The word budgeting, Jason said to me outside of class, was for a long time synonymous with handcuffs and restriction. The word restriction in the dictionary means to limit one’s freedom of movement or action. In reading that world alone, some of you are feeling the actual physical manifestation of being unable to move. It is no wonder that the mere idea of talking about finances can be debilitating for some.
Right now 8 out of 10 people are living paycheck to paycheck and that is because they never learned or applied the most foundational part to financial freedom, budgeting. Instead we are so used to going to work, earning a paycheck, spending unconsciously, and borrowing money we have not yet earned to pay for our lifestyle.
Some of you are thinking, well I have never had to borrow money before. Do you have a car payment? A mortgage payment? A credit card payment? A home equity loan? Student loans? Medical bills? If the answer is yes to any of these, then you have at some point guaranteed your future earnings to pay back borrowed money. YOUR FUTURE!! That’s indentured servitude in the 21st century. That debt is what should feel restricting, not a budget.
Budgeting allows us to become conscious. It puts the control of our future back into our hands by giving us a map for our money to follow when it comes in. Below is a recommendation on how to assign your money to different categories by Dave Ramsey: 10% to giving, 25-35% housing, 5-10% utilities, 10-15% food,10-15% transportation, 5-10% health, 10-25% insurance, personal 10-15%, recreation 5-10%, saving 10-15%.
Giving (10%): $500
Housing (25%): $1250
Utilities (5%): $250
Food (15%) – $750
Transportation(10%) – $500
Health (5%): $250
Insurance (5%) – $250
Personal (10%) – $500
Recreation (5%) – $250
Savings (10%) – $500
Total (100%) = $5000
Now that you have these numbers, you need to track them! It’s not enough to set a budget and come back at the end of the month to see if you hit your targets. BE INTENTIONAL. Some of these categories might be on autopay and be directly deposited from your bank account, like the mortgage. Other of these may need a separate account where the funds are immediately distributed at the beginning of the month, like savings. And others may need to be taken out in cash and put in an envelope so you know tangibly when you are reaching your limit, like groceries.
There are free apps like mint, you can use the note section in your phone, or be nerdy and make an excel spreadsheet. But every transaction needs to be recorded, so find a way that works best for you.
Each class in the series builds upon the other, so if you don’t nail the most foundational piece of budgeting, saving, paying off debt and investing for wealth is pointless for me to teach you. Get to it!!!!
Average Household Debt
We Americans were sold a ‘dream’ that, for most of us, has actually proven to be a financial nightmare! We were taught that once we graduated high school we were to get a college education, find a decent paying job, get married, buy a house, raise kids, and retire at 62 and die sometime later. While these benchmarks may very well be part of almost everyone’s journey, the majority of us Americans will dig ourselves so far into debt that we will end up working in jobs we don’t like to pay off cars we couldn’t afford, weddings that we financed on credit cars, and student loans for majors in college we likely do not even use in our current professions. Here are the staggering numbers for the average per person consumer debt we hold reported by TransUnion Consumer Wallet Study in 2014.
$5100 Credit Cards
$16,917 Auto Loans
$29,575 Student Loans
Like I mentioned above, most of us will experience these life benchmarks but not all of us will be in debt up to our ears after. The difference? Learning to live within your means and only pay for things with the cash you have.
Paying Off Debt
But here you are! Along with the other 8/10 Americans living paycheck to paycheck. You are not alone! And you can get out of this. It will take some intense focus and endurance but if you follow the plan below you can come out from under that debt.
In my previous post I explained how to use every dollar of your income to create a plan for your spending.
This is where you list your debts from smallest to largest and pay the minimums on all the debt but the smallest amount. On the smallest one you are going to take all the money you can find in your budget to pay it down and pay it off as quickly as you can. Once that debt is paid off, then you will roll that monthly payment onto the next smallest debt until that one has been paid down and paid off. Repeat until all your consumer debt is paid off.
Dave Ramsey says personal finance is 80% behavior and only 20% head knowledge. Your probability to become wealthy has more to do with your behavior than it does your sophistication or your academic underpinnings. Getting rid of your credit cards is saying, no longer will I continue the behavior of spending money I don’t have yet.
When you are tens of thousands dollars in debt, it may seem over simplified to break it down this way but if you can be diligent about the steps above, you can beat debt and start your path to true financial freedom. Check out Dave Ramsey’s Debt Snowball calculator to see how long it will take you to pay off your debt https://www.daveramsey.com/fpu/debt-calculator .
