The Steps to Breaking the Norm
Step 1: DEBT BE GONE
You’ve heard these steps before, and if you haven’t, they are a standard in the pursuit of financial independence. You will hear some variance between every financial independence guru. You have to find what works for you around the basics. I will give you the bare bones basics and then we can dive in even further.
- Eliminate Debt;
- Create an emergency fund;
- Invest.
First step, eliminate debt. It doesn’t matter how much or how little, it needs to be gone. Now we will get into the weeds on this, with low mortgage rates and a credit card bill that is paid off every month. There can be exceptions to this rule. But if you are living paycheck to paycheck, not saving anything and barely getting by, we need to realign. We need to change the way you are living and that means removing the debt. By eliminating debt, you are taking control. How do we eliminate debt? With a budget.
I hate budgets. I loathe them. I love spreadsheets and numbers, but I despise budgets and apps that make you track everything. If this is your thing, then go right ahead. You are better than me. There, I said it, you are better than me. If budgets aren’t your jam, you have found the right place. But you do need something to keep your life on track and to know where your money is going. Sit down, not right now but when you get done reading this, and pull all of your bills, credit card statements, mail, subscriptions and put them on the table. Literally, on the table. You need to see where your money is going.
Next, eliminate what you can. Do you need 17 tv app subscriptions? Do you even know what some of those things are charged on your credit card every month? Now eliminate them. This can be a big step. A tedious step that takes some of your energy. Don’t stop. Keep going. Because the next part is the most important. Now that you have eliminated unnecessary expenses, determine your income.
Not your gross or your potential or what may come with that Christmas bonus. Your bare bones income. We will build off of that. Write that number at the top of a page or spreadsheet, whatever you prefer. Then write down every expense. Everything. Daycare, gas, nails, kid’s activities, everything. Now do the math. How did you turn out? Negative? Positive? If you are in the negative, we need to go back to the cutting step and eliminate everything that is not required to survive. And repeat the write it down step until you reach a positive number.
Once you reach a positive number, think about what you could put that towards? Do you have a credit card bill that charges you hundreds in interest every month? If you just applied that excess positive number, could you eliminate that debt? Would it take you a month or five months? Even if it would take you 36 months, you have to start somewhere.
There are multiple debt payoff methods but i will highlight the two most popular, the debt snowball or the debt avalanche. The snowball method starts with your lowest balance of debt and you pay that off while making the minimum payments on your other debt. Once the lowest is paid of you move to the next, applying the excess to that payment and so on and so on. The debt avalanche method starts with your highest interest rate debt and once that is paid you move to the next highest interest rate.
What is the main difference between the two? The debt avalanche can sometimes save you some money in interest compared to the snowball. But the snowball is much better for the mental aspect of paying off debt. Feeling that accomplishment of paying off a debt is a great push that is often needed when we start this journey.
Examples. We all need examples. I love a good example.
John has $5,000 in credit card debt at 24% interest, $10,000 in student loan debt at 5% interest and a $45,000 car loan at 7% interest.
By applying the debt snowball (smallest balance first), John will pay off the credit card, followed by the student loan followed by his car loan.
By applying the avalanche method (highest interest rate first), John will pay off the credit card, followed by the car loan, followed by the student loan.
There is a good chance John will pay more in interest in scenario one, however, he may have the smaller debts paid off significantly faster than the larger, providing for a mental boost and encouragement that is needed when your lifestyle changes. This is specific to you and what you need to accomplish the long-term goal. You have to decide.
Speaking of lifestyle change, you noticed we eliminated a portion of our life by cutting out parts of our spending, mentioned above. It is critical not to eliminate those things you are passionate about. You may have to find alternative ways to do those things, but you can’t eliminate them. For example, I love physical activity. I used to do triathlons. The bikes for triathlons are costly. The maintenance, the updating and the races. Instead, I found that I enjoyed solely running more than I did triathlons. Instead of buying new swimsuits, caps, bikes, bike parts, I now buy new running shoes. That’s it. I eliminated a substantial cost but still greatly enjoy my hobby. Don’t eliminate your passions. Find your line and draw it. You may have to narrow down your passions, but don’t eliminate them. We can’t go crazy on this path.
Now we are starting to see a potential plan. We know what debt we have. We know what we bring home every month. Now it’s time to plan. If you like budgets, find an app or spreadsheet and work your magic. If you don’t and need more freedom, read on.
We work with a spreadsheet that gives us a range. I know our grocery budget is $800 every month. I can spend $200 every week. When I make the weekly trip to the store, I have a meal plan and a budget in mind. Don’t go over $200. If I do, I will adjust the next week. You can estimate your monthly expenses based on years past or even months past. Your electricity, water, gas should all run in a range. Type that range in the spreadsheet or on your notepad. Do this with every expense. Every. Expense. The debt, the kid’s baseball cleats, the gym membership, all of it. Make it a range. If it’s an exact number every month, write that number down. We will be exact when we can. Once you add them all up and subtract from your income, what do you have left? That is going to debt. Now go on over to that website and set up an automatic draft. When that paycheck comes in the bank, the next day, an automatic draft goes out to your debt. (This will soon change to an investment). This will be a habit you are in for the rest of the time you are working. Why do I say that? What happens when your debt is paid off? This will transition from your debt payoff rate to your savings rate, and your savings rate is what makes you retire faster. However, that is for another post.
Your goal every month should be to zero out your account. Don’t overdraft, you need some padding in there for an emergency. But that isn’t money you touch. You need to zero down to that balance every month. Knowing you have given everything you can to debt. And month after month you continue this.
When it gets hard, go for a walk. When you want to shop on Amazon, play solitaire. When you see ads on social media, turn it off. This will get hard. It’s boring. It can be stressful. But remind yourself of your why. If you don’t have your why, you need to find it.
