Getting Started on Your Money Journey
For many of us, we weren't taught a whole lot about money growing up. Our parents didn't talk about money except maybe to complain about having to pay bills or how we couldn't have that toy we wanted because 'money doesn't grow on trees.' They never told us how much money they made, how much the rent or mortgage was, how much groceries cost, or why we couldn't go to Disney World this year.
We didn't really get an education about money in school either. I remember learning about checking accounts when I took an elective accounting class in high school. If I wasn't in that class, I wouldn't have learned anything about money. I didn't learn about taxes, buying a house, how student loans for college worked, or anything else I would need to learn if I was going to be financially successful.
When I got into college it wasn't much better. Even though I went to school for accounting, they didn't even have an elective course on personal finance, only how businesses worked.
What I learned the hard way was that within five years of graduating high school, you need to learn how income taxes work, how to buy or rent a home, how student loans work, how your job's retirement account works, and how credit cards work. You're pretty much thrown to the financial wolves with no education to work with. Everyone is just expected to pick it up as they go along, making expensive financial mistakes along the way.
If you’re like most people, this probably sounds like you. Maybe you've thrown your hands up in the air in frustration believing there's no way you're ever going to get on your feet financially. But, the truth is, no matter what your income level, you can achieve financial security. You just have to take the time to learn a few simple principles about how money works. Let's start with identifying what you believe Financial Independence is.
Financial Independence: It's Personal
You see, most of us are at different stages of our lives. Some of us are single and some of us are in long term, devoted relationships. Some of us have several kids, some have only one, and some have none. Some of us are taking care of elderly parents and some of us have only ourselves to support. Some of us are young and some of us aren't. And don't get me started on the differences in income, debt, home ownership vs. renting, and other hot topics. With all of these different scenarios, how can I define something like Financial Independence for so many different people at so many different stages in their lives? It's actually pretty simple. Here it is:
Financial Independence is that point in your life where your passive income exceeds your living expenses on an ongoing basis. It's where you don't have to work if you don't want to and you don't have to worry about money anymore.
What do I mean by that? Let's look at a few different life scenarios to see if I can help you get a clear, concise mental picture of what that means for you.
- I work a job where I'm able to save money each month and my savings are growing. Am I financially independent?
If you quit your job tomorrow, would you have to get another one to support yourself and/or your family? If the answer is yes, you're not financially independent.
- I live with my parents and work a part-time job just to have some spending money. I don't have to work if I really don't want to. Am I financially independent?
If something happened to them and you needed to move out, would you need to get a full-time job to support yourself? If the answer is yes, you're not financially independent.
- I'm on public assistance and get my rent, utilities, groceries, and medical expenses paid for. Am I financially independent?
Maybe. You have a roof over your head and food on the table. You may go on vacation from time to time. Your kids may be going to a good school. You may even have some money saved up. But, if the government changed the rules and cut your benefits, would you struggle financially? If the answer to this last question is yes, you're not financially independent.
- I'm retired, my house is paid off, and I don't have any debts. Am I financially independent?
Maybe. Are your savings growing month to month or are you spending down what you've been saving for years. If you live long enough, will there come a point where you run out of money and have to go back to work? If the answer is yes, you're not financially independent.
- I have a certain amount of money set aside that generates multiple streams of income (interest, dividends, business income, etc.) which grows each month. That income meets or exceeds my monthly expenses. I work a job part-time which I enjoy just to keep busy. I go on several vacations every year and I'm completely debt free. Am I financially independent?
Basically … yes. Congratulations, you're financially independent!
Just imagine! You're at a point in your life where you don't even think about money on a daily basis any more. If you want to go out to eat, you can without even looking at the prices on the menu. If you want to go on a trip, you can without even comparison shopping for air fares, hotels, or cruise tickets. Your monthly utility bills get automatically paid out of your accounts. Your kids go to whatever college they want without needing complicated financial aid forms filled out. You just write the check. Just imagine how stress free your life would be!
Okay, that sounds great but I'm not there yet. How do I get on track?
Great question! A lot of people get stuck on the answer to this one. The solution isn't complicated and doesn't require a college degree in finance to put into place. What it comes down to is knowing what to do and what not to do and then going out and getting the job done. What it does take is some hard work, perseverance, and a clear vision of where you want to go.
What we've done is take complicated financial terms and broken them down into simple, easy to understand concepts written in plain English. We've turned them into one simple picture you can write on the back of a napkin. It's called our Home Run Plan and it goes like this.
It's just as easy as playing baseball.
If you’re like most people, you probably know something about playing baseball. When you're playing baseball and you hit a home run, what do you need to do? You run the bases, right? Why? Because those are the rules. And if you don't want to play baseball by the rules, the coach is going to bench you. Well, life has rules just like baseball and if you don't play by life's rules, life will bench you too. But by running the 'bases of life', you'll hit a 'financial home run'.