Let’s be real, sometimes life gets hard. REALLY hard. In step 1 we built ourselves a $1000 emergency fund for when our tire blows out, our dentist finds a cavity, the dog needs an unexpected vet visit or whatever other small inconveniences comes our way. Don’t get me wrong, I am not trying to downplay how much these circumstances can suck! When you have no savings at all these small inconveniences can feel like full blown disasters! But in reality, it can get much worse. That is why after debt is paid off in step 2, the next step is to build 3 to 6 months of expenses to set aside for when a real disaster strikes.
I emphasize the word ‘financial’ because I’m going to add unplanned pregnancy to the list and don’t want you to think I have something against bearing children. It’s just that having a baby costs a lot of money and requires time off from making an income. Below are just a few examples of what might be considered a financial disaster.
Loss of Employment
Emergency Room Visit
These are examples that you may have been through or likely know someone who has been. These disasters can snowball into home foreclosure, bankruptcy, not being able to provide for your children, marital stress, divorce, and more. It can be very scary.
That’s why it is so important that after you pay off all consumer debt, not including your home mortgage, you continue to roll that monthly payment that you were allocating towards credit cards, student loans, & car loans straight into a Money Market Account to sit in case of an emergency.
They typically yield higher interest rates than a traditional savings or checking account.
So why not just put the money in the stock market for better returns?
This money needs to be liquid and is not meant for the purpose of investing. We will get to that step later.
If you are self employed or in a single income household it’s better to build a bigger hedge against your variable income. If you are a dual income household you may opt for 3 months. At the end of the day it will depend on what makes you feel better prepared. I chose the 6 month route for my household.
This money is set aside for when Murphys Law goes into effect, as Dave Ramsey puts it in his Financial Peace University Course. The saying goes like this “anything that can go wrong will go wrong.”
And things will go wrong at some point.
Here is a quote that’s been stuck in my head since my Air Force ROTC Days “failing to prepare is preparing to fail.”
So get prepared! When you are finally free from your debt, make sure you stay that way by saving 3 to 6 months of expenses.
This is my favorite step! Once you have learned to budget and live within your means, paid off your debt and saved up 3 to 6 months of expenses, you finally get to start putting money towards growing your future dreams instead of just escaping your financial nightmares.
This step is SO important because you have relieved all the pressure from the present financial struggles so that are free to project yourself into the future and decide who you want to be in 10, 20, 30, even 40 years from now. Before I jump into the how, I want you to consider a few questions.
Think about what you want your dream retirement to look like. Jot it down. Do you want to travel more? Do you want to volunteer more? Do you want to spend more time with family? This is what’s going to motivate you to complete step 4, contribute 15% of your income towards retirement.
In Chris Hogan’s book Everyday Millionaires, they did a study of over 10,000 millionaires and the number 1 vehicle they used to create wealth was their 401k. A 401k is an investment account that you contribute to at each paycheck that gets invested into mutual funds or index funds like the S&P 500 for example. Your employer may offer a match for whatever you contribute or it may be only what you allocate from your check pre taxes.
Let’s use the S&P 500 as an example. Since the inception of the S&P 500 in 1926, the average annual returns of this Index Fund has been 10% annually. That means if you invest $100, in 1 year you will have $110. Then both the principal and annual interest get to experience what is called “the compound effect.”
Let’s take a look at the example below to demonstrate how the compound effect works.
Meet Joe, at 21 he started to contribute $2400 a year for 10 years to his 401k that he invested in the S&P 500 and then he didn’t contribute for the rest of his life but allowed the balance and the yearly accruing interest to grow at 10% until he was 67. At 67, he has invested $24,000 of his own money but the balance has now grown to $1,477,156.
Meet Steve, at 31 he started to contribute $2400 a year until he turned 67, also receiving 10% interest. At 67, he has invested $86,400 of his own money but the balance has now grown to $841,351.
This is the compound effect! Steven never caught up although he contributed over 3.5 times the amount than Joe. This message is to motivate you to start now! The longer your money hangs out with compounding interest and time, the better your retirement will look.
Also, if you are self employed, you can open a Roth IRA and contribute to it. It works a little differently than a 401k in how it is taxed but it is also a retirement account that can be invested and receive the magic of compounding interest.
Remember, you are first to start a budget, save $1000, attack your debt with a vengeance until it’s paid off, save 3 to 6 months of expenses for emergencies, and only then start contributing 15% of your income to retirement.
