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The Financial Freedom Letter I Want To Write To My 30 Year Younger Self

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Letter To Self

Dear Self,

Freedom is a big deal. Great people in our country have fought and died for it. And financial freedom is no exception. If you start early and 1) aggressively save,  2) use the power of compound interest and 3) exercise some budget restraint, you can achieve complete financial freedom and transition into retirement at an early age. What does this mean? You will have the freedom to choose if and where you work. You will have freedom from worry about money and the anxiety of debt. You will have freedom to chase your dreams and spend time in those things you are passionate about. Sound good? I think so too. If you are seriously interested in financial freedom, listen carefully. There are just a couple simple actions you need to take right away. They require immediate commitment and action. Still interested? Then read on…

Begin With The End In Mind

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The first step toward financial freedom is to know your “why”. Actually, it is to know your “what” and your “why”. The what we already discussed. The what is to retire from full time employment at an early age and to experience financial freedom. To go a little further, let’s be more specific. The what is to retire by age 55 and have the freedom to pursue the passions of your heart, namely: tropical beach centered living, travel and generously giving back in my community. That brings us to the why. The why is that financial freedom allows me to contribute the most to my family and to society in general. I am more valuable to my family, community and God if I am financially free to live and serve others without the constraints of a full time job or full time financial worries. Let’s get started.

Save And Invest From The Start

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You’re 22 years old and fresh out of college, making a good salary in a growing industry. Your first step is to save aggressively. You just came out of four years of living frugally on the college campus, so before you expand your cost of living with the new salary, dedicate yourself to save 30% of your salary from the first paycheck on. That’s right, 30% right off the top. Have the savings automatically deducted from your paycheck before you see it in your checking account. That way you don’t even miss it, because you never had it to spend in the first place. Where will the savings go? Three places to start: 1) 10% of your paycheck will go into an emergency fund until it gets up to one month’s of expenses. 2) 15% will go into your retirement account, offered by your employer, and includes a matching program. 3) The balance, 5%, goes into a new investment account. Once the emergency fund totals the equivalent of one month’s of expenses (enough for a single guy with a stable job, for now), that 10% of your paycheck will be added to the investment account (now totaling 15%). It’s that simple. Do this and your on your way to financial freedom…but not there yet.

Keep It Simple And Watch It Grow

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You were taught compound interest and investment principles in college, but go back and learn them again. What will you learn? That compound interest of savings that is invested in low cost, equity based investments develop rapid growth of wealth. Let’s go over the basics in some detail. The emergency fund goes into a checking or savings account and does not earn any investment return, but acts as self-insurance. This is called “sleep at night” money because it helps you sleep at night knowing that you can cover most of the unexpected little costs that come up in every day life. The emergency fund is the single biggest deterrent to mounting credit card debt. In turn, credit card debt is the single biggest threat against financial freedom, so we want to avoid consumer debt at all costs.

The retirement account goes into the company 401K program as a pre-tax investment which lowers your taxable income and is eligible for the company matching program. That means the 15% of your income that you put aside from each paycheck automatically gets another 5% (50% match up to 10% of your income) added to it and then gets invested in low risk equity based mutual funds. This retirement savings, match and investment gets done automatically, each paycheck, before you see your paycheck.

Last, your regular investment savings goes straight into a low cost equity index fund. Specifically, an S&P 500 Index Fund, which over the course of history has produced a 10% return annually. It’s that simple. Save money, invest money, let compound interest do it’s thing. What’s the key? Have the money automatically taken out of your paycheck so you don’t see it or be tempted to spend it before it goes to your investments.

Embrace The Budget

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To ensure you stay disciplined in your regular savings, embrace living on a budget. What does that mean? Develop a spending plan and learn to live (and spend) by it. Take the 70% of your paycheck that is left after savings is invested and allocate the money for living expenses. It’s pretty straight forward but you would be surprised how many people do not have a budget and lose track of their spending, only to end up broke or in debt. Here are the big budget items and targets for spending:

Housing (house payment/rent, utilities, insurance, taxes, HOA): 30% of net monthly pay

Auto (Car payments, gas, repairs, insurance, etc): 15% of net monthly pay

Food (Groceries, toiletries, eating out): 15% of net monthly pay

Debt Payment (No debt payment, no credit card balances, start off right!)

Generosity (Tithe, donations, etc): 10%

Entertainment (Fun, travel, vacations, pets, hobbies): 10%

Living Expenses (Clothes, gifts, household stuff, medical): 10%

Misc. 10%

Make a budget, live by that budget and get comfortable living well below your means by learning how to find low cost or free entertainment, food, transportation and household needs. You will not miss anything important by keeping your cost of living down. It’s that simple: Save, invest, live on a budget…and oh yeah, compound interest!

Enjoy The Ride

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I’ll say it again, it’s that simple: starting right out of college, save 30% of your paycheck, invest in an emergency fund, a retirement fund and low cost equity investments, and live below your means using a simple budget. Those are the primary vehicles to financial freedom. Because, over 33 years, from age 22 to 55, using the power of compound interest, those investments turn into something much bigger than the sum of the savings made over that time. Let’s take a look at the math with a couple assumptions:

Starting pay right out of college: $50,000 annually.

Assume 3% annual salary increases, pay by age 55 is $128,000 annually

Total savings over 33 years at 30% of income (Age 22 to age 55): $1,030,550 including company match

Investment value at age 55, given the following returns: emergency fund 0%, retirement fund 6.5%, investment account 10%: $2,991,000

That much money, almost $3M, produces $120,000 a year in annual income at age 55 (4% rule) or $10,000/month, which supports just about any lifestyle. More importantly, this income, allows for full financial freedom! And this does not include other income sources such as social security. In addition, by starting your saving and living on a budget early, and investing regularly, the process to achieve financial freedom was simple and easy. Compound interest does the heavy lifting. It turns your million dollars of savings over 30 years and into three million.

