Pockets Money ep. 20
Resources:
- spendmenot.com
- investedwallet.com
- financialimpulse.com