I hope to teach you how to use your income so that you can make it grow to millions. You will learn to make your income work smarter and, by virtue of a few tweaks, will learn how to make your income work even harder because of compound interest. Working smarter means taking the advantages in government programs, tax write-offs, and interest rate financing when it makes mathematical sense.
The basic concept of wealth building is simple: spend less than you make, save wisely, invest the difference, spend on things that appreciate in value, and stay away from debt as much as you can.
Like any good battle there is good and bad, and in this case it is a battle between good and evil, the good is your earning power and the evil is anything that sucks away your hard earned income without giving you much of a return. The evil here, and I’m only talking metaphorically, are banks, car dealers, consumerism, and the almighty evil--your inability to control yourself from doing destructive things with your finances (I’ve been there, cashing out my IRA to pay debt was a horrible and destructive decision). So try to do good with your income and watch it grow.
10-Steps to Wealth Building-The steps you need to accomplish for a brighter financial future.
1-Live Within Your Means
2-Budget for Success
(a) Save between one month’s income for emergencies
(b) Take the match
3-Payoff Consumer Debt (Excluding student loans if you cannot pay them all within 24 months)
4-Wealth Building Part 1- Increase retirement savings to 10 percent
5- Pay Off Student Loan Debt
6-Wealth Building Part 2
(a) Save 3-6 Months of expenses for Emergencies
(b) Save at least a 20% down payment for a House (avoid Private Mortgage Insurance (PMI))
7-Build Dream Retirement (Increase retirement savings to match your retirement dream)
8-Save for College
9-Payoff Your Primary House Early (while maintaining Steps 7 and 8).
10- Financial Independence and Retire Early (the joy of being on FIRE)
Step one: Live Within Your Means
Your first goal on this journey is to stop the bleeding and live within your means. This first step, and most important step, will stay with you throughout your journey. Every month your primary goal is to spend less than what you make in total income. The best and fastest way to do that is to stop using credit cards and to monitor what you spend money on. Once you’ve accomplish this task, which should take anywhere between a few days to a whole month, you will move to the next step, creating a zero-sum budget. Estimated time of completion, less than a month, but you will apply this principle every month for the rest of your life.
Step two: Budget for Success
This means getting on a written budget so you can track where your money's going, which will make it easier for you to stop using your credit cards to make ends meet. Budgeting for success means that you budget consistently and have a game plan with built-in contingencies for any unforeseen events. Life will throw you curveballs but if you start each month with a written, zero-sum budget, you are more likely to move the pieces around the chessboards to counter those unforeseen situations. A zero-sum budget allows you to track where you spend your money and account for each dollar. A zero-sum budget simply means that every dollar you receive as income is allocated to a specific expense. The end result is that if you make $5,000 a month, each dollar is slotted for a specific item in your budget. Once you’ve allocated the full amount, you then have a zero-sum budget.
One major downfall for anyone who is trying to live by a budget is to assume that every month is the same and that you can have a one size fits all for all the months. That would be wrong; August and September months are far different than say December, or a birthday month. Your budget is a living, breathing document that you can manipulate each month to shape the unique situation of that particular month.
Save one month’s income:
Once you have completed a working budget, you can start moving the pieces around to meet two important goals: A) Saving enough to reach one month’s income as an emergency fund; and B) paying yourself first by getting at least the company match in your 401k.
You need an emergency fund to avoid using credit cards should or when an emergency hits. Not using credit cards or limiting credit use during the first few months of your budget is critical to stay on task. To save this amount, you must pay the minimums on all eligible bills so that you can save the amount. Once you reach the amount, you can then start paying more on your bills to pay them off. Life will happen, it is critical that you have an emergency fund. Some folks use their credit cards as that emergency fund, and as long as you use this concept, it will be more difficult for you to get out of debt and stay out of debt.
Take the match:
Even when trying to get out of debt, it is important that you take the 401k match. It is free money. This is an important concept of paying yourself first and building towards your financial freedom even when trying to get out of debt. Moreover, taking the company 401k match by contributing enough to receive the full match means that you can still work on your long-term goal of financing your retirement while not losing out on the free money that your company is providing you. This is a critical steps, one you should strive to make unless your financial situation is so dire that you cannot pay for your basic necessities of housing, food, and transportation. I recommend cutting back on entertainment, restaurant expense and any other discretionary expenses so that you can take advantage of this free money.
Estimated time of completion for this step is one to three months, but you will apply this principle every month for the rest of your life. Failing to budget every month means that you will start losing track of your money and may end up going back into debt. Whether you enjoy budgeting or you think it’s a drain, its an important step to building wealth.
Step three: Payoff consumer debt (Excluding student loans if you cannot pay them all within 24 months)
Step three is the start of reducing your financial liability, the debt that you are carrying around with you. You need a game plan that will hone you on what to do to pay off those credit cards that you have that are sucking the life out of you by charging 12-30 percent interest, sometimes more. You will also pay off your car, department store cards and any other debt excluding student loans and mortgage related loans.