Did you know that the average college student racks up a whopping $37,172 in student loan debt by the time they cross their tassel on graduation day? And the burden doesn’t stop there. This is simply the average, which means that it is not uncommon to see debt burdens of more than double this shackled to the ankles of your child during a time period in which they are just entering “the real world” where building wealth does not get any easier for them. It’s like starting the race of life a mile behind the actual start line. They are losing the race before it’s even begun. To make matters worse, the average trend line of tuition increases is currently at about 8% per year. At an 8% inflation rate that means that the cost of college tuition will double in the next nine years!
As parents what can we do about this? How can we help give our kids a fighting chance when we ourselves are struggling to get out of the rat race and achieve financial freedom? It’s understandable to see that saving for your children’s college fund makes the list of 7 steps to financial freedom and finds its rightful place in step 5. Helping your children have a fighting chance for their own financial freedom out of the gate is vitally important, however I know it seems like such a tall mountain to climb. And, your right, step 5 is not easy, but just like the steps before this, with hard work, careful planning, and the right financial vehicles it’s possible. Below are three 3 tax-favored plans that you can use, and 5 tips your kids can use, to come out with that diploma debt-free!
All information below is current as of February 2020. And remember these are meant to be tips to point you in the right direction, as with all financial and tax information make sure that you seek a professional tax and financial advisor to help you navigate this.
These are incredible vehicles that allow you to save $2,000 (after tax) per year, per child. Not bad! The best thing is that your funds grow tax-free! Rates of growth can vary based on the market and investments in the account of course but typically you will earn a much higher rate of return than in a regular savings account. Also even though your yearly contributions are after tax contributions, you won’t have to pay any taxes when you withdraw the money to pay for education expenses
529 plans are another great vehicle especially if you want or need to invest more for your student’s education or if you are outside of the income qualification limits of an ESA or Education IRA. 529 plans can also be more flexible because you can change the beneficiary to another family member so for you parent’s that have more than one child that your saving for this gives you the option to change from the your first born to your second born if your first decides that college isn’t the right option for him or her. Some 529 plans also give you the option to choose the funds you invest in through your account, and definitely be sure to find a plan that gives you this option. Some 529 plans will put constristions on your options or change your investment ratios based on the age of your child and you definitely want to stay clear of these plans.
The bg difference between UTMA or UGMA accounts is that they are in your child’s name, not yours. As a parent you are simply the manager or custodian of that account until your kiddo reaches the age of 21 (18 for the UGMA). These accounts are much more flexible and can be used in any way much more like a savings account and don’t have to be used for college expenses only.
Also keep in mind that this step involves your children’s future so get them involved in the process! These 5 simple things can relinquish some responsibility, create good financial habits, and take the sole burden of paying for college off your shoulders.
Step 5 in the path to financial freedom is one of the most important and also one of the most impactful in strong stewardship with your finances because it’s affecting your financial freedom and your children’s. Not only is passing down the gift of a debt-free degree to your children extremely impactful to their own path to financial freedom, but leading them by example and incorporating them into the process is an incredible way to teach financial literacy and diligence.
What would you do with no mortgage payment? Imagine saving tens or hundreds of thousands of dollars in interest? What could you invest or have the freedom of purchasing without a house payment every month? Paying your mortgage off early gives you not only freedom but peace of mind in tough economic times knowing that your house is paid off. If the worst happens and you lose a job or have a medical emergency, you’ll be able to get by on a whole lot less. Did you know that an average 30 year mortgage on a $250,000 house can turn into a total of $500,000 in payments over the life of the loan depending on your interest rate and other factors? But it doesn’t have to be this way! Phew! Step 6 in your path to financial freedom is a big one! At this point in the journey your mortgage is your last remaining liability standing in the way between you and a completely debt-free life!
Let’s face it there are a lot of arguments out there against paying off your home early. Here are a few of the ones I think have very valid points.
The argument: Cash is king. At this point in your path to financial freedom – you have paid all other debts and keeping your extra cash in more liquid holdings gives you flexibility. When you invest your extra income in your house you can’t exactly cash it out or gain access to it in case of emergency.
