Before we get started with the first two things you need to tackle once you save some money, credit card debt and investing in a 401k or IRA, let me lay some ground work. You need to be prepared for what happens when you start down this path because it’s likely that most things you have tried failed. If you do what I recommend and get serious about the basics, something amazing happens.
It Actually Works
Once you get serious about financial freedom and start spending less and saving more, things actually start to work. When you save more, a mound of cash starts to build up under mattress, and it can get tough to sleep comfortably. What do I do now?
Change this significant often throws people off. For the most part it’s likely that you aren’t used to actually having money. In fact the old you is probably still trying to get you to turn back. The temptation gets stronger and stronger. Unfortunately I’ve seen many succumb to the lure the shiny and new, especially since now they think they actually can afford it. They often go through that deceptive “I deserve a treat” phase. Actually what you deserve is a life that isn’t restricted by financial bondage, not a new 55 inch TV or pair of Jimmy Choo’s. Think bigger.
Small thinking got you into this mess. A consistent sting of “treats” that you “deserved” keep your creditors on high alert. Your debt keeps snowballing, and you wonder why. Your cable bill costs you a grand a year; you don’t track your expenses or have a budget; your cell phone bill costs you a grand a year per person; you buy things on a whim; you spend another grand eating out for lunch while at work; and you wonder why you’re broke. Add to that the drinks at the club or with your dinner at that fancy restaurant, the bad habit you have to support at five to seven bucks a pop, and all those sodas you get with your gas tank fill up at the convenience store. It’s just out of control.
I’m not judging you. You can do what you want. As a kind and caring mentor, however, I might ask you a question. “But what do you really want?” You see, you can have almost anything. So picking your “anything” is paramount. Because while you can have almost anything, you can’t everything.
I’d like for you to get your true “anything.” If you’re “anything” is something bigger, I can help you get started. Read on.
A Little More Review – Savings Rate And The Power Of Compound Interest
Let’s review the most important factor for retiring early or arriving at financial freedom for those who just joined us. You need to increase your savings rate. The higher your savings rate, the sooner your are in a rock solid financial position. The better you leverage that position, the sooner you call the shots on how you spend your time… maybe even retiring early. More on savings rate here, which I recommend you read before going any further.
So back to that lump under your mattress. What I’m referring to is the fact that when you spend less and save more you will have sizable amounts of money to start leveraging. Let’s dream a little before we talk about that.
Wouldn’t it be nice if you could clone yourself, and those clones worked for you? Aside from the new mouths to feed, heads to be sheltered and bodies to be clothed, you’d have new streams of cash heading your way and have an unprecedented opportunity to arrive at this whole financial freedom thing faster.
That would be nice. While I can’t offer you the technology to clone yourself, I can offer you a sort of mini clone that can work for you. It’s that dollar you saved. If you invest it, it starts working for you. You’re asleep. It’s working for you. You’re watching a movie. It’s working for you. You’re working. It’s working, too!
For instance, the S&P 500 has a 7% growth rate since inception. This number is adjusted for inflation and of course not guaranteed. Mind you that up to 40% of that growth can attributed to dividends. Dividends actually help making investing a little more tolerable in terms of risk. So we like dividends. A lot.
Based on 7% annual growth, your $1,000 makes you $70 a year. You did nothing extra that year. Your dollars were just working while you were going about doing your thing. Eventually, you’ll have $10,000. It will make you $700 a year. At $100,000 you get $7,000 and it requires no extra work from you. Start reaching the $500,000 mark and things start looking really nice. You aren’t supposed to spend it yet, so that extra money also starts making extra money. Rinse and repeat. It’s glorious!
Something like this plan is your goal. You just need to get started. So finally, once you start saving and accumulate a small chunk of cash, here’s where you start.
Step One – Credit Card Debt and High Interest Loans
First, pay off your credit card debt and any other high-interest loans you may have. Pawn shops, pay-day loans, whatever. Knock them out, and do it fast. Every purchase you are making is costing you up to many times what you actually thought you paid due to the interest you are paying.