However, if you have more than $100,000 household income, you should budget to pay off your debt, including student loans within 24 months, by averaging at least paying $40,000 towards your debt. If your total debt exceeds $80,000, excluding your home mortgage, you should strive to pay a minimum of $40,000 per year towards your debt for the first two years and then pay the remainder in step five.
It is extremely difficult to pay your debt for more than 24 months. You are more likely to give up after 24 months due to a variety of reasons. This is why step three should not last for more than 24 months. Additionally, you want to start investing towards your retirement and buying a home. Delaying these two things puts you behind your eventual goal of reaching financial independence. This is why it is so important, when possible, to sacrifice and pay off your debt within the first 24 months.
If it will take you longer than 24 months to pay your consumer debt, then you will have to take drastic steps to get you to 24 months. Get rid of your car. Sell your car, get something cheaper and pay cash for it. For most this is the easiest step and also the hardest because a car is often a status symbol. The next step is to get a side hustle, a second job. If you can’t pay the debt within the 24 months, you will need to increase your total income to get you there. A side hustle or second job can increase your monthly income by several hundreds to more than a thousand dollar a month. This means working extra hours during the week and on the weekend. Again, this will require sacrifice, and you will have to work hard to get to the finish line.
Step four: Wealth Building Part 1- Increase retirement savings to 10 percent
Once you’ve gotten rid of some, if not all, of your consumer debt, you can increase your retirement investments to 10 percent of your income. The goal here is to start taking advantage of compound interest by investing at least 10 percent of your income into retirement. The earlier you start, the less money you have to put into your retirement. The sooner you can contribute a meaningful amount towards retirement, the sooner you can allow the component of time and compound interest to really get you across the finish line. Even delaying starting just a few years can make a huge difference in the amount of money you will have in retirement or how long you will have to wait to retire. The Ten-Step process assumes that your goal it so retire by age 59 ½ and not 60 or later, so it is critical that you start saving early, especially if you are in your 30s or early 40s.
Step 5- Pay off student loan debt
When you reach Step Five you can give yourself a pat on the back because you have made some great strides into changing your net worth. However, the average American has $32,000 in student loan debt and if you are married, you could have anywhere between $50,000 to $75,000 in student loan debt. Therefore, it is critical that you focus on paying off your student loans as quickly as possible. The goal is to devise a plan where you can pay this monstrosity within a 24-month period. Keep in mind that most of the money that you used to pay down your consumer debt will be funneled to this step. The longer you allow this step to drag, the more likely it will have an adverse effect on your overall life and your ability to fulfill your ultimate goals of being financially successful. Again, if it is going to take you longer than 24-months, you will have to look at other options for you to get you down to 24 months or something closer.
6-Wealth Building Part 2-Emergency fund and a down payment on a home.
Step six incorporates two goals. The first goal is to increase that emergency fund from one month to three/six months of expenses. This step will ensure that you stay away from credit card debt. An important point here is to avoid having a large emergency fund for “emergencies” while also carrying a large interest-bearing balance on your credit card. Quite a few people do this and it is time to take the money out of your bank account, pay your credit card balance in full, and avoid paying the high interest rate.
Home down payment:
The next goal is to save for a sizeable down payment of at least 20 percent for your first home. Incidentally, if you already own a home, but have a home equity line of credit that you have used in the past, this is where you would pay any outstanding amount and close that line of credit. With a fully funded emergency fund, you will no longer need that line of credit.
If you are a first-time home buyer, there may be programs which do not require a 20 percent down payment. However, if you are required to pay private mortgage insurance ([PMI), you should try to save for the 20 percent or as much as possible to avoid the PMI.
If you are in the military, you can use your VA loan to buy your first home or reuse it to buy a subsequent home once you’ve refinanced the previous VA loan. I’m not a fan of the VA loan but there are benefits to it that you should consider if you’re not in a position to put down 20 percent. The Active Duty Passive Income Podcast (ADPI) and their facebook group provide information on how to maximize your VA loan (which has caused me to reconsider my stance on using the VA).
Step six is a critical step because home ownership and saving for retirement are two key pillars of building wealth and becoming financially successful and independent.
Step Seven: Build your dream retirement
The goal here is to sit down with your spouse/partner and lay out your dream for retirement as a couple. The purpose here is to set realistic goals that fit within your lifestyle and agree on an age to when you would like to stop working and retire. Once you have those two things worked out, you can plug in a few numbers in a number of online retirement calculators, which will tell you if you are on track, need to save a little bit more, or adjust your retirement age or withdrawal amount to meet your goals. Like Chris Hogan likes to say, retirement is a number, not an age. You will have to figure out how much you need. This Step will open your eyes to where you are and where you are heading. The good news is that if you have reached this step, then you are heading in the right direction.
Step Eight & Nine: Save for College and Payoff the Primary Residence
Steps eight and nine are done simultaneously. Step Eight is establishing a college fund for your children’s education. If you don’t have kids, then you can skip this step. If you believe that kids will learn to appreciate the value of a dollar by having to figure out how to pay for college, you can choose to not save towards their education. There is no judgment on this step, it is a personal choice. I would recommend letting your kids know that you do not intend to pay for their college so that there is no surprises when it comes time to fill out college applications.
