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Dumb Financial Freedom Dichotomies & How To Avoid Them

Dumb Dichotomies

So, you’re eliminating your credit card debt. And your friend tells you that they know a thing or two about personal finance and tell you that you MUST quickly choose between using the Debt Snowball method or the Debt Avalanche method to pay off your debt or else you are making a huge mistake. Which method are you going to use?

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Really? There’s only two choices and I MUST pick only one right now and use it forever? Not true! Although there are pros and cons for these two popular debt elimination approaches, nothing says you must only use one of the two methods and be faithful to that method forever.  That’s a dumb dichotomy. You don’t have to pick one over the other. In fact, many times, a mixture of the two methods might be best. Why would we want to put that kind of unnecessary pressure on anyone who is trying to do something as important to personal finance as eliminate their credit card debt? Debt elimination is hard enough without undo requirements. Dumb dichotomies can get in the way of financial freedom because they make the task that much harder to accomplish. Here’s a look at some financial freedom dumb dichotomies and how to avoid them:

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Snowball Or Avalanche

To finish the discussion of which debt elimination approach is best, we first have know a little about the person eliminating the debt. Does that person need constant motivation to stay the course? If so, then the Debt Snowball is perfect, where the focus is to pay off the smallest credit card balances first and then work off the larger accounts as the smaller ones are paid off. This approach motivates the debtor in that the debtor sees a rapid reduction in creditors and uses that motivation to continue the debt elimination effort.

Another valid debt elimination technique is called the Debt Avalanche, whereby the debtor pays off the highest cost debt first. In other words, the debtor pays off the credit card that has the highest interest rate first, then works his way down the list towards the lowest interest rate card until all debt is repaid. This technique may interest a “math person” or a cost conscious person. This approach affords the debtor the lowest cost approach to debt elimination. This blog is not judging one approach versus another, but intends to highlight that you don’t have to pledge allegiance to one or the other. In fact, a combination of the two can very effectively motivate the debtor to eliminate the debt AND minimize the amount of interest paid during the debt elimination. For instance, some people have had success starting out with the debt snowball by paying off a small balance to get a quick win, and therefore boost motivation, and then switching to the debt avalanche to reduce interest payments.

From my point of view, “just tackle the debt!” Eliminate it as fast as possible and at the lowest cost as possible because debt, especially consumer debt, is the biggest obstacle to building wealth and more importantly, financial freedom. Debt snowball, debt avalanche or a combination of both…use either or both but just kill the debt!

Looking for a great resource to lead you through debt elimination? Check out Dave Ramsey’s book:

The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness

Emergency Fund: In Savings Or An Investment?

An emergency fund, money set aside for when, not if, you have a real financial emergency, is central for financial freedom. In effect, an emergency fund is self-insurance to ensure that an emergency  1) does not force you into deep credit card debt or 2) cause you physical and emotional stress from money worries. And for some time there has been an ongoing debate where that money should reside. The two loudest groups suggest that an emergency fund show either be placed in a savings account (because it is the most readily available) or in a secure mutual fund (because it can earn a “greater than inflation” return while sitting in the account). In reality, this is a dumb dichotomy, because you don’t have to choose one or the other. While both are valid options, you could also split the money between an account that is readily available (like a savings account, understanding it will have a very low or no return) and a safe investment like a mutual fund or something similar that produces a larger return on your money. While leading experts, like Dave Ramsey, suggest you have between three to six months of expenses in your emergency fund, you can allocate that money according to your priorities and risk level.

Investing: Active Or Passive?

Active investing, defined here as using professional investing resources to buy and sell investment instruments, is an effective investment approach. So too, is passive investing, where investors invest their money in simple automated investments, like index funds or ETF’s. I recently witnessed a lively debate where people took sides on the “right” investment approach. The battle was focused on the slightly better returns of the active investment approach versus the low cost and low stress of the passive investment approach. There is no one right answer! This is a dumb dichotomy. Both approaches work and the right approach for any investor is based on that investor’s needs and approach to investing. Some people, like me, have both active and passive investments. The point is, there’s no one right approach and you don’t have to unilaterally choose.