So, how does it work?
It goes like this:
Your first goal is to reach 1st Base which is Income Protection. That's basically getting all your insurances in place. Why do we call it Income Protection? It's because your ability to earn an income is your most valuable asset. It's more important to your financial well-being than your house, your car, and your money in the bank combined! Without your income, your finances come to a grinding halt. Your bills don't get paid, the roof over your head gets taken away, and other bad stuff happens to you. You get the picture.
But, if you have life insurance, health insurance, car insurance, homeowner's insurance, disability insurance, and other protections in place, if something happens to your income or assets in any of these areas, there will be money for you (or your family) to take care of any financial difficulties that may come along the way.
On the way to 2nd Base are the Legal Documents you and your family need to have in place to secure your hard earned money and to make sure your wishes are known if you're unable to communicate them yourself. These are your will, living will, durable power of attorney for health care, trusts, and other documents. With these in place, there won't be any second guessing as to what you wanted done with your money, your house, your investments, or even who you want to take care of your young children if something happens to you.
2nd Base is Budgeting. Now, if you're like most people, the thought of budgeting is about as exciting as the thought of cleaning your bathroom. Yuck! Most people think budgeting is about not being able to have any fun. They think a budget stops them from spending any money on what they love to do. Well if that's the case, I wouldn't want to be tied to a budget either! Fortunately, we've cracked the code on how to create a budget that's not only customized to your lifestyle, it also puts you in a position to save money, have fun, and free you from worrying about how you're going to pay your bills.
Here's how most people budget. They take their paycheck and they start subtracting.
Let's see, I'll take my paycheck. Then I'll subtract my rent, then my car payment, then my electricity, then my cable bill, etc., etc., etc.
By the time they get to the bottom of the list, they hope they have some money left over to pay themselves! But there's a better way!
Check out our Budgeting Pie Chart
Let's say your take home pay (that's your pay after taxes, tithes, and other deductions) is $2,000 a month. You'd take that $2,000 and multiply it by each of the five budgeting categories to find out how much you could spend on each of them during the month to stay financially stable. Here's the breakdown:
Housing (35%) = $700
Transportation (20%) = $400
Living Expenses (20%) = $400
Debt (15%) = $300
Savings = (10%) = $200
Housing includes your rent or mortgage, utilities, property taxes, homeowner's/renter's insurances, and property maintenance.
Transportation includes your car note, gas, parking fees, and repairs. If you don't have a car it can include bus passes or train tickets instead. If you fly on a regular basis it would include your airline tickets.
Living Expenses include groceries, eating out, toiletries, entertainment, kids' school supplies, and anything else you buy on a regular basis that supports your household.
Debt covers your minimum payments on your credit cards, student loans, or what you owe friends and family. It doesn't include your mortgage or car note since those are covered under the Housing and Transportation categories.
Savings covers three areas: your Emergency Fund (everybody needs one), your Short Term savings, and your Long Term savings. Every month you should be contributing something towards each of these three important areas.
Now, at this point you might be saying to yourself “There's no way I have the money to cover all five of those areas!” If this is you, then something's gotta give.
If you have a really nice place to live that's over the 35% you're budgeting for housing, you're probably either driving a junker or you're getting into debt and not saving. The same holds true if you're driving a really nice car that's over the 20% for Transportation. You might find yourself behind on your rent or mortgage.
Usually the first thing to go is Savings. You find yourself living paycheck to paycheck with nothing to show for all your hard work at the end of the month. The next thing to go is usually Debt. Either you've tapped out your credit cards or you're behind on your payments.
For any budget to work, you have two choices to make. Either spend less or make more and ours isn't any different.
The Budgeting Solution
The beauty of our Budgeting Pie Chart is that it doesn't matter how much money you make. It works for everybody. Let's say you hustle and get a better job that pays $3,000 a month take-home. Here's what that looks like.
Housing (35%) = $1,050
Transportation (20%) = $640
Living Expenses (20%) = $600
Debt (15%) = $450
Savings = (10%) = $300
Now you can afford to start looking for a better place to live and for a better car to drive. You'll have more money available for eating out, your debts will get paid down faster, and you'll have more money saved at the end of the month. If you work your budget right.
The same goes for figuring out how much money you need for the future if you flip it the other way and focus on your lifestyle. Once you know what kind of lifestyle you want to live, you can create a goal of how much income you need to make to match it. If you want to live in a certain neighborhood, just plug in the new housing number and you'll know how much of a raise you need in order to be able to comfortably afford it. The same goes for your car. You can ask you boss for a raise or look for a better job that will enable you to live the life you see yourself deserving. You control your budget. It doesn't control you!