There are different ways to save for college from 529 plans, state tuition prepayment plans, to The Uniform Transfers to Minors Act (UTMA). I have used an UTMA, and the state of Utah’s 529 plan because it has extremely low fees and uses Vanguard funds. I don’t live in Utah and was able to use their plan, so there are lots of options for you to choose a plan that is part of your state or out of state depending on your situation. Whether you choose a 529 plan, UTMA or state tuition plan, focus on what’s best for your family by analyzing what each have to offer. I’ll write a blog on why I picked Utah’s as my choice at a later time.
Conversely, you may be the type of parent that want to provide some, if not all, the support to your children when they attend college. In that case, contribute towards their college as early as possible to allow compound interest to work in your favor. The one thing that is critical to remember is that while those brats can work, join the military, get scholarships, or attend community college to help fund their college dreams, you cannot get a “loan” to pay for your retirement.
Paying off your primary residence.
This is why personal finance is so personal-paying off your mortgage on your primary residence is one of those things that people differ on depending on where they are in their journey and how they feel about debt in general. If you hate debt of all kinds, then you will likely want to pay off your house. If you want to use debt as a vehicle to wealth building, then you may choose to invest the money you would have paid on your house as extra principal payment towards your retirement accounts to max them out, or your brokerage account to build a bridge account towards your goal to FIRE, or to buy more real estate because you want to build your passive income portfolio. For those of you who a risk adverse, hate debt and or want the safety of having a paid off home, you may decide to through all available money towards paying off your house. Like I said, personal finance is personal and you will have to make the choice of what is most important to you-a paid off house or money to invest.
We picked safety over having more money to invest. This is strictly a personal choice. I’ll write a blog on this at a later time.
Here, the two Steps are very personal. You may be the type of parents who do not believe in paying for your child’s college education, in that case you may contribute very little in a college account while focusing on retirement and paying off the home. There are certain situations where you can delay paying extra on your home to maximize as much as you can towards your retirement, but again circumstances dictate. Ultimately, whatever you decide to do during Steps Eight and Nine will put you in a better position to do other things when you reach retirement age.
Step 10: Enjoying Wealth Building Financial Independence and Retire Early (the joy of being on FIRE)
Finally, Step 10. I’m not there yet so I really don’t know what to tell you. I’m only guessing here.
Once you have reached Step 10 it is likely that you have surpassed or at the brink of reaching your goal of having a net worth of one million or more. But more importantly, Step 10 allows you to think about where you are financially and when you could potentially stop working and retire early. Financial Independence is the freedom to stop working if you so choose. To do so, you would need a sizeable nest egg that you can start pulling from at age 59 ½ but also an account that you could live off of before 59 ½ (bridge account). A bridge account is the money you save to use before you can start using traditional retirement account that are available to you starting at age 59 ½. There is other ways to pull money from your retirement accounts and the MadFientist has great suggestions on how to position yourself in ways to maximize those funds.
This step is difficult to reach, but every person should strive to be financially independent so that they can make the choice to work, not work, or do something they love without worrying about how they will pay the bills. This concept is not new but is seldom discussed because most people assume that you will barely have enough income during retirement let alone enough of a net worth which would allow you to retire well before normal retirement age. This is the ultimate goal.
Be smart and be intentional with why you are doing each step. At the same time, however, blindly following steps because someone else said that's what you should do won't get you to your ultimate goal because the why is important. Be smart means to analyze the best way for you to get from point A to point B, there are many paths to choose from, this is where educating yourself is important. Be intentional means that once you've decided on a course of action, follow it and do whatever it takes to accomplish it--like a soldier on a mission, the work is not done until the mission is complete.
Be honest with yourself, are you better off today than you were five years ago? Is what you've done the last five years really working out for you? Are you still in debt? Have you increased your wealth by at least 50 percent over the past five years? Are you closer to your dream retirement than you were five years ago? If you can't answer yes, then it's time for you to try something different. Where would you be today if you applied the principals outlined above? Where are you going to be five years from now if you applied those principals now? No matter the circumstances, you can rise and win. Just do one step at a time.
Let’s Do this, 3 Steps you can take:
1-Get a copy of Dave Ramsey’s book, the baby steps. Personal finance is personal, but you won’t make any progress if you can’t figure out how to live on less than you make. There are lots of tools out there to help you and I highly recommend Dave Ramsey’s book.
2-Learn about budgeting, investing and building wealth. There is a slew of resources, check out these podcasts: ChooseFI, The Ramsey show, Bigger Pockets Money, Bigger Pockets, Active Duty Passive Income Podcast (ADPI), and the Chris Hogan show (not listed in any particular order of preference). Most of these folks also have websites that you can use. Don’t forget the Madfientist as well and other FI bloggers that I’ve mentioned. All of them offer you a different take on building wealth.
3-Just do it. Get off your butt and start learning. Start tracking your expenses. Start living on less than you make so you can invest in the future you.
As always, if you have questions or need help, feel free to drop us an email. Join our mailing list here.