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Budgeting: To The Dollar Or With Margin

Budgeting is essential to achieving financial freedom because the budget “tells our money where to go instead of just wondering where it all went” (Dave Ramsey quote). Yet most Americans don’t take the time to budget and the results are not good. The facts are that the same percentage of people in America that do not budget (roughly 74%) equal the same percentage of people who are living paycheck to paycheck! Budgeting is important. But the debate between the experts that say you must either budget “to the dollar” and have every dollar accountable to a category, or, budget with a large amount of margin, or reserve cash, has formed a dumb dichotomy. It doesn’t have to be one form or the other. Pick the budget form that works for you and follow it. Since only 26% of Americans budget anyway, any form of budget would be better than the norm! There’s just a couple foundational rules that a good budget must follow to be effective and sustained: The budget must balance, must be measured and must be followed to be effective.

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Financial Freedom Is The Point

Eliminating debt, having an emergency fund, investing money and having a budget are all essential to developing financial freedom. But the approach to accomplish each one of these elements is dependent upon the person or persons involved, and any person suggesting that one approach is inherently better than the other is causing a dumb dichotomy, which is both unnecessary and distracting. Eliminate your consumer debt as fast as possible, using the method, or methods, that work best for you. Make and keep an emergency fund and reduce your financial worries. Invest money to develop wealth in the way you are most comfortable. Last, make a budget and follow it to ensure proper allocation of your precious dollars. Don’t let any dumb dichotomies distract you from your pursuit of financial freedom! These dichotomies are just…dumb.

For more information on financial freedom, check out Dave Ramsey’s book:
 
The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness

Financial Freedom Geek Fest // Budget By The Numbers

Many, if not most people, start off the new year with new goals and dreams for the upcoming year that include budgeting and financial goals. When it comes to personal finance, that is the easy part. The hard part can be following that plan during the course of the year. Now that we are several months into the new year, we can look at our budget performance and see if we are sticking to our plan. We can compare our financial goals and corresponding budget to our actual spending. Simple enough. Then we can make adjustments, if needed, to keep on track on meeting those goals.

But there is another budget exercise that is also worth doing. How does that saying go: “A manager makes sure things are done right, but a leader makes sure we are doing the right things?” So it might make sense to spend some time making sure that we not only are staying on budget but to make sure we have a good budget in the first place. What is a good budget?  In fact, let’s go one step further. Let’s look at the budget through the lens of financial freedom. Let’s make a budget that not only makes sure the bills are paid and our goals and dreams are being funded, but is also optimized to let us experience ongoing financial freedom, and eventually, financial independence.  It may sound complicated but it is not if you have the discipline to stay the course!

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Budget: A Dirty Word

Let’s just put it out there. For some people, a budget is an awful thing. It is hard to make, confusing, very confining and seems to steal joy from life. But let’s start by change our perspective on the budget for this discussion. A budget is simply a tool to help us meet our goals.

“The budget is a plan for our money so that it goes where we want it to go, instead of getting to the end of the month and wondering where it all went.” Dave Ramsey

Don’t think of it as constraining or difficult math, but simply as a useful tool. A good budget can be as brief or detailed as you need to meet your goals and experience the financial freedom you want.

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Financial Freedom: What is it? Why Do We Want It?

If a budget is a tool to help us meet our financial goals, then what is the overall purpose of having financial goals? Is it simply just to afford more stuff? Or to be rich? No, the purpose of having financial goals and a good budget is to achieve financial freedom and hopefully, financial independence. Financial freedom is discussed a lot but what is it?

“Our definition is having the attitude and resources to live abundantly in each stage of life, free of worry and free to completely live out the full purpose and goals of one’s life.”

This freedom allows peace of mind, security and choices, which usually result in a fulfilling life. So let’s get started to define a good budget that can get us on our way to financial freedom.