Start early, be disciplined, trust investments over time and the power of compound interest. It’s that easy!

Sincerely, The older you.

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Financial Freedom: No Goals, No Plan, No Measurement, NO WAY!

Financial Freedom?

There are many definitions of financial freedom, but I particularly like this definition quoted from Kim Kiyosaki several years ago:

Financial freedom is much more than having money. It’s the freedom to be who you really are and do what you really want in life. And many of us… lose site of this by putting others first and playing many different roles such as parent, spouse, employee, friend, and more.” Kim Kiyosaki

I like this definition because it goes beyond money and possessions and focuses more on the freedom to pursue the vision, goals and passions in your lives. Who doesn’t want that freedom? But to be financially free, we need to have a clear view of what we want to be free FROM and where we want to be free TO GO. So we need to have a goal(s), a plan and some measurements to make financial freedom a reality.  Unfortunately, the converse is also true. If there is no goal(s), no plan and no measurement it is very hard, some would say impossible, to reach financial freedom. Thus, I give you Financial Freedom: No Goals, No Plan, No Measurement, NO WAY! to help us think through the basic mechanics to achieving financial freedom.

Financial Freedom Goals

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Where to start? Let’s start with some sound financial freedom goals. If you already have yours, then skip to the next part. But if not, take a look at these fundamental financial freedom goals:

  • Become and stay debt-free (consumer debt at least) 
  • Adequate emergency fund to handle life’s financial challenges
  • Savings and investments to fuel future goals, needs, passions and obligations
  • A financial system to eliminate the stress and anxiety of financial management

Do these goals make sense to you? The list starts with being debt free, primarily because debt is an expensive obligation that presumes that you can control the future in the form of future payments and that is not always the case. For instance, right now in America, roughly 6% of all car loans are delinquent or in default. That means that roughly one out of every 16 cars on the road are not being paid for, which could result in forfeit of the car. Those people who took out those loans to buy those cars didn’t intend to default on those loans. But for one reason or another they can not make their payments and will risk losing their cars. There’s no freedom in owing other people money, so we must have a goal to eliminate our debts.

What about an emergency fund goal? Each of us pursuing financial freedom must have some sort of emergency fund to handle the expenses of unexpected, but inevitable, challenges and troubles in life. People get sick, get in an auto accident, get a leak in the roof, or have some other unexpected emergency.  The list goes on and on. We need to have money set aside for such occurrences. How much is enough? The traditional answer is three to six months of expenses but the actual amount depends on your situation and personal risk aversion. The emergency fund is the single biggest insurance of financial freedom. Why? It prevents debt and it gives emotional comfort in knowing that it is there. Some call this “sleep at night” money.

Savings and investments, what’s the right amount? The answer to that is based on your goals and objectives. For most people there are at least three goals to achieve with their savings and investments: 1) Retirement needs. Most people want to retire and the best way to do that is to start saving early in a tax-preferred plan, like a 401K. 2) Household needs. Cars, furniture and homes, among other needs, either become too small or wear out and need replacing. Money, properly invested producing compound interest, will provide the means to purchase these needed items at the proper time, without debt.

What financial system goals are needed to ensure financial freedom? Let’s start with a system to automate our payments and savings. If possible, isn’t it liberating to have a system that ensures your bills are fully paid, on time, every month? Just as important, or maybe even more so, is having a system that automatically moves money each month into your savings and investments to ensure you are funding your future needs and passions. Automated savings also has the added benefit of being done before you even see your net paycheck, so you don’t “miss” the money or be tempted to re-direct it toward other pursuits.

Take a moment and define what financial freedom means to you. Then, write down your financial freedom goals for your life. It is important to know what we are striving for so when the process gets bumpy, we can stay focused on the goals.

 

Freedom Plan

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What should a financial freedom plan look like? It should contain a set of coordinated actions that allow you to reach your financial freedom goals in an acceptable timeframe, that usually culminates in a detailed budget. Say, you want to be consumer debt free in 14 months. You would prioritize in your budget the debt payments that would allow that. Say you want to have a fully funded Emergency Fund in 12 months. You would prioritize a savings line in your budget that would make that a reality. In these two examples I used the word “prioritize” because the plan to meet your financial freedom goals must take precedence over daily living expenses. What does that mean? It means that if debt elimination is a true goal for you, you must ensure you make those debt payments BEFORE you allocate money in your budget for discretionary things like entertainment, eating out or clothing. It means you may have to forego some entertainment or cable TV for a season to fund your financial freedom goals. It is a small price to pay for freedom. In the case of debt elimination and savings to meet your financial freedom goals, we can adapt a quote from Warren Buffett that says “Don’t save what is left after spending, but spend what is left after saving and debt-reduction.”

I would suggest your financial freedom inspired budget should have four prioritized allocations before you spend anything on discretionary spending: 1) Debt elimination, 2) Savings for the emergency fund, retirement, kid’s needs and future purchases, 3) Basic living needs including shelter, food, needed clothing and transportation, and 4) Generosity of some kind to keep us humble, grateful and generous. I would also suggest that savings would be automatically withdrawn from each paycheck, BEFORE you see your balance for bill payments and that bill payments would be automated to ensure prompt payment and to lessen the need to think about and stare at your obligations. Last, I suggest reviewing the budget periodically, to ensure it is still accurate and it is still supporting the achievement of your financial freedom goals.