The Answer. This is absolutely a great point. But by following the 7 steps to financial freedom you are one step ahead of this game. You have saved your emergency fund (read more about step three here), and you have paid off all your other debts using the debt snowball (read more about step two here). So at this point in your journey you have hedged yourself against emergencies and other unforeseen events which may cause you to need cash to fall back on for flexibility. Also keep in mind your ultimate goal here. One of the best things about paying your mortgage off early is that it helps you minimize the risk of emergencies once it’s paid off. With no mortgage you know that you are much closer to true financial and emotional peace simply because you don’t have the debt weighing on your shoulders. The fear and risk of losing your home because of a job loss or medical issue are greatly reduced. No mortgage means you’ll only need to cover the minimum of life’s essentials giving you more power and control over your financial future.
The argument: My mortgage rate is 5% and I can get 7% return on my money with other investments. This argument required a few key assumptions. First, and the main assumption, is that you earn a consistent return. Second, you achieve a premium rate of return. Third you accomplish both of these things for an extended period of time. Based on those three assumptions this is a very sound argument. If you can achieve a higher return, for an extended period of time, and achieve that consistently without fluctuation your cash may produce a better return for you than chopping down your mortgage.
The answer: The reality, and any of us that have lived through the great recession can attest to this, is that these 3 assumptions are not dependable. The market does not produce consistent returns, you can’t rely on it to be at 7% or above in the near and moderate future, and you certainly cannot predict timing (although many have tried and failed). For most of us we are not professional investors, we don’t have time to seek out the perfect investments or study markets, therefore there is inherent risk in trying to compete with your mortgage interest. Your mortgage is a debt that you owe, here and now. It won’t go away and it cannot be escaped. As many of you might know who follow me, I am a big fan of building wealth through real estate, and I am a believer in investing. However we will be able to get into more wealth building in our last and final step to financial freedom so for now hang in there and remain disciplined.
The argument: I hear this argument often and it goes like this: Inflation goes up by an average rate of 3-4% every year, so by not paying your mortgage early you are essentially paying less money for a home that is increasing in value every year. So as an example, if you were to buy a house this year with a 30 year fixed rate mortgage, the amount you are paying is the same in 30 years when you make your last mortgage payment as it is now, even though your home has increase in value an average of 3-4% per year for the next 30 years. So aren’t you getting more for your money?
The answer: Yes this is a true and fair argument! The problem with this logic though is that you are comparing apples to oranges. Let me explain by asking a simple question: Would your house stop appreciating in value if you didn’t have a mortgage payment? Of course not! In fact you win from both angles because without a mortgage payment and all the interest baggage that comes along with it you now not only get what equates to a huge raise every month in income, but you are ALSO seeing your home appreciate in pure equity. This is when you truly see the power of wealth building in real estate at its peak, and why building wealth in our next step is so powerful to through more real estate purchases (more on that in step 7 here).
So now that we understand the importance of buying real estate with a financial game-plan, and answered some of the objections that come with paying your mortgage off early, let’s dive into some strategies on how to tackle this financial mountain.
First of all let’s clear something up. Owning a home has huge benefits and we talk a lot about it here on this site. I speak with homebuyers all the time that are looking to buy a house and they don’t have all their debts paid off or they haven’t set clear budgets. And you know what? That is ok! You can let yourself off the hook. There are many benefits of homeownership and you should be a homeowner. However, what you must do before you go into one of the biggest financial purchases of your lifetime is have a plan. Otherwise you make the already difficult journey of financial freedom even more challenging by pinching your ability to save, pay down debts, invest, and give! I help people create wealth through smart real estate transactions and the very first thing I do is sit down with my clients and build out a financial strategy and game-plan for their next home purchase. Ideally your mortgage payment should not be more than 25% of your monthly income. A lot of factors come into play here not just purchase price, including mortgage rates, HOA fees, insurance, and more. Reach out to me today and let’s build a roadmap so we can get you on the path of homeownership that is sustainable and within your means. Don’t stretch yourself, it’s not worth it. If you’re reading this and it’s too late, your mortgage is already more than 25% of your income, don’t worry. Contact me and see if you have options to get into a more suitable payment or scenario so that you give yourself a fighting chance to financial freedom!
Now let’s dig into the execution. Dave Ramsay, the author of the Seven Baby Steps Formula, suggests that people refinance into a 15 year mortgage as the best way to pay off your loan and save all that interest. And for some that is a great option. However there are ways to achieve effectively the same result. Here are 3 potential options.
As with all our advice make sure to talk with a professional about mortgage your options and see what scenario is best for your situation. These are merely general suggestions but everyone is unique and might have a slightly different scenario that needs to be accounted for. Feel free to reach out to me directly to get in touch with one of our trusted mortgage partners and build a game plan today.