Typically, a good budget has four characteristics:

  1. The budget has clearly defined goals
  2. The budget funds those goals
  3. The budget has margin, breathing room,  to account for emergencies, opportunities and life challenges, in general
  4. The budget defines and prioritizes needs over wants

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It Starts With A Prioritized Set Of Goals

Before we start talking about making a good budget, we need to define our financial goals.  Goals should be the priority in your budget. They should be funded first. Goals should include responsibilities, short and long term plans, life goals, passions of the heart and family goals. Common goals include:

  • Home ownership
  • Financial security or financial independence
  • Large expenditures: cars, vacations, travel, furniture, etc
  • Retirement
  • Kid’s education/college
  • Hobbies/side businesses
  • Bucket list items

Make a list of your goals. Then ask yourself: Am I willing to fund these goals at the expense of other possible uses of my money? If not, drop them off your list and go through the process again until you have a set of goals that you are excited to pursue AND are willing to fund. Here’s a sample list of 2017 goals with dates and amounts:

  • Max out 2017 401K retirement savings, to support a 2020 retirement from full time work. $18,000 this year
  • Family reunion vacation in July. $3,000
  • Braces for our teenager in June. $3,200 out of pocket (Insurance pays the rest)
  • Tithe, charitable giving, to my local church. $9,000 a year

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Needs vs Wants: Knowing The Difference

One more step before we start making our budget. We need to know the difference between needs and wants, and make sure needs are funded before any budget money is used on wants. A need is something required for basic living. Needs usually fall into six basic categories:

  • Housing and utilities
  • Reliable transportation
  • Groceries/basic food needs
  • Clothing
  • Medical/prescriptions
  • Insurance

One more thing on needs. What you need to spend is just the amount for basic living so as to keep you safe, secure and functional. Anything more is a want that will be discussed later. An example of a need versus a want: The transportation need for a family might be a basic four door sedan or SUV, but a transportation want might be an expensive European sport car.

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Margin Means Freedom: What Does It Look Like In A Budget?

Margin, or breathing space in a good budget, is fundamental for financial freedom and usually takes two forms:

  • An emergency fund (usually between 3 to 6 months of expenses saved for emergencies)
  • Adequate insurance that usually includes: medical, property and long term disability insurance

The amount of money in an emergency fund varies depending upon your situation and risk-adverseness level. Once you reach your goal, you do not need to keep contributing to it but each time you use money from the emergency fund, the money should be replaced for the next emergency. What constitutes an emergency? Job loss, auto repairs, housing repairs, deductibles for medical issues and such.

Many people working full time today have medical, dental and vision insurance (medical) through their employers, but one way or another, we need to have medical insurance to have financial peace. The same is true with insurance for our large pieces of property (home and auto) and with employment insurance (long term disability). Note: Short term disability insurance can be your emergency fund.

One more note on having margin in our budgets. We know each year that we have seasonal expenses coming, like presents at Christmas time and for birthdays. We should budget for them. You might say, what’s the big deal about birthdays? But if you have an 8 year old, that is in a class of 21 students, and has the same school invite policy as our school, you know that you are required to invite all classmates to your birthday party AND you should expect to be invited to ALL 20 of the other classmate birthday parties too! That could be $400 or so of presents each year you should be setting aside for financial freedom in your life.

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Pressing The Information Into A Good Budget

Let’s recap: We know what our goals are and how much money they require. We know what margin in our budget looks like and we’ve identified what that costs. Also, we defined our basic needs in our budget and classified everything beyond those needs as wants that should be funded last, if money is available. Now we can start allocating money to make a budget.

Where to start. A GREAT place to start when forming a budget is to use tools by successful organizations who specialize in budgets and budget allocations. Two such tools are made by Dave Ramsey, http://www.everydollar.com,  and Crown Ministries, http://www.crown.org, that provide guides as to how much money should be allocated to each budget category. Here is a great starting point for each budget category:

Take your net income (net pay after taxes) and allocate as such:

Budget Category       Percentage of Net Pay     Description                             

Charity (tithe)              10%

Savings/Investment   15%   Retirement, emergency fund,

Total Housing             30%    Mortgage, taxes, utilities, cable, HOA, insurance, repairs

Auto                              12%    Car payment, gas, repairs, insurance

Food                              14%   Groceries &  eating out

Entertainment              6%   Recreation, pets, travel, gym, gifts

Household                      6%   Clothing, phone, beauty, services (lawn, cleaning, etc)

Medical/Insurance       3%

Children                         4%   If no children, go towards savings or a college fund

100% of net pay. Can’t be more than that or we have an unbalanced budget (Read: debt!)

