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Becoming Financially Independant
First and foremost, I want everyone to know I am NOT a financial expert by any stretch of the definition. What I am, though, is a real person, probably just like you, who has used, and continues to use, all of these ideas I'm about to present to you, as a way to work toward becoming financially independent. I'm not there yet, but I'm well on my way. I've used these ideas over the years with great success. Having said that, there have been roadblocks that have slowed me down, and you need to realize that these will happen to you as well. But I've never lost my focus or my determination in becoming financially independent.
This is the number one question most people ask. Most people want to be financially independent but have no idea how to start. First thing you have to do is look at your budget. Without this step, nothing I tell you later will matter. This is the most important thing you can do. Even if this is the only piece of advice you take from this, it may still save you money.
The average person has no idea how much money they really spend every month. Most Americans, around 76% of them, are living paycheck to paycheck. Less than half have a 3 month savings cushion in place, and about 27% have no savings at all. Why is this? Well, there's several reasons. Job losses are a part of this, as well as declining wages. Personally, I think the biggest factor is our debt culture and a lack of financial education for children. What do I mean by those? Well, we've become a society of "I need to have it now!" but we don't have the money for it, so we take on debt. Now, that doesn't mean that some debt can be good and that you should never take on debt, but you need to be extremely picky about what debt you take on. Mortgage? That's usually good debt. Car loan? Usually bad debt, but if you need a new car, sometimes this is unavoidable (remember those roadblocks I mentioned earlier?). Credit cards? Almost always bad debt. I'm getting a little off topic here, but this does matter to what I'm saying.
You need to know how much you bring in each and every month. I make my budget off two very simple rules: 1. Estimate your income slightly lower than it usually is, and 2. Estimate your expenses slightly higher than they usually are. Let's look at these a little deeper.
- Never add in bonuses. Bonuses are just that: bonuses. If you begin to account for these as regular pay, and base you budget off of that, that one month you don't get a bonus, you'll be struggling to pay the bills.
- Overtime is the same as a bonus. Never make this part of your budget.
- Do you have a second job? Can you afford to pay your bills without it? If the answer is yes, then this also shouldn't figure into your budget. This can be a huge key to your financial security.
- Round your income down to the next $50. In other words, if your regular salary brings in $782, budget it at $750.
- Overestimate your utilities. Round it up to at least the next $5 or $10 mark. For example, if your electric bill is usually $72, budget it as $75 or $80. This helps if you ever have a high month.
- See if your utility company offers budget payments. If you don't know what these are, your electric company, gas company, even the water company will sometimes offer what they call a budget plan or budget payments. They look at your usage over the past year and set you a monthly payment that is the same for every month. They usually adjust this amount yearly. This allows you to have a consistent payment every month, instead of, for example, you gas bill being much lower in the summer and much higher during the winter. If you do this, again, round up that amount.
- If you have credit card debt, add 20% to your minimum payment each and every month. This has a twofold effect, which I will explain later.
- Round up all your other loans Car loans, student loans, home equity loans, etc. Everything but your mortgage (there's a reason for this that I'll explain). Again, this has a twofold effect, which I will explain shortly.
- Include groceries, gasoline for vehicles, dining out, entertainment, etc. Everything you spend money on monthly.
- Also, as part of this, make note of the balances on all of your debt, excluding your mortgage.
Now that you're done with this, you need to ask yourself a big question: can I afford to live based on this budget? If the answer is yes, you're ready for the next step. If the answer is no, then it's time to make some hard choices.
Trimming the Budget
Even if you answered yes to the "can I afford my budget" question, this section doesn't hurt for you to read, either.
Along with out debt culture, we also have a problem determining the difference between what we want and what we need. This is the point where a lot of people will start to struggle with this plan. You need to look at your budget and determine if those items are wants or needs. Now, a little caveat to this. Debt that you've already incurred, i.e. mortgage, car loan, student loans, credit cards, etc., are not necessarily easy things to eliminate, even if you determine you don't need them. You have to sell your home or car and pay off those loans with the proceeds. There are occasions where selling won't get you the money you need to pay off that debt. For this reason, I recommend not doing that. There are other areas you can cut out of your budget.