 

Measurement

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Measurement, what does that look like? Most people I know prefer to measure their financial freedom progress with a Net Worth Statement that compares your net worth (assets minus liabilities) over time, usually month to month. Take a look at this sample net worth statement:

Net Worth Statement
Assets Current Month Last Month Difference
Cash/Savings $3,000 2800 $200
Emergency Fund $24,000 22500 $1,500
Investments $95,500 95000 $500
Home $217,000 217000 $-
Car $21,000 21300 -$300
Total $360,500 $358,600.00 $1,900
Liabilities Current Month Last Month Difference
Mortgage $180,000 180550 -$550
Car Loan $12,000 12300 -$300
Credit Card $2,500 2750 -$250
Student Loan $11,000 11150 -$150
Total $205,500 206750 -$1,250
Net Worth $155,000 $151,850 $3,150

This net worth statement gives you instant measurement on all but one of your financial freedom goals: It shows you your debt elimination progress, it shows your savings and investment progress and it shows specifics on your emergency fund. It also shows your the overall progress in growing your net worth. In this example, the person increased their net worth by $3,150 in the last month. What it does not show is if you are on schedule to meet your debt elimination and savings timeframes. For example, the net worth statement shows reductions in debt: The car loan amount by $300, the credit card amount by $250 and the student loan by $150. But the question arises, is this the right amount of reduction to meet the debt elimination timeframe? For this, you would need to keep a debt reduction schedule. Maybe something like this:

Debt Reduction Schedule Goal: All consumer debt gone in 4 years
Loan Amount Owed Payoff/month # Months Goal Met?
Car Loan $12,000 $300 40 Yes
Student Loan $11,000 $150 73.3 No
Credit Card $2,500 $250 10 Yes

In this example, the debt reduction amounts DO NOT meet the goal because the student loan will not be paid off in the desired time of four years. So an adjustment would have to be made in the budget to increase the amount paid each month toward the student loan debt from $150/month to about $230/month in order to meet the desired timeframe.

Financial Freedom Final Word

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Financial freedom is much more than having money. It is having the resources to pursue who you really are and your passions in life, while being free of worry and anxiety about money in the process.  Financial freedom is not easy, but very worth it! And the best way, the only way really, to achieve the goal of financial freedom is to have set goals, a plan to achieve those goals in the form of a budget and clear measurements to ensure your are making progress towards those goals, in an acceptable timeframe. Over time those goals, plans and measurements may change or adapt, but without them and the direction they provide, we are running aimlessly and run the chance of failing to achieve true freedom. I think Benjamin Mays said it best when he said: “The tragedy in life doesn’t lie in not reaching your goals. The tragedy lies in not having goals to reach.” Take the time to define your goals, plan your approach to those goals and measure your progress to ensure your achievement of financial freedom!

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Three Common Budget Leaks & How To Prevent Them!

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Here’s the setting: You’re committed to living in financial freedom. You’ve got big dreams and goals. On paper, you have a balanced budget, meaning, your expenses are less than your income each month, so there is money for savings and investments that support your goals. You’ve got an emergency fund. You’ve got no consumer debt and you are working toward paying off your mortgage. You’ve got a great plan to realize your dreams but there’s just one problem: At the end of each month, there’s not much money left to meet your savings and investment goals. You are trying to do everything right but you are leaking money somewhere. A little over budget here, a little over budget there and next thing you know, there’s little money to save or invest for the future. Help!

Three Common Budget Leaks…

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Budget Leak #1: Eating out

What is the biggest discretionary expense budget leak? Eating out. Eating out has become a bigger and bigger percentage of the American family food budget to the point where in 2015, the cost of eating out surpassed the cost of groceries in the average American food budget. And eating out can quickly become a budget buster! By the numbers, a home cooked meal averages about $2.45/meal whereas the average purchased meal is $7.55/meal. That’s almost three times as expensive as eating at home! All told, the average American family spends around $2,650 a year eating out, or $50/week. How does your eating out spending compare?

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Budget Leak #2: Paying for Convenience

The cost of convenience can cause several leaks in your monthly budget. Whether it is food, coffee, getting cash, mowing the lawn or getting our entertainment, the issue is usually paying money to save time. So we do things like buy food or a snack at the convenience store attached to the gas station while we are getting gas. Or we buy our coffee on the way to work instead of making it ourselves. Sometimes it is as simple as hiring someone to cut our lawn on a regular basis so we don’t have to do it ourselves. One type of convenience option that is popular but mostly forgotten are the entertainment subscriptions: Most of us have Netflix and/or Hulu, cable on demand or premium cable channels. In each of these cases, we pay a premium for convenience. The question is, are we using them and getting the value out of them?

By the numbers, convenience food and drink is roughly 50% more expensive than that from the home. The average lawn service is $150 a month and average monthly entertainment subscriptions are $83/month. Don’t forget about other convenience costs too like ATM and other banking fees, home cleaning and valet parking. All told, we have hundreds of dollars of convenience spending each month. Is it worth it?

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Budget Leak #3: Impulse buys

Impulse buying is a huge budget breaker. Everyone does it, right? Well, yes, according to a 2015 report, over 84% of Americans admit to impulse buying. And most of that impulse buying is done in the store (79%). In fact, department stores, grocery stores and more recently, online stores focus their displays to promote impulse buying. That doesn’t come as a surprise. What may be a surprise to most of us is that a recent report it was calculated that each American family will spend more than $114,000 in their lifetime on impulse buys! In the long run, is it worth it? Most times, no. But we see that pretty display or see that sign that says “Sale” or “For a limited time only”, and we just have to have it. This is what I know, most of us can’t recall that impulse buy we made last month or last week, but we would remember anything we did with $114,000 if we used it to fund a life goal and dream with! That would be a really big life goal(s)!!!

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…And Four Ways To Prevent Them

Budget Leak Prevention Tip #1: Get The Budget Order Right

Warren Buffett is credited with this quote about the proper budgeting order for savings and spending: “Don’t save what’s left after spending, but spend what’s left after saving!” This quote sums up the proper approach to determining our starting point for budgeting our expenses. The dollar amount we have to spend each month is determined AFTER we pay ourselves (and fund our dreams) first. Fund your emergency fund, retirement fund, college expenses fund and future purchase fund first. Then allocate the money that is left for spending. This is the first, and most important (arguably) action to prevent budget leaks.