What Makes For A Good Budget?

What makes this budget any good? First, it funds our financial goals (In this case, retirement, travel, children’s needs and entertainment). Second, this budget amply provides for all our needs (housing, food, transportation, insurance and clothing) and many of our wants (cable, eating out, etc). Third, this budget provides savings for an emergency fund and prevents the accumulation of credit card debt, which is the biggest wealth stealer around. Notice what this budget doesn’t have in it? It doesn’t have debt payment as a line item, consumer debt that is. That is because consumer debt is not a financial freedom maker, it is a financial freedom stealer. So pay off your credit card in full each month, while sticking to your budget. It also doesn’t have any money that is not allocated in the budget. Unallocated money usually results in mindless spending. In fact, in 2016, Fidelity reported that 22% of all discretionary money is spent on items we don’t remember just 24 hours after the purchase. Mindless.

Recap A Good Budget

Let’s go through our “good budget for financial freedom” checklist:

  1. Our budget clearly funds our current goals, In this case retirement, travel, children’s needs and entertainment). Check
  2. Our budget has margin built into it in the form of an emergency fund and insurance. Check
  3. Our budget has funded all our needs (basic housing, transportation, clothing and food), all of our goals (previously stated) and some of our wants, like cable TV, pets, etc.

There’s one more important thing our budget provides for and that is charity or generosity. It is the first line item in our budget, because generosity helps us keep money in its proper place as a tool, nothing more, and it is a huge component in financial freedom!

Wait! You say, you have completely different budget needs to obtain financial freedom. Ok. Just re-allocate the money according to your goals and/or lifestyle and as long as you are living within your means, savings for your goals and dreams and have ample margin for life’s challenges, you will be all set.

There you have it. We have a good budget that supports financial freedom. There’s nothing better than that!

 

Want more help with your budget. Try Dave Ramsey’s book: The Total Money Makeover. Click here and SAVE!
 
The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness
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And Then There Was One

 

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On The Path To Financial Freedom

To this point, the path toward financial freedom has been straight forward. The budget is in place. All consumer debt has been paid off, including cars, student loans and credit cards. Emergency fund is all set. Same is true with college savings for our last child in the house. We are saving and investing 15% toward retirement and tithing 10% to our church. And any left over money gets invested in a taxed account that will be used for future purchases.  Last, everything is automated so it “just happens”. Now, time and compound interest should produce results that lead toward freedom freedom. So far, so good. Now there’s only one debt left to deal with, the home mortgage, so the big question is: Do we pay off the mortgage, our last debt,  or do we invest that money to meet future needs?

Two Choices, Is One Better?

I think the choice between paying off an existing mortgage on a primary residence or investing that money to growth wealth is a matter of priority between financial freedom and financial independence. They are the same thing, you might say? I don’t think they are. Financial freedom puts peace of mind at a priority, including freedom from money worries and anxiety. So that would favor paying off the mortgage, because a debt, any debt, is an obligation that presumes we know and can control the future. Unknown-3It presumes we can make all the payments, but that is not a sure thing. Because in a 30 year mortgage, (15 year mortgage if you are really savvy), a number of things can go wrong that are out of your control and could prevent you, or hinder you greatly, from paying the mortgage like job loss, physical injury or other family health related issues. Yes, an emergency fund certainly helps in these circumstances, but if peace of mind and total freedom from money worry is the top priority, you probably would pay off the mortgage as soon as possible to ensure you always have a place to live.

Want financial freedom but don’t know where to start? Start with Dave Ramsey’s Total Money Makeover, click and enjoy!


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Financial independence, on the other hand, prioritizes choice over freedom. And it is quite possible that investing the money, instead of paying off the mortgage, can provide more choices. Choices like work (or not to work) choices, location choices and purchase choices. The assumption here is that the return on the money invested is greater than the savings in interest paid on the mortgage. And for the last ten years, including the financial recession of 2008-2009, that has clearly been the case. First, let’s look at the math.