So what's the difference between a want or a need? Well, the biggest question is do I need this to survive? We need gas, electricity, and water to survive, but cable? No. What about dining out? Nope. Movies and concerts? Again, nah. A lot of people mistakenly think some of these items are necessities. They're not. But you as an individual or family need to make those determinations. I don't know your personal situation. I don't know how close or how far away you are from hitting your budget. I can, however, give you some examples on how to save money.
- Do you eat out a lot? If the answer is yes, either eliminate this expense or cut it back by at least 50%. Keep in mind, you won't be saving the entire amount you spend eating out because you'll have to replace it with groceries at home, but the savings can be significant. Include in this if you eat out for lunch at work. Try packing a lunch. That alone can save you about $25 a week.
- Do you buy a lot of high end foods when you grocery shop? Things like steak, gourmet cheeses, sushi, etc. A lot of these items are nice luxuries, but are not truly needed. Again, eliminate or cut back.
- Entertainment. This is a broad category. This includes going out to the movies, concerts, any subscriptions you have to magazines or book clubs, or even a Netflix account, and your cable or satellite TV service. Again, you may not need to eliminate these, but at least cut them back. For example, if you have HBO, how much do you really watch it? And if you have Netflix as well, do you really need both? I personally eliminated our Netflix account because we barely used it. I've even had a friend cancel his DirecTV service and go to just having Hulu Plus and Netflix. Combined, those are less than $20 a month and he was spending close to $75 on DirecTV. He still has something to watch at home, but he's saving $55 a month!
- Also, look at your utilities. Do you run the dishwasher half full? Maybe even do a small load of laundry on occasion? These add up on your utilities. If you keep your thermostat on 70, maybe turn it down to 68. It doesn't seem like much, but it adds up, believe me.
- Do you have cell phone insurance? This is one you may be able to change if you rarely break your phone. Notice I said change, not eliminate. I'll tell you why below.
These are all just suggestions. There's probably a hundred more I didn't cover. You need to take a look at what you can eliminate where, and do it. I even know a few people that cut all their entertainment out, got an over the air antenna for their TV, and started going to the library to check out books. This may seem extreme, but sometimes this is what it takes. You just have to ask yourself just how important this is to you.
Now that you've trimmed your budget, I want you to trim it more. You need to find some more money where you can add in a savings plan to your budget. The more you can make this amount, the better it is for you.
About how much is the average month cable bill?
Now that you've examined your budget, now it's time to look at your banking habits. A lot of people never examine their banking. You ask most people why they bank where they do, and a lot of times you'll hear things like "my family has always banked there" or "a friend recommended it to me."
I don't put my money anywhere it isn't making me money. What do I mean by this? Interest. Do your research. Find a checking account that pays interest. If you can't find one suitable to you (some require you keep a minimum balance in to earn interest), at least find a free one. I'm going to give you a dirty secret a lot of people don't know about banks. Banks take the money you deposit with them and turn around and loan it out to other people. Does this make banks bad? No. This is their business model. It's how they make money. However, these banks are taking the money you put in your checking account (let's assume you have no savings at this time), and loaning it out to other people as loans. These people then pay interest on these loans, which the banks keeps. And in most cases, the bank charges you a monthly maintenance fee for the privilege of letting them do this with your money.
Stop the cycle! Not all banks do this. There are plenty of banks who pay interest on checking accounts, or at least have a completely free account. Usually there are some conditions, such as at least one direct deposit a month, using your debit card x number of times a month, etc. These are are very easy to achieve but just living life. All I'm saying here is take some time and do your research. These banks are out there. A lot of them are internet banks. Don't let that scare you. I've been using internet banks for about 10 years now and I've never had an issue. They're all FDIC insured and are chartered. Do your research and you'll be able to find the good ones.
Debt: The Enemy & Savings: Our Friend
Now we're going get into the nitty gritty of this guide. Again, I want to let everyone know that I am NOT a financial expert nor do I purport to be. These are steps I've taken in my life to help me in striving for that financial independence.
Now, the reason this is called debt and savings is because this is a twofold plan. You have to work both at the same time. There are plenty of ideas out there that suggest get out of debt first, or invest x amount of money first. Neither of these are wrong in any way, and if you choose to go either of those routes, I wish you the best of luck. It's just been my experience that concentrating on one or the other first, people tend to feel like their not getting anywhere. If you do debt first, people don't see they're debt going down, the just see that they're spending "more" money. We know this isn't the case, but it's human nature. If you concentrate on savings first, your debt literally doesn't seem to go down, because it's really not by any significant amount, and your savings doesn't seem to increase much because the average person can't just drop a large sum of money into some kind of investment, so it never seems to grow. I like doing both because inherently in, in your mind, you know you're doing small amounts and you begin to see the small differences.