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Budget Leak Prevention Tip #2: Know The Value Of Your Time

The value and convenience of using services to gain more time in our schedules is frequently worth it. But not always, so we need to know the value of our time so we can answer the question: Is the cost of this service worth it? We want to spend money when it is worth the cost in our lifestyle and budget. But we have opportunities to save money (and stop budget leaks) if we can eliminate unnecessary and cost prohibitive services, or services we have just because someone you know is doing it. For me, I use $50 an hour as the value of my time. So if there is a task that costs more than $50/hour, I try to do the task myself. For each person and each task, this value varies. But it is good to review the value of each service you are using to look for ways to save money (or stop leaks) in your budget. Here are some personal examples: Cutting the lawn, cleaning the house and small painting jobs are all jobs I choose to do myself in order to save money in my budget. Why? Because these tasks cost more than $50/hour to have someone else do them. But things like changing the oil in my car ($24) and weekly trash service ($4) we have others perform because it is not worth our time to do. Know the value of your time and know what you are willing (and not willing) to do to save money for bigger purposes like funding goals and dreams.

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Budget Leak Prevention Tip #3: Maintain Short Term Goals

Having short term goals to work towards keeps us motivated to stay on our budget. In Tip #2 listed above, I mention that I chose to mow my own lawn and clean my own house. Why would I do these dirty jobs? The answer is simple: Because the cost savings of those two actions alone, over the course of a year, completely pay for one of the vacations we take every year! That’s right, a little bit of dirty work each week (under an hour each) provides us with a debt-free vacation to our happy place. To me and my wife, it is worth it. Having that short term goal also motivates us when we don’t feel like cleaning and mowing the lawn.

We have made other short term goals that help keep us on budget to achieve bigger goals and dreams, like retirement, the children’s education and, someday, a new, smaller home, paid for in cash. For example, the goal to fund retirement requires a very bigger number, seven digits. Seemingly almost unachievable. But breaking down that goal into monthly savings amounts makes it seem doable and motivates us to stay on our savings plan.

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Budget Leak Prevention Tip #4: Practice Contentment

 

Practicing contentment helps us prevent budget leaks because it reduces our need for spending, impulsive or otherwise, that comes from the need for instant gratification or from envy of the neighbors. Contentment helps us keep our eyes on our bigger dreams and goals, and away from the immediate wants in front of us. Sometimes contentment gets a bad rap, and is viewed as being complacent or staid. But that is not contentment at all. Contentment is being joyful and having ease of mind where you currently are (and maintaining the budget), on your way to where you are going (dreams and goals). And we need to work at (practice) contentment because it doesn’t come to us naturally as we are bombarded with commercials and advertisements telling us that we need more (spending) to be important, successful and happy. In essence, contentment helps us prevent budget leakage from seemingly “good” ideas at the time, to save up for “great” dreams and goals in the future.

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The Final Say

U.S. News and World Report did a study that found that the average American spends 22% of their discretionary money on things they can’t recollect. That’s almost one out of every four dollars spent that has no lasting value! That’s a lot to pay for forgettable stuff! The purpose of making and using a budget is so that every dollar is allocated according to your dreams, goals and plans. Thus, budget leaks are dream stealers and should be prevented or corrected. I hope these tips help you prevent budget leaks and I hope you achieve everyone of your dreams and goal!

Free Money! What Do I Do With It?

Free Money!

Maybe its money from a long lost relative. Maybe its a business deal or stock trade that went far better than planned, or maybe its a big tax return check or a bonus. We all LOVE getting money we weren’t expecting. I call that free money! Boy, the possibilities start to enter your mind on how to enjoy that money! I’m not talking about the dollar bill you found on the sidewalk or the five dollar bill folded up in a pocket. Those finds are sweet, don’t get me wrong, but I’m talking about some serious money that could afford something big, like a vacation, a new car or a whole lot of fun! If you’re like me, my head can get filled with ideas on how to use the money real quick. So years ago, when I was in one of these sweet situations, I had to stop for a moment and come up with an approach to dealing with large amounts of unexpected money so that I would make the best use of this new windfall. I call it the 30/50/10/10 plan. Here’s my approach:

Before We Get Started

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Before we get started let’s do two things: First, take a moment and list your overall financial goals and objectives. It helps to look at the big picture before we get into the details. For me that’s pretty simple: 1) Live in complete financial freedom, 2) Provide for my family, 3) Responsibly help in my community, 4) Pursue our passions. What does that look like practically?

  • No debt, no money worry or anxiety, no dependence on others for our needs
  • Ample savings for emergencies, retirement, family/house needs, and college expenses
  • Live on a balanced budget and teach our kids to do the same
  • Tithe to our local church plus support some local charities
  • Travel!

Second, before we use the free money, subtract an amount for taxes and (in our case) our tithe so that we know the real amount available for use. Typically, that totals about 30% of the free money. This is the 30 in the 30/50/10/10 plan, meaning the first 30% of the free money. In other words, if we received $10,000 of free money, we would put aside about $3,000 for taxes and tithe, ( giving thanks to God and giving Uncle Sam his portion), then plan to use the remaining $7,000. By doing this, we eliminate a nasty surprise come tax time at the next of the year when the money is all spent and we have nothing to pay the taxes with. Now we are ready to use the rest of the free money. But what do we do with it?

 

Step #1: Pay Yourself (The “50”)

Since financial freedom is our top priority, always, we need to pay ourselves first, in the form of eliminating debts and/or adding to our various savings and investments. At least half of all free money goes to paying ourselves first. This is the 50 (50% of the free money) in the 30/50/10/10 plan. First step: pay off any outstanding consumer debt. Is there a credit card with a balance still on it? Pay it off first. No questions asked. If there is no credit card balance but there is a car loan balance or a student loan balance, we make payments to pay down that debt. Next, if we paid down our debts and we still have some of that half left, we pay ourselves by adding to our savings and investments in this prioritized manner:

  • Top off our emergency fund, if it needs it, which when full, stands at three month’s worth of expenses
  • Extra savings for upcoming household needs: replacement used car, replacement washer and dryer, etc
  • Money towards the kid’s needs: College 529? Summer camp?
  • Add to long term investments
  • The retirement fund already gets maximum contributions from the budget so it gets a lower priority for any free money allocation.