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The Math – The Easy Part

Simply put, the cost savings by paying off the mortgage in the last ten years has been significantly less than the return on investment if that money was put into any S&P500 Index Fund for investment. This is how it works out for me: Mortgage interest rate of 3.875% minus the mortgage interest tax break (use a conservative tax rate of just 10%) gives you an effective cost of the mortgage money around 3.5%. Another way of saying this is that the financial benefit of paying off your mortgage is roughly a 3.5% return on your money. Compare that with investing that same money in a simple S&P500 Index Fund for the same time period, ten years, which according to Fidelity Investments, returned 7.5% annually, not including dividends. Minus out the taxes on that return and you have an after tax return of roughly 6.7%, or almost double the return when compared to paying off the mortgage!

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But There’s More

The math between our two choices is the easy part. Clearly, investing money instead of paying off the mortgage will generate more value. In my example, investing produces almost two times the return as paying off the mortgage. But there are several other factors to consider:

  • Peace of mind – Clearly paying off the mortgage will give you great peace of mind but it will cost you. In my ten year example, the investment difference of investing the money instead of paying down the mortgage is worth over $115,000! That is a high cost for peace of mind but for those that are truly risk adverse, it may be still worth it to pay off the mortgage.
  • Cost of the mortgage – If your mortgage interest rate is over 5%, the financial freedom of paying off the mortgage may be worth it, since the financial benefit of investing the money is much smaller. But, something else to consider, if your mortgage interest rate is that high, consider refinancing your mortgage. Today’s rates are much lower.

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It’s A Personal Decision, Possibly An Expensive One!

For me the decision is simple, because my investments actually did far better than average over the past ten years, (10% including reinvested dividends) and my mortgage rate is fixed at 3.875%, I choose to continue to invest our money instead of using that money to pay off the mortgage. Our six months of expenses emergency fund gives us peace of mind as far as making the mortgage payments, as does our long term disability insurance. Worst case, I can change my mind any time and pay off the mortgage with a portion of the investments. But the priority is to invest the money for a greater return. Assuming my wife and I live an average life span and we keep the money invested in the market, we can expect to earn about $400,000 more dollars by this decision than if we decided to pay off the mortgage. That certainly helps calm the nerves about having a mortgage!

What do you think? This is what I think: Financial freedom (or independence) is hard work, but it is worth it!

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Kissing Frogs & The Pursuit Of Financial Freedom

 

It’s Been A Long Time

It seems like I have been really busy working on our family’s financial freedom since the start of the new year, but you can’t tell by the number of posts I have made (three). We have now officially completed one quarter of the new year and as I looked at my progress toward financial freedom, I see my blog post productivity going down, but seemingly my effort going up. What gives? So I took an inventory of what I have been doing. This is what I found: I made a lot of progress in finding side hustles and passive income. By that I mean I found what works and doesn’t work for me and my family for side hustles to help us meet my financial freedom goals. I want to share both our side hustle successes and failures to help others finds their path to financial freedom!

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Kissing Frogs

At the start of the new year I made it a goal to find side hustles that could grow our passive income or side income. I found some great ones that I can see my wife and I doing for the rest of our lives. But not before trying a whole bunch that just did not work out with our lifestyle and priorities! Like the fairy tale says: Sometimes you have to kiss a lot of frogs before you find your prince! We kissed a lot of frogs and found a couple princes.

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Before we take a look at what works for us, let’s review the side hustles that I pursued that did not meet our goals. Note: This is not to say these side hustles are bad and you should never try these. These all worked to some degree over a three month period but were not what we were looking for. Take a look at what didn’t work for us: Our Frogs

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First, I tried to make money with the apps Ebates and Ibotta, getting rebates on household purchases but I found that our frugal lifestyle doesn’t gain much in the way of rebates. In fact, I found the opposite, I found the temptation strong to buy stuff I didn’t need in order to get the rebate (That’s probably the point). So I stopped those.

Second, I tried the apps, Swaybacks and Receipt Hog, where you scan and track your receipts and earn money doing so. But after three months I only made $10 bucks, so the payback was not there. What did I expect on only grocery store and gas station receipts?