You've already begun paying off your debt in your budget.
How? Remember when I said bump up the minimum payments on your credit cards by 20%? That's it. And it's twofold, like I said. First, that 20% gives you a cushion. A little short this month? It sucks, but just pay your minimum payment. It's not a lot but it saves you a few dollars. Secondly, you're paying down this debt more quickly and the credit card companies like payers who do this. Why? Because you're showing you can pay your debts, but you're also letting them make some money off of you. This is good for building credit. Also, remember when I said round everything up? Same thing goes for your loans. Pay that rounded up number. It may only be $2 or $3, but that will add up over the term of your loan.
Remember when I said to trim you budget even more? This is where that comes in, for your savings.
I want you to take that amount, no matter how small, and invest it. Cut it in half. Take half and actually invest it, something longer term that will earn you a good return. Personally, I use peer to peer lending for this. I'll explain why later. Take the other half and put it into savings. Savings will earn you very little money and take a long time to grow, but it's very safe. Even if you lose all your money you invested, you still have your savings.
Now, what I explained seems very simple, and in all honesty, it is. And it takes a long time to do it this way. So I want to really get into the meat of how you can make things happen. I'm going to use myself as an example. I'm going to give you all the steps I've taken and show you how it can work for you too.
How I'm Doing It
This isn't any kind of secret or get rich quick idea. Wealth is a marathon, not a sprint. Sprints do happen, but they're the exception, not the norm.
I've done everything I've explained above. I've trimmed my budget, examined my banking, and made my debt and savings plan. Here is exactly what I do:
When I started, every pay period (my wife gets paid biweekly, I get paid twice a month, so I base our budget and this plan off of her paychecks) I had $50 that went toward my investments and savings. I also had an extra $10 budgeted monthly to handle some more savings and paying down my debt. Let's start with the $10.
Where did that $10 come in? Remember when I mentioned cell phone insurance? My wife and I take good care of our phones, so we never carried insurance on them. However, when we decided our son was mature enough to have his own phone, I thought the insurance might be necessary. I paid the first month of it ($6.99) and realized this was just wasting $7 a month. Now, I know most insurance can be viewed this way, but hear me out. We had already warned our son that if he breaks his phone, he wouldn't be getting a new one. Also, the cost of a phone is nowhere near the cost of a house, car, or major medical procedure. So I cancelled the insurance and budgeted $10 a month. Why? well, I had already adjusted out budget to accommodate the extra cost for his phone plus the insurance, and I always use my round up rule. Now, I do two things with that $10. First, $7 every month went into a savings account that is used solely for that purpose, and still does even now. And now that I mentioned that, I want to quickly mention I keep seven separate savings accounts. When I get down to the savings section, I'll explain why I do this. The remaining $3? That went to paying down debt, and still use it for that even now.
So the question becomes, what do I try to pay off first? I use Dave Ramsey's Baby Step that he calls the Debt Snowball. Find your lowest balance debt and pay it off first. If you have two debts with similar balances, pay off the higher interest rate first. Now, This is where this discipline really starts to matter and I'll use my personal experience to demonstrate. My lowest balance debt was a credit card. I only owed about $150 when I set this plan into motion. The minimum payment on the card was $25. As I explained above, I added 20% to this, making my monthly payment $30. When I started adding in my extra $3, my payment was $33 a month. On top of this, I added in my investment profits, which I'll explain when I get into the investing. From here, I started prioritizing all my debts. After this first account paid off, I concentrated on higher interest rates as opposed to lower balances. You can do it whichever you choose, but the discipline is the biggest key here. My second account I chose to pay of was another credit card with a $450 and also a $25 minimum payment. I was paying $30 a month on this one the entire time I was paying the extra $3 and investment profit onto my first account. In fact, all my credit cards were receiving this extra 20%. Now, once my first account paid off, I then took the extra $3 plus the $25 minimum payment from credit card 1 and started making $58+ payments on credit card 2. I did it this way for a couple reasons. First, I already have that credit card 1 payment in my budget. Second, it's nice to see an extra $5 a month. It shows you that the progress is happening. I call this $5 your treat money. Spend it if you want, add it to your debt if you want, or, do like I did, invest it. Now, this is how it snowballs, because you continue to use budgeted money to pay off debt, the larger debts will pay off more quickly. You need to keep those payments for the accounts you've already paid off going on the next debt you choose to pay off. Mr. Ramsey suggests you concentrate on the small balances, but I prefer to mix it a bit. Both ways work great, it's just a matter of how you want to do it, but either way, stay the course and pay off that debt.