Again, about half of the available free money goes to paying off any debts and/or savings, with the hope that we can achieve a milestone of some sort that we then can celebrate as a family.

 

Step #2: Celebrate!

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Celebrate! Take some of the free money and take time to celebrate 1) the free money and 2) the debt reduction and savings milestones you achieved in step #1. If the free money allows us to completely pay off credit card debt. Awesome! Let’s celebrate that. If the free money allows us to purchase, with cash, a good replacement washing machine because the old one died, great, let’s celebrate. If we can put some money away for that next vacation, celebrate! You get the idea. Most people don’t celebrate saving money or paying off debt, but most people will get excited about achieving a milestone. Take the family out to dinner, or go to a movie, or something that everyone gets excited about. Let your kids know what you are celebrating so they connect the fun with the milestone. The celebration doesn’t have to be big. Just big enough to make the point that the free money is an unexpected blessing that allows you to obtain or maintain your financial freedom as a family. The money to celebrate is a portion of the first 10 in the 30/50/10/10 free money distribution plan. In fact, step #2 and step #3 (explained next) combined make up the full 10%.

Step #3: Meet Family Needs

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Now’s a good time to put some money aside for upcoming family needs. These are things like kid’s school expenses, clothes, a delayed car repair or shoes. This money can also go toward a date night with your spouse or attending a special event. This money allows us to catch up on “want” expenses. Those purchases or experiences that make you feel special but don’t qualify as a “must have item”, like an emergency fund or putting money towards retirement. As mentioned in step #2, the combined total of money spent in steps #2 & #3 is not to exceed 10% of the free money.

 

Step #4: Be Prepared…And Generous (The Last 10)

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Want to really experience financial freedom? Try taking 10% of your free money, after you have tithed, paid Uncle Sam, saved, eliminated debt, celebrated and bought something special for that someone special, and set it aside…for what comes your way. That’s right, set aside money for living, and helping, in the moment. Do you have a friend that needs a little help? Maybe that friend just lost her job and you feel like you’d like to bring over some groceries. Use this money! Maybe you get an opportunity to help a local charity. Use this money. Maybe you’ve got wedding/birthday/Christmas presents you want to purchase, outside your regular budget. Use this money. Take 10% of your free money and set it aside as a contingency to help and/or bless others as you feel moved to do so. You may be surprised how freeing this money makes you feel, because it gives you the freedom to act in the moment. This is the final 10 in the 30/50/10/10 plan.

Financial Freedom Is Better

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Coming into free money, that is, a large amount of money that you did not expect to get, is wonderful in and of itself. But free money that is allocated in a way that supports your financial goals following financial freedom principles is even better. Why is that? Because the money is allocated consistent with your long term dreams and priorities. Let’s recap the free money allocation discussed here:

  • We gave thanks to God for the free money (Tithe)
  • We set aside a portion for taxes so that there would be no “gotcha” come tax time
  • We paid off debt
  • We saved and invested money for future needs, emergencies and dreams
  • We celebrated the blessing of the free money
  • We invested in some family  wants
  • We set aside money for opportunities that come our way

That is great use of money we never expected to get. It is invested in both our present and future needs that the whole family will benefit from. This distribution of free money is also generous, grateful and opportunistic, which goes a long way in our quest to live in financial freedom. What do you think of the 30/50/10/10 model? Let’s us know what you think! However you use your free money, I hope you achieve and maintain financial freedom.

How Much Should I Be Saving? a.k.a. Prior Planning Prevents Poor Performance

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Knowing What To Do, And Doing It, Are Two Different Things

In January of this year, Fidelity Investments published a report that said we need to be saving at least 16% of our net spendable income (total income minus taxes and charitable giving). It went on to say that we really need to be saving closer to 23% of net spendable income if we want to be sure to have enough money to fund most of our dreams and plans. Yet, in that same article, Fidelity reported that the actual American savings rate is actually in a range between 4.5% to 7% of net spendable income. That’s right, Americans are saving roughly one third of what we should be saving. So what does that mean? Does it mean we only have 4.5-7% of our money left after paying our bills to go towards savings? Or maybe it means that we aren’t serious about the American dream, including retirement, travel and helping our kids with college. In any case, let’s take a look at what we should be saving for, how much we should be saving, and why it matters.

Categories Of Savings

Before we discuss the categories of savings, we should determine WHY we need to save. We save money from each paycheck to 1) build wealth to fund our lifestyle, dreams and goals, 2)self-insure against disaster, 3)  raise our families and 4) to help others through generosity. When there is enough savings to cover all four of these areas, we are well on our way to financial freedom. If that is the case, then there are four types of saving we need to maintain:

  1. Emergency Fund
  2. Retirement
  3. Family/Kids Savings
  4. Future Needs Savings

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Emergency Fund

First and foremost is an emergency fund. This is money set aside for true emergencies so that we don’t rely on debt when an emergency strikes. In fact, the emergency fund is the number one way to keep out of debt, as it is the most cost-effective self-insurance. How much emergency fund is enough?  Most pundits agree that somewhere between three months and six months of expenses is the right range for an emergency fund, depending on your risk adverseness. Once the emergency fund is fully funded, we do not need to continue to fund it. But every time we dip into the fund, we need to re-fill it to prepare for the next emergency.

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Retirement Savings

The second reason to save is for retirement. Let me say it another way. Once we have funded an appropriate emergency fund, we need to start saving for retirement, and the earlier we start the better because of the power of compound interest. There are many theories about how much and where you should save for retirement but the fact remains that we must prepare for life after full time work and/or old age. It is not our children’s responsibility to take care of us when we are old but our own. How much do we save? As a general rule, target 25 times your annual expenses as the amount you want to have for retirement. And though this amount varies for each individual, there are some smart rules to follow:

  1. Start saving for retirement early, letting compound interest work over decades of savings.
  2. Take advantage of tax preferred accounts like 401K, Roth, SEP and IRA accounts to minimize taxes
  3. Take advantage of employer matching plans and/or other employer retirement benefits

How much should we be putting away for retirement each month? Experts suggest we save 15% towards retirement.

 

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For those raising families or expecting to raise families, we need to be saving for known children expenses, including school, marriage, cars and other events (think summer camp and travel) that are assumed to occur. For most of us, this can be done over many years so slow and steady savings can meet your needs. Why not start savings accounts for each child on the day they are born? Where should we save this money? 529 Plans come to mind for their education. Also trust accounts or ESA’s. But they should be separate from our day-to-day funds and take advantage of tax preferred accounts if we know the money will be used for higher education. How much should we be saving each month? Experts suggest  3-5% of our pay.

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Future Needs Savings

Life happens and it can be expensive. All of us have autos, homes, furniture, appliances and other items that wear out or need upgrading over time. We need to be saving for these eventualities. Since these savings are short term in nature, less than 10 years, the money needs to be invested in something that is safe but returns more than the cost of inflation. Maybe a safe low cost, low turnover mutual fund or an ETF. How much each month? Again, 3-5% of pay.

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Total It All Up

Savings must be a part of the monthly family budget. Savings is as important as the rent, food and clothing. Why? Because savings, when invested correctly, generates the wealth needed to fulfill goals and dreams. Want to retire some day? Invested savings is the answer. Want to send your kids to college? Savings is the key. Want to stay out of debt? Saving, in the way of an emergency fund, is the only way to prevent credit card debt when (not if) an emergency occurs.

What are we looking at when it comes to savings as a percentage of net income? When you add it all up, it really is between 16-23% of our net pay. Wow! Some people even suggest it should be 30% of our net pay. That’s a lot. But it pales in comparison to the financial and mental cost of debt, worry and anguish that comes when “life happens” and we don’t have funds set aside to deal with the emergencies. Or don’t have the money when a car of some other piece of equipment wears out and we can’t replace it. What is the alternative? Credit card debt? Student debt? Auto loans? Line of credit? All of these option are expensive and ultimately steal away financial freedom.

Here’s the mindset we must have as stated by Warren Buffett: “We must spend what’s left after saving, not save what’s left after spending.” Instead of trying to save what’s left after spending, we need to make savings a priority and right-size our lifestyle to live comfortably on what’s left after saving.

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Knowing The Difference Between Emergency & Urgency!

Living In Financial Freedom

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Financial freedom is on everybody’s list of must-haves, or should be, because financial freedom allows us the attitude and resources to live abundantly in each stage of life, free of worry, anxiety or money concerns, to completely live out the full vision and goals of one’s life. Although financial freedom is defined differently among people, each definition  contains in it some basic common elements: Let’s take a look at those elements and how they fit into our lives. Common financial freedom elements:

  1. VISION for how you want to invest your time, talents and money
    • Answer the questions: Why am I here? What am I passionate about? What does my life plan look like? How can you pursue your dreams when you don’t know what they are?
  2. PLAN (budget) that supports your vision and quality of life you want to maintain
    • A budget is simply a plan for spending your money that is consistent with the vision you have for your life. It’s making a plan for using your money instead of wondering later on where it all went. Good budget meets a couple criteria:
      • You live within your means: Only spend money you have
      • It includes savings for your goals
  3. DEBT-FREE approach to everything we purchase
    • A debt-free approach doesn’t mean we NEVER use debt, but that we use money we have whenever we can and when we use debt, we prioritize the elimination of debt in our budget. A wise man once said: “The debtor is slave to the lender.” There’s no slavery in freedom.
  4. A bias toward SAVING
    • Savings must be a priority in our budget. How much do we need to be saving? Let’s start the conversation at around 15% of our take home pay. Why? Because we need to have three types of savings for future needs: We need an Emergency Fund for when life throws us a curveball. We need savings for Retirement and we need to be saving toward known future expenses, like cars, furniture, kids, etc. Adequate savings allows us freedom to act when we want to.
  5. An ATTITUDE of contentment with where you are, and gratitude for what you have
    • Don’t compare yourself to anyone else, but be content with where you are. Contentment brings peace and peace is a large component of freedom. Gratitude focuses our mind on what we have instead of focusing on what we do not have. Be grateful, always.

This blog post focuses on the savings component of financial freedom, specifically the Emergency Fund Savings, and how to build it and use it correctly.

Emergency Fund Savings – The Best Self-Insurance

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Emergency fund basics:

What is it? Savings set aside for immediate use in the case of an emergency. Essentially, it is the lowest cost self-insurance.

Where does it reside? In a safe, accessible location, like a checking, savings, money market account or any place that is quickly accessible.

Why do we need it? To self-insure against inevitable emergencies or disaster and prevent the build up of debt, worry or frustration.

How much is enough? Most experts suggest 3 to 6 months of expenses, and almost all suggest at least $1,000 to cover insurance deductibles or instant emergency needs.

What priority is the emergency fund? It is top priority, before retirement savings, college education savings for the kids or savings for a home or new auto. The first $1,000 is even more important than debt elimination!

For most people dedicated to financial freedom, building the emergency fund takes a little time but otherwise is easy and straightforward. So what’s the hard part?