On the way to 3rd Base are Debt Elimination and Credit Rejuvenation. Having good credit and being debt free are two of the most important stepping stones towards financial independence. They can impact your overall financial picture in ways you can't begin to imagine and can make or break your journey to financial independence.
When you're debt free, you're no longer under the financial thumb of others. I can remember having two credit cards a few years ago that had ongoing balances on them. Although the balances themselves weren't large, I was at a stage in my life when my income wasn't that large either. Whenever I saw those emails in my inbox saying my monthly payments were due, I cringed and worried about how I was going to rearrange my bills to get them paid on time. Fortunately, a few months later I received a windfall and was able to pay both of them off and, as I sent in my payment, I felt a huge weight come off my shoulders. I haven't gone into debt since and it's been wonderful.
As far as getting your credit under control and in good shape, one thing to remember is that your credit score gets checked a lot more often than you realize. In today's world, employers are checking new hires' credit scores before signing them onboard and landlords regularly check potential tenant's scores before allowing them to sign a lease. A low score can prevent you from buying a car, applying for a new credit card, or even buying a house. Even if you can buy these things, a low score can cause you to pay a higher interest rate which can add hundreds (or tens of thousands of dollars in the case of a house) to the eventual cost of the item. It's like you're paying two or three times as much for the item than the price advertised.
3rd Base is Investing. Now comes the sexy part. Everyone loves to talk about investing. If you check the news on any given day you'll find everyone talking about what the stock market is doing, what the next greatest company to invest in is, and even how much you should be saving towards retirement. But here's a great question to ask someone: “So, how much do you have saved up in your Emergency Fund?” They'll be shocked. “What? My Emergency Fund? That's what you want to know?” Why are they shocked? It's because nobody ever thinks about that kind of stuff. It's not sexy, it's boring. It's plain old vanilla savings. How important could that be? It's hugely important!
Suppose you're humming along with putting money into your retirement account and paying your bills and then ... WHAM! … you get hit with a couple hundred dollar car repair bill, or your water heater goes out, or you have to go to the emergency room, or … well, you get the picture. Where's the money coming from to pay for it? You could charge it to one of your credit cards but then you'll be getting back into debt again. Or you could take the money out of your retirement account but then you'll get hit with an early withdrawal penalty. You could even borrow the money from family or friends but that's often not a comfortable conversation.
If you watch the news on TV or from the internet, you'll hear that most of us are living paycheck to paycheck. Many of us don't have a whole lot saved up and we're just one paycheck away from getting evicted or losing our cars to repossession. That one emergency can be just enough to push us over the edge. Remember, it's not if, but when an emergency will happen to you and you need to be ready.
So, what do you do to protect yourself? Having three to six months of living expenses saved up in an Emergency Fund is a good rule of thumb. Why this amount? It's because it usually takes that long to find a good paying job to replace the one you have now. With that kind of cushion, having an emergency goes from a catastrophe to a small bump in the road. It becomes something inconvenient that you quickly put behind you instead of something that financially haunts you for weeks, months, or even years.
For my Emergency Fund, I like to keep the money in an on-line high interest savings account that's FDIC insured. I've found that the interest they pay is considerably higher than you'll get through your local bank and the money is just inaccessible enough that I'm not tempted to tap into it for paying day to day expenses. Also, the funds grow surprisingly fast when it's set up with automatic deposits on a regular basis.
Now, let's quickly talk about Short Term investments. I like to consider those anything that you need to pay for within the next three to five years. These are things like a down payment on a house, a dream vacation, a large home improvement, or even a wedding. They're things I might not have the cash to pay for today but that won't take decades of dedicated saving and investing to pay for. For these types of important life events, I like to invest my money into an ETF (Exchange Traded Fund) or Index Fund. They both have a historically high rate of return compared to savings accounts (but not guaranteed), low cost management fees, and it's relatively easy to get your money out of them when you need it.
As far as Long-Term Investments are concerned, I only consider two items under this category: Retirement and College Savings. In both cases you need a lot of money but not for over a decade or more.
If you're like most people, retirement seems far away, but trust me, it really sneaks up on you if you're not paying attention. Since you'll probably need your retirement nest egg to last you for the rest of your non-working life, you'll need somewhere that's safe and secure while still affording you the opportunity to have the money outpace inflation. That's why I love tax deferred retirement plans that many jobs offer. There are several different types out there depending on where you work. The most popular are 401k's (for-profit company jobs like factories and retail stores), 403b's (non-profit jobs like hospitals and schools), or PERS (public employee retirement system workers). What I like most about them is that most match a percentage of whatever funds you deposit into them with a contribution by the company. Say you put in 10% of your pre-tax income into them; the company will match 5% of your income. That's like getting a 50% return on your investment! Where else can you go to get that kind of return on your money? Plus, you don't get taxed on any of it until you take it out years or decades in the future.