While you're paying off your debt, you want to start earning some extra money. As I said above, $50 was my investment and savings money every paycheck. This was added to the budget to ensure that's where it was used. $25 went to investing, and $25 went into savings. Let's start with the savings.
As I stated above, I keep seven separate savings accounts. These are broken down into categories based on what they're for. Here is the list I use:
- Cell Phone
Now, use what categories you choose, but I recommend doing something like this. And this harkens back to what I said about researching your banking. This is where internet banks are handy. I personally use Capital One 360. This is not an endorsement, nor do they pay me, they're just who I like. I can have up to 25 savings accounts, I pay no fees, and they pay a higher than average interest rate on basic savings accounts. I keep separate accounts because people tend to see a large amount of money in their savings and they get the urge to spend it. I've found that if you separate them and stay disciplined to know what that money is earmarked for, it's easier not to spend it where you don't need to. You can divide up you savings half however you choose. You can divide it evenly, or, like I do, spread it based on your current need or want. What I do is prioritize on where I think I'll need money the most next. So say I've determined I'll need a new car soon. I start putting the largest amount into my vehicle savings to save up for that car or at least the down payment. I split my accounts in this way:
I prioritize and adjust the order as needed, but I never touch that money until I need it for that category. Notice how there are only six amounts listed? That;s because the cell phone account is a fixed amount based on what I'd be paying for the insurance otherwise.
Now to investments. I wanted to earn some extra money quickly, so I did some research into how I could do that. This is where I found peer to peer lending. I want go into a long explanation as to what peer to peer lending is, but basically you take the role of the bank in the lending model. You take all the risk, but for that reason, you also can earn higher returns. There are a few out there. I prefer Prosper Marketplace, but Lending Club is another good one. There are some things to keep in mind with peer to peer lending. First and foremost, not everyone can invest in it. Laws vary from state to state, so depending on where you live, you may have some rules and minimums you need to follow and meet, or you may not be able to invest at all. If you can't use peer to peer, find some good mutual funds, stock, or bonds to buy into.
Now, with Prosper (and I'll be using them as an example because I know them best) you can invest as little as $25 into a loan. This is why I leaned toward Prosper for my investing. Again, I'm not going to go into detail about investing on Prosper because that's not what this guide is for. Instead, I'm trying to show you what I did, and continue to do, to get out of debt and grow my wealth. I transfer my $25 every pay period into Prosper and then invest it into a loan I like. Once that loans originates, every month I receive a payment based on the loan term, interest rate, and payment amount the borrower is paying. Based on the $25, these are usually less than $1 a month per loan. What I do with this money is where things can get exciting. As I get those payments, I ALWAYS reinvest the principal amount I received. So, for example, let's say my payment I received was $0.82 for a particular loan for this month. Of that $0.82, $0.02 went to Prosper as their fee for administering the loans (the loan is given out from investors money, but Prosper handles the payments, contact for late payments, etc.), $0.59 is the principal payment, and $0.21 is interest. I reinvest that $0.59 into the next loan I invest in, making my investment for that loan $25.59. The $0.21, however, I withdrawal and use it to pay down my debt. Why? Because that's extra money not included in my budget. I don't need it to live. This is where you start to see it compound.
I also stated I never account for bonuses or overtime into my budget. This is a good place to use that extra money. You can invest it, pay down debt, or do both. I invest it. I hope to build my wealth more quickly this way. Paying down debt isn't a bad idea, either. Just try not to spend that money on something you don't need. Get to a point where money is no longer a stress
Now, there are many guides out there on investing and as I've already said, I'm not a financial expert. Read these guides and make your investing choices wisely!
I hope this guide helps. My last piece of advice : have fun with this! Make it a game. Watch your wealth grow. Watch you debt come down. If you have any questions, just ask in the comments below and I'll do my best to help.