In the path to financial freedom it can get hard at times to fall off the bandwagon and stay consistent. Most get rich quick schemes and real estate investing gurus paint a picture of building wealth as this fast past action movie that is high style and highly entertaining. The reality is that building wealth is not fast paced, and can actually be very boring.
The key to financial freedom is a very simple formula that many of us overcomplicate. Have a plan and stick with that plan long enough to achieve a goal. That’s it. These 7 steps to financial freedom give you a plan, a roadmap to achieve your goal. It’s up to you to be diligent and stick with it long to reach the finish line. Picture the day you become mortgage free and truly “own” your home. What will you do to celebrate?
Path to Financial Freedom: Build Wealth and Give
If you aren’t at this step yet and instead reading this while your in the midst of your path to financial freedom, sometimes it can be hard to imagine a day when you are completely debt free, have an emergency fund, you’ve paid for your kid’s college, your investing for your future in a retirement account, and you have a mortgage free home you can feel secure in. But even though that mountain looks hard to climb, get on the bike, pedal hard, and stay focused. Soon a day will come when you get to the top of that climb and get to coast down the other side. Discipline and hard work will pay off in the end, and if you’re here at this final step you’ve done it. Dave Ramsay, the creator of these 7 steps to financial freedom, famously boils it down best:
“If you will live like no one else, later you can live like no one else.”
How will you live like no-one else?
Will you invest into more passive income producing real estate so that you can continue to build wealth and achieve even more financial freedom? Will you go take that trip to Greece? Maybe you’ll enjoy simple freedoms like spending time at the spa or a round of golf once a week. How will you give away more of your time, talent, and treasures so that you can help, influence, and be a light to the community and world around you?
There are two main goals in this seventh step.
Number one; put your money to work for you through investments that are increasing your net worth and creating passive income. At this point your monthly expenses should be relatively low. Essentially you have whittled down your expenses to just your everyday costs to live because you have removed the burdens of debt and future saving needs. Your main goal at this point is to level up even further in your quest for financial freedom and acquire assets that create passive income every month regardless of how many hours you put in “on the clock.” If you can grow that passive income to exceed your monthly living expenses, you have truly achieved financial freedom. You can rest assured that regardless of how many hours you punch, or what happens to you or your family medically, that you have income rolling in like clockwork.
Number two, Give back. The point of building wealth isn’t just to stockpile money for yourself or your own benefit, but instead to leave a positive legacy for your children, your community, and the world around you. The saying really is true that giving is better than receiving. And at this point you finally have the financial means to affect real change through giving.
You still need a plan for every dollar.
Keep in mind that even though you are now on the downward coast of that mountain climb, you still are on a journey, and the final destination has not arrived. So this isn’t the time to fall off the bandwagon and veer off path. During this phase it is just as important as ever to remain diligent and have a plan for every dollar you make and put it to work. You must still maintain a budget. You must still keep your savings and investment funds in tact. However, it’s time to start playing a little offense instead of so much defense. There is no exact formula at this phase in your journey, but carelessness and poor investment choices can certainly take you back up the mountain to climb again. To help you navigate here are a few tips to help you build wealth and give with consistency.
5 ways you can build wealth through real estate.
3 tips to make giving consistent.
Through the first 6 steps of this process your family has been your top priority, and understandably so, but now comes the real gift of this process being a blessing to the world around you. Anytime is a great time to give, and that is why I outline during step 1 of this process that you should be making room in your budget for 10% of your income to be going toward giving. However, it is nearly impossible to make big financial impacts in the larger community around you when you are laser focused on paying off your own debts and investing in your retirement and children’s college education. Now that those are out of the way your desire for giving can finally meet your ability to give. So where do you start?
Congratulations you should be extremely proud of yourself when you have made it this far. Remember to stay diligent, don’t get sloppy, but most important have fun and embrace the magnitude of this moment. Be proud of yourself and keep pedaling!
I am here to be a guide an a resource for your on your journey. Feel free to reach out to me today with any questions you have!
I am a real estate agent that educates people on how to become financially free through budgeting, paying down debt, saving, and investing in real estate.
I don’t go to work just so that I can earn a paycheck. I go to work so that I can make a difference in people’s financial futures. Real Estate is so important to me because it is one of the very few ways to create long term wealth. My mission is to share my knowledge in this area and help people buy a home that is both a safe place to foster their hopes and aspirations as well as an investment vehicle that will pay them back in the future.
Sincerely, Allie Pfannenstiel