But what if I'm self-employed or my job doesn't offer a retirement plan? If that's the case then a good alternative is to invest into an IRA through a broker (not through your local bank). If you're under fifty, a Roth IRA is your best bet or a Traditional IRA if you're over fifty (it has to do with tax advantages when withdrawing). There are other types of retirement options out there but that's a detailed topic for another time.
Now, let's talk about putting money away for college. There are a few options when it comes to saving up for what has become a huge expense for a lot of families and individuals. You can choose between 529 Plans, Coverdell Savings Accounts, or UGMAs and UTMAs. Regardless of which one you choose to use (or combinations of them), there are really two main things to consider.
First of all your investments should receive some sort of tax deferral benefit (whether for retirement or college savings), so that the return on your investment isn't taxed each year. This will allow it to grow faster year over year.
The second important thing to consider is what the cap is on how much can be invested into the account each year and by whom. Some investments only allow a few thousand dollars a year to be invested each year while others are virtually unlimited. The choice will determine how much your child will have to work with when ultimately paying for college.
Now you're rounding third and heading for Home Plate. You're almost there but there's just one more thing you need to take care of: Long Term Care Insurance. This is an area that's often overlooked when it comes to financial planning but it's critically important if you're going to truly be in a position to never need to worry about money again.
Picture this, you have your income, your home, your car, and your health protected with the right kind of insurances (1st base). You have the legal paperwork in place to protect your money and your family in case something happens to you (between 1st and 2nd). You're working within a great budget you can live with on a daily basis (2nd base). Your credit score is great and you're completely debt free (between 2nd and 3rd). You've been investing for a number of years and you've acquired quite a nice nest egg for yourself (3rd base). This sounds like a perfect place to be, right? What could possibly go wrong at this point? Well, to put it simply … your health.
You see, by this time in your life you're probably much older, maybe even retired, and as we all know, the cost of health care is rising every year. Suppose you or your spouse get sick enough to need to be put into a nursing home. Now, many people believe that Medicare will take care of those kind of expenses but that's just not the case. Medicare will only cover the cost for a few days stay in the hospital or a nursing home. If you're there any longer, it's coming out of your own pocket … and it's not cheap.
The average long term nursing home stay is two years and cost for room, board, and care can range in the hundreds of dollars per day. You can eat through a lifetime of savings pretty quickly at that rate. Those are savings you may want set aside as an inheritance for your spouse or your kids. So, what's the solution? A good long-term care policy that will cover those expenses and protect your hard earned investments.
Home Plate: Financial Independence
Yea! You've finally made it! You've put everything in place that you need in order to not have to worry about money any more. Your money is protected and growing, you're living the life you've always dreamed of, and your time is your own to do with as you please. Welcome to financial independence!
One Last Piece of the Puzzle: The Pitcher's Mound
So, when you're looking at the Home Run Plan you may be asking yourself “But what about the Pitcher's Mound? What do Multiple Streams of Income have to do with financial independence? Great question!
Multiple Streams of Income (MSI) help you get to financial independence faster and without some of the speed bumps along the way.
Gone are the days when a person would work at one job their entire life with job security, benefits, and a nice retirement package. Nowadays those kinds of jobs are few and far between. In today's job environment it's not unusual to work 10-15 jobs in your lifetime with an average stay of just 4.6 years according to the Bureau of Labor Statistics. With numbers like that it's smart to have at least one or two side hustles in your back pocket to not only allow your savings and investments to grow but also as a backup plan in case you quit your primary job or are laid off or fired. This lets you keep a steady cash flow and not need to dip into your savings or go into debt while you're looking for another job. It also keeps your skills fresh and allows you to jump into one of those side hustles full time if you really love what you're doing.
So, what kind of side hustle should I pursue you might be asking? It should be something that's satisfying to you. A satisfying job has three parts. First, it provides you with some autonomy. It's the kind of work that doesn't require a boss looking over your shoulder all the time. Second, it should be creative. You should be able to use and expand your natural talents while pursuing it. Third it should in some way provide a link between the effort you put into it and the rewards you get out of it. Those rewards aren't always monetary but they should include something you care about.
For example, not all artists (for example YouTubers) make a lot of money but the work is creative, is autonomous (you mostly work alone), and even if it doesn't pay all that well on a regular basis, you get rewarded when your fans and patrons applaud your efforts. Hopefully, as time goes by, your work as an artist enables you to grow your fan base to the point where you can either supplement your full-time income with it, or transition to making it your main thing if your job prospects change.
Now, your aspirations may not be to become a multi-millionaire, but it's been reported that most millionaires have an average of seven sources of income at any one time. Wouldn't at least two or three be a great step towards making you financially independent?
Financial Independence isn't just something you stumble into. It requires focus, patience, and the will to see the job through. But if you're willing to put in the work, the rewards can be amazing for you, your family, and for generations to come!