It goes like this… you’re shopping so hard and find that special item at 40% off! You’re saving money, right? Nope, the interest will accrue from your credit card debt, and you will pay more than retail in most cases. Just stop it. One great way to start making wiser purchases is to delay everything. I talk more about that here. Stop adding to your credit card debt and high-interest balances. Don’t just stop adding to them. Completely eradicate them.
Credit card debt and high interest loans are the the arch enemy of financial freedom. You have to get these things out. It means you have change. You have to face that fact. Buying something before you have the money for it just isn’t going to cut it. In fact, you won’t be able to build much of a future that way. Also, you certainly won’t be able to retire sooner. These kinds of loans trap you in a cycle that feeds your instant gratification desires, and consuming this way makes you financially unhealthy.
You’re also more apt to continue the cycle because you haven’t built up much of a resistance muscle. That new iPhone is available or that new car commercial gets your dreaming. You make an impulse buy at the check out or super size that “value meal.” It all adds up. Actually you could go back and print out your credit card statements and see just how much.
Printing those statements and taking inventory might be a helpful exercise for you. What’s the total balance? What do you have to show for it?
We did that when I first started dating the amazing woman I’m now married to. We had $15,000 in credit card debt. When we inventoried it, we had little to show for it. It was shocking really. Sure, there was a little junk we didn’t use or even want any more. However, there was nothing we could point that anywhere in the neighborhood of $15,000.
What we did have was credit card debt. $15,000 at 15% interest accruing monthly. Minimum balance payments were almost all going toward interest. It was a brutal realization.
You know what we did? We attacked our credit card first. It was gone in less than a year. Since then, we have never carried a balance forward to the next month. I’m telling you, it made a huge difference in our financial lives.
You can do the same. Get rid of your credit card debt. Get rid of your credit card debt as fast as you can. Doing so will get you started on a path toward financial independence and freedom. You won’t regret it when you arrive.
Step Two – 401K and IRA
Secondly, take advantage of things like 401K and 403b programs you have access to. If your employer matches your contribution at any rate, even more so. It’s like getting free money to work there. Just work toward maxing out that program every year. If you don’t have access, there are some other things you can do like opening and adding to a ROTH IRA.
Like I mentioned before, you need to get used to putting your money to work for you. In step one, your money is killing off interest you have to pay for money you borrowed. Likewise in step two, you money is making you money through compound interest. That first investment may not seem that impressive, but it may be the most important one. That investment has the potential of working for you every day for the rest of your life. Over the course of your life, it will likely double, then double again, then again. As you add to it, it helps the additional money make more money. There could even be a day when you principal (the actual amount you paid in) is less than the interest you gained (the money your money made for you).
Try this out with a compound interest app on your phone or compound interest calculator online. Put some amount in the principal line or the line where you type in your investment. Stretch it out for 10-20 years at 7% or more. If it’s a good calculator, it will show you your principle and also the interest you gained. At these rates your principal should be close to double or even more!
As you can see, It would be wise to invest it in some low-risk, low-cost Index Fund that pays dividends or something you feel comfortable with. You will be surprised at the power of compound interest. It works against you for all your loans. It will work just as well for you.
It’s Basic And Tough But Worth It
These first two steps will get you on the right track. I won’t lie to you. It will take some time. Remember, you’re thinking about something bigger, something of almost immeasurable value. Those kinds of things cost, and they often require sacrifice and focus. I never said it would be easy. I will say it is worth it.
For many of you, these steps are pretty basic. I get that. However, I also get that sometimes a little push back on my part is warranted. Have you completed steps 1 and 2? Let’s not get lost in how obvious these steps are. Rather, let’s focus on the brutal facts of completion. If you haven’t completed them, cut me some slack and get to the real work. While the mental shifts are important, knowing them isn’t the point. The doing is. You have to put it in practice.
If you have completed the first two steps, I genuinely and seriously congratulate you. In fact, you may have no idea how few people in the United States have zero credit card debt, zero high-interest loan debt, and a balance in their 401k plan or IRA. I know people in their fifties and beyond who still can’t get these things knocked out. Especially credit card debt. Seriously. Well done! I will give some next steps in a future post that will help you and others keep moving forward.
Until then, I’m rooting for you. I’m thinking about you when I write these posts. I’d love to hear your stories along the way.