Emergency Fund – The Hard Part

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The hard part for many people is not saving the emergency fund money, but determining when is the appropriate to use it. It is tempting anytime we save money to use it for something “special”or when you get “an offer too great to pass up”. But an emergency fund is different from any other type of savings we have. Emergency funds must be saved for true emergencies because it is this money that keeps up out of debt when a crisis occurs. Thus, we need to be very judicious in using the emergency fund.

Urgency vs. Emergency – Know The Difference

For many people, it is hard to determine the difference between urgency and emergency. They look at their emergency fund as ready cash “if something really good pops up.” This is the wrong way to approach the emergency fund, because there will always be a sale, or a special deal, or “any opportunity” to purchase, which can put you at risk when that real emergency unexpectedly shows up. Most sales or special deals use time pressure to get you to buy, so we have a sense of urgency to make the purchase or risk missing out on the deal. By definition, these situations are urgent…but not an emergency. The best way to ensure there is money available for emergencies is to develop and follow a set of emergency fund access rules. Literally, criteria that must be met to access the emergency fund money.

For me and my family, the emergency fund can only be used in four situations: Health, Home, Auto and Family emergencies. Let’s look at some situations in each of these categories that are true emergencies where we can use emergency fund money, or just urgent situations where we can not use emergency fund money:

Type Situation/ Opportunity Emergency or Urgency? Can Use Emergency Funds?
Home Leaky waterheater Emergency Yes
Tables – 75% off sale Urgency No
Broken window Emergency Yes
Health Broken leg expenses Emergency Yes
New yoga class on sale! Urgency No
New workout shoes Urgency No
Auto New cool rims Urgency No
Blown out tire Emergency Yes
New water pump Emergency Yes
Family Job loss Emergency Yes
Vacation Urgency No
Attend family funeral Emergency Yes

Having clear criteria for emergency fund use helps us discern in a time pinch whether or not fund usage is appropriate. Otherwise we risk using the emergency fund money on urgent matters like a sale or special offer and then we are left unprepared for when true emergencies arise.

 

Why All The Fuss?

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The fact is, each of us will experience significant emergencies in our lives. It is reported that each adult has a 78% chance of a real emergency in any 10 year period of time. So over the course of your adult lifetime, about 60 years or so, chances are you will have 4 or 5 real emergencies when you need to have the emergency fund ready and funded to help you through the situation. It’s not a matter of “if” you will have an emergency, but “when”, so we must be prepared.

What’s the best plan? Build and maintain an emergency fund, with somewhere between three and six month’s of expenses in it. Develop criteria for using the emergency funds and a process to access the account to ensure the fund is used for emergencies and not urgent, emotional purchases. Because, missing a great sale may feel like a missed opportunity, but not having money when an emergency occurs could put us in a financial bind and potentially lead us into debilitating debt. Financial freedom requires that we save and properly use an adequate emergency fund to self-insure against inevitable emergencies. Financial freedom is not easy, but it is worth it!

 

Save And Invest Money Or Pay Off Debt?

The question of which is most important, saving and investing money, or, to pay off debt, is much like the age old question: Which came first, the chicken or the egg? Cases for both answers have been convincingly made. For some, this question is easy and they pick either saving or debt reduction as first priority and do it. But to others, the lack of clarity as to the priority has cause them to pause, or even worse, caused them to not act on either priority. So where do you start to answer the question? I think it starts with understanding why we save or eliminate debt. We save and/or eliminate debt to obtain financial freedom. Financial freedom defers for each person, but it is rooted in having the resources to pursue one’s goals and dreams. This financial freedom allows us to be free from worry and concern over money and be free to achieve our long term goals.

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Financial freedom, in most circles, is predicated on four main principles, which include saving and investing to build wealth and eliminating debt. The other two core principles are living within a balanced budget and insuring against disaster. It is the first two principles, building wealth and eliminating debt, that sometimes get at odds against each other. Because many times, debt reduction and savings for investment compete for the same dollar in our budget. It’s a common dilemma that goes something like this: If I only have limited money available to achieve financial freedom, is the priority to pay off my debts or should I save and invest the money to earn a decent return? On the one hand, we have debt, the wealth killer that is to be avoided or eliminated as a top priority. On the other hand we have the need to invest to build wealth to fund our goals and dreams. Both actions are paramount for financial freedom. But which action is the MOST important? Which action comes first?

The Case For Eliminating Debt First

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Debt is an obligation that assumes we know, and can control, the future, in that debt requires regular payments over time which we can’t 100% control. Job loss, natural disasters and health issues can interrupt future payments. Debt is also expensive. Here’s some examples: Home mortgages cost us 4% (Interest rate on the money borrowed) and it only gets more expensive from there: Car loans and student loans are between 3%-7%, and the worst, credit cards, cost anywhere from 10% to 25%. This means that the couch that we purchased on a credit card for $1,000 and made minimum payments on for many years ended up costing us about $2,400 in all. In essence, we had to pay a fee of $1,400 to borrow $1,000 for the couch. Ouch, that’s expensive. And in comparison to the return on money invested in most safe investments, like money market accounts, certificates of deposit or savings accounts, which only pay a percent point or two in interest at most, most debts are more costly than any safe investment return received. So one could argue that paying off our debts is the top priority.

The Case For Investing First

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Building wealth, another core principle in financial freedom, is about investing early and often and letting compound interest work over time. It is imperative to start as early as possible, so we should make saving a priority. In addition, the return on investment for  blue chip equity investments, like an S&P500 index fund, is higher (averaging over 10% per year including dividends over the past 75 years) than the cost of some debt that people carry, like student loans, home mortgages and car loans. So, it could be argued that it is better to invest the money than to use that same money to pay down debt which has a smaller return. In other words, if I can make 10% on my investment, why would I instead pay down debt that only costs me between 3% to 7%?

What’s The Smart Decision For Financial Freedom?

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The answer to the question: Should I pay off my debt or save for investment to build wealth?, is rooted in the current condition of the four main principles of financial freedom mentioned previously:

  • Live within a balanced budget
  • Insure against disaster
  • Building wealth
  • Eliminating debt

If you’re reasonably insured against disaster (have an emergency fund) and you’re living within a balanced budget, then eliminating debt is the top priority. But if you don’t have both an emergency fund or a sustainable balanced budget, then the priority shifts to getting those right before attacking the debt.  Let me explain a good way to approach it.

Step #1: Start an emergency fund. Do you have an emergency fund? If you have no emergency fund, then the first priority is to save up at least $1,000 in an account for emergencies. Why is this the first priority? Because an emergency fund is savings to PREVENT further debt associated with any unexpected emergency. It is self-insurance, a key component of financial freedom. We’re not done with the emergency fund quite yet. More on this later. To recap, the first priority is to establish an emergency fund if you do not have one.   If you already have $1,000 saved in an emergency fund, or better yet, your emergency fund covers 3-6 months of expenses (discussed later) then skip this step and go straight to step #2.

Step #2: Eliminate debt. Within the confines of a balanced budget, treat consumer debt with extreme prejudice. What does that mean? It means after a minimal  emergency fund is established, the next priority is to eliminate the consumer debt (and a commitment to stay out of consumer debt).  How would I do it? I would list all my consumer debts (all but the mortgage for now) and rank them by the interest rate paid on each. Then I would pay the minimum amount on all debts except for the one that has the highest interest rate. That one I would pay as much as possible (while keeping a balanced budget). Personally, I would cut back on my lifestyle and use that saved money to make as big a payment as possible each month until it is eliminated, all the while staying within your budget. Here’s an example using the chart below:

This person has three debts, with amounts ranging from $1,000 to $5,000, and through squeezing his budget, can allocate $500/month towards paying down his debt. In the chart below you can also see interest rates and minimum payments. The first step it to prioritize the debt by interest rate. In this case, the first priority is the Visa card at 16%, then the MasterCard and last the Student Loan (See Priority Column). At this point, we pay the minimum payment to all debts except for the top priority. So we pay $125/month toward the MasterCard and $50/month toward the Student Loan. But the top priority, the Visa card, gets ALL of the remaining money available that month for debt reduction, the balance of the $500. In this case, that is $325 ($500 – $125 – $50 = $325). $325 is far more than the minimum payment requested, $60, so the pay off of this loan will be hastened. At this rate, the $1,000 Visa debt will be paid off in full in four months, at which time the payment amount of $325/month gets moved to the next highest priority, the MasterCard. That will make the MasterCard monthly payment $450, while keeping the Student Loan payment at $50/month. Once the MasterCard is paid off, about five months later, all the money will be put towards the Student Loan. In all, using this method called a Debt Avalanche, it will take 18 months to fully pay off all the consumer debt.

Debt Pay Off Plan Available to pay down debt: $500/month
Debt Name Amount Owed Interest Rate Minimum Payment Priority Suggested Payment
Visa Credit Card $1,000 16% $60 1 $325
Student Loan $5,000 6% $50 3 $50
MasterCard Credit Card $2,400 12% $125 2 $125

Step #3: Start serious saving! At this point, we have no consumer debt and $500/month which was used to pay off the debt available to save and invest. But invest in what? There is a priority in your savings and investment. If all you have is the initial emergency fund discussed in step #1, of $1,000, the top savings priority is to build up your emergency fund to self insure against disaster, which could return you to debt. How much is enough? The standard answer is somewhere between three and six months of household expenses, depending upon your risk tolerance. For instance, if your monthly household expenses total $5,000, then your emergency would need between $15,000 and $30,000.

Once your emergency fund is fully funded, it is time to start funding other priorities, starting with retirement. Why is retirement the second priority? Three reasons: first, a retirement account like a 401K, SEP or IRA requires a large amount of time to build up to meet your long term needs. Nothing like compound interest over time to build your nest egg. Second, a retirement account is tax preferred, meaning not only are you saving but you are paying less taxes all the while. Third, many retirement accounts offered by employers have a match program where the employer matches a portion of the savings you commit to your retirement account. In essence, this is free money given to you by your company which then will return interest in your account. How much is enough retirement savings? It is recommended that the full amount by law be saved and invested in a retirement account, roughly 15% of your net spendable income each month.

What’s next after the emergency fund is full and we are meeting our retirement savings needs? If you have children and plan to financially help them attend college, you need to set up and fund an education fund, like a 529 plan, and then contribute an amount that will meet your financial goals and timeframes. We are still not done saving yet. We need to save and invest for future needs too. Cars, homes, vacations and furniture are just some of the things we need to save for so that we don’t go back into debt when it is time to purchase them. In all, there are a lot of things to save for, but using a prioritized approach will ensure you don’t go (back) into debt when an emergency occurs or a large expense is required.

Some Sage Advice

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Warren Buffett is credited with some really sound advice on the topic of saving. To obtain and maintain financial freedom in our lives, he said we need to “spend what’s left after savings, not save what’s left after spending.” Here is where the balanced budget comes into play. It is crucial that we first factor savings into our budget to ensure our goals and dreams are being financed and to keep us from going into debt. Then, and only then, can we determine what we can afford in the way of monthly expenses. So often, people build up a lifestyle that is comfortable, only to find out they can not afford the savings needed to fulfill their dreams. They save money after they finish spending. Then find out there is not enough money left over to save! Make a budget, save first, then spend while not exceeding your income.

There you have it. The answer is quite straightforward, though it is not as easy as deciding between saving or paying down debt. The flow goes like this: Develop and maintain an emergency fund, then eliminate consumer debt, before saving and investing for your dreams and goals in life, including retirement, children’s education, homes, cars, vacations, etc. AND, all of this must fit into a balanced, sustainable budget in order to experience financial freedom. Financial freedom, it’s not easy, but it worth it!

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