Then I tried flexjobs.com doing data transcription, but that was a lot of work for just pennies an hour, literally. Not right, so I stopped.

As a budding photographer, I wanted to see if selling stock photography on iStockphoto.com could earn us some good money, but after 3 months I learned that I can only make about $2/hour selling my stock photography online. So it is not a good source of side income.

I learned a lot by trying these forms of side hustle, but they weren’t for me. The payback was too low and the impact on our lifestyle was too great to keep pursuing them. So I looked for other sources of side income, and found a couple that really worked, sort of:

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Downsizing Pays Dividends

My family decided to downsize and de-clutter our home. We didn’t physically move, just simplified and changed our style to one of a clean, de-cluttered look. In the process of repainting, recarpeting and removing all the old knickknacks and decor, we developed a huge pile of stuff to get rid of! That pile was the “inventory” for a huge garage sale, quickly followed by online selling through Craigslist, Facebook and Ebay. The results were great! We sold almost everything, including old stereos, clothing, furniture, cameras, shoes, jewelry, toys, stuffed animals and anything else you can think of. It kind of stung at first, getting rid of all that stuff. Some of it sentimental. But once we got started we made over $1500! The good news is that we made good money for such a small amount of work. The bad news is, we ran out of stuff to sell! However, this selling spree did open the doors, and our eyes, for us to sell other stuff we find in our travels on Ebay and other online marketplaces. I would characterize this side hustle as a huge success but you need constant inventory to keep selling online. We would need to find a source if that were to become a regular part of our side hustle income stream.

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From Frogs To Princes

One of our 2017 side hustle goals was to generate $2,500 a month in side hustle income. The online efforts listed above weren’t going to get us there and the reselling of stuff on Ebay helped a lot but would not be consistent because we ran out of inventory to sell. So the next thing we tried was dividend investing and options trading. Now these forms of side hustles are not for everyone, but I’m pretty sure they are perfect for us!

First, dividend investing. I have been an investor in stocks for a long time, but only recently adjusted my investing strategy to dividend investing. For many years I was simply a growth investor, investing in growing companies who, for the most part, reinvest all their earnings into the business. This type of investing had done well for us but it was not generating any side income. And the vicissitudes of the stock market were not letting me experience financial freedom. I was not free of worry and until I sold the stocks, there was no real profit. But dividend investing seems to be my thing! In November and December I researched everything I could about dividend investing and made a plan which I executed in January. I reorganized my investments to include many dividend champions and aristocrats that started paying dividends right away. For each of the last three months, our dividends have increased and the payback on the time invested to research and buy stocks is exceptional. Far better than the $2/hour I was getting woking on selling stock photography! Our goal of averaging $1000/month in dividends is well within reach and something I really enjoy.

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The other side hustle I really enjoy and have had some success with is options trading. Again, option trading is not for everyone, but it is for me, because I love the research and technical analysis. And with the help of some really smart mentors, I have come up with a simple and easy way to generate income, leveraging my stock investments that are already in place. My process is really pretty simple: Each weekend, do my homework and make a plan that I then execute the following week. The time commitments are not very taxing and so far, for the first three months of 2017, have been quite fruitful. So much so that I believe our $2,500/month in passive income is doable and sustainable.

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Lessons Learned From Kissing Frogs And Finding Princes

As you can see, I was really busy pursuing side hustles for financial freedom these last few months, but you can’t tell by the few blog posts I made, (now four). But the lesson learned is that it takes a while to find your financial freedom voice and pursuit. For us, financial freedom is in the form of frugal living, ample savings and some extra income through two side hustles: Dividend investing and options trading. It took us a long time, and a lot of effort to sift through a number of side hustle opportunities to find what works for us. And we are not done yet by any means. We will keep trying new things to build our passive income in pursuit of financial freedom. I hope I get back to sharing more financial freedom via this blog over time too. In the meantime, keep on hustling and never stop pursuing your financial freedom. It’s hard work but worth it!

Need help with your personal finances and don’t know where to start? Start here:

The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness
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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.

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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.

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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.

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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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The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness

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!

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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.

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The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness

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.

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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.

images-3Family/Kids Savings

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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The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness

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!

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The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness