Becoming wealthy is all about your personal finances. Making sure your personal finances are in shape can mean the difference between living pay check to pay check and sipping margaritas on your private beach. The formula to become wealthy is a simple mathematical equation, Income minus Expenses. Earn more than you spend. It works every time. Guaranteed. How fast you start rolling in the dough depends on how big the difference is between your income and expenses. There are two ways to make the formula work quicker for you. Number one: increase your income, which is covered in some of my other posts. Or two: decrease your expenses. One of the biggest expenses most people have is the amount of interest they pay each month to their credit cards and loans.
There are various simple plans. Most of them boil down to paying more than the minimum payment due each month. Here is a list of several ways, use one or use them all. The first step for all of these is STOP using your credit cards.
The simple way (above) is just that - simple, you will pay down your debts eventually but will likely be slow and you probably won't stick to it when your bonus or tax refund arrives. You'll say “I'll just spend part of it then the rest to my credit card”. The problem is human nature: in your mind, you will have spent your tax refund three times over. You get a $1,000 refund, but you've already purchased $3,000 of stuff in your head. However, there is an answer. Actually, there are two. The debt snowball and the debt avalanche.
The Debt Avalanche is the same as the debt snowball except for this time you pay off the credit card with the highest interest rate first. This is the most efficient way to pay down your debt. You pay the least amount of interest this way, but you may not get the early wins like you do when you pay off a credit card in the debt snowball method. This is the method I used because I'm a geek and hated to pay more interest than I had too.
|Credit Card 1||$1,000||9%||$50|
|Credit Card 2||$4,000||18%||$125|
|Debt Snowball||Debt Avalanche|
|Credit Card 1||Credit Card 2|
|Credit Card 2||Credit Card 1|
|Car Loan||Car Loan|
Using our example debts and $100 extra to pay each month.
We would pay $150 ($50 min payment + $100 extra) each month to Credit Card 1 (smallest amount to pay off). When Credit Card 1 is paid off we would take the $150 we have been paying and add it to the minimum payment for our next smallest debt, Credit Card 2. So now we have $275 a month to pay down credit card 2. Once Credit Card 2 is paid off we add the $275 to our last debt, the Car Loan. We are now paying $625 per month on our Car Loan.
We would pay $225 ($125 min payment + $100 extra) each month to Credit Card 2 (highest interest rate). When Credit Card 2 is paid off we take the $225 we have been paying and add it to the minimum payment for our next debt, Credit Card 1. So now we have $275 a month to pay down Credit Card 1. Once Credit Card 1 is paid off we add the $275 to our last debt, the Car Loan. We are now paying $625 per month on our Car Loan.
It's amazing to watch your debts decrease so fast. I used the Debt Avalanche personally when I was paying off my debts. I can tell you that it works and after you have cleared down a couple of your debts it starts working quickly. You and enter your debts, extra payments, and select which method you want to use. It will calculate the amount to pay on each debt and show you when each debt is paid off. I hope it comes in handy.
I know how scary it can be to be deep in debt and wondering if you can ever escape. I'm here to tell you that you can because I did it myself. I've gone from living pay check to pay check, hundreds of thousands of dollars in debt, to having cash in the bank, stocks, no debt and able to stop working for 6 months for a mini-retirement. If I can do it, then you can too.
Making sure that your personal finances are in shape can mean the difference between living pay check to pay check or sipping margaritas on your private beach. Most people just dream about being wealthy. They spend their time trying to find a shortcut to riches or win the lottery. They live in hope that a long-lost uncle somewhere will leave them millions in his will. The truth is that becoming wealthy is hard work - but it's worth it. It's about making tough choices and having the perseverance to see them through. And funnily enough, the journey is actually part of the reward; the satisfaction of seeing all your work grow into something amazing. Whether it's traveling around the world, providing for your family, or helping those less fortunate, you will be the one that did it, you will be the one that made it happen. Do you want that? Well then, jump in and take action.
A financial plan is simply a list of short and long-term goals. It doesn't have to be complicated or hard - it’s not a budget. Writing down goals helps to make them a reality. It holds us accountable and makes them tangible. If your goals are just in your head, then they aren’t actually goals - they are dreams. In order to achieve them, we need to make them real. Think about what you want, your first home, a huge retirement nest egg, to eliminate your debt, or that trip to France you've always wanted to take. Think of some 6 months, 1, 2, 5 and 10-year goals then write them on the Financial Goal Worksheet, or type them up on the computer, hell, write them down on a napkin, just do it. Don't limit yourself here. Include some really big goals. Just make sure you have achievable goals as well or you’ll get frustrated and give up. You need to look at these every day, tape a copy on the bathroom mirror, leave one on your keyboard when you leave for the evening, so it's the first thing you see when you get in the office. Need a coffee first thing in the morning? Well, stick a copy there too. Normalize those goals, if you can do that, they’ll become so much more achievable.
Before anyone can get where they want to go, they need to know where they are starting from, where they are NOW. That figure is your net worth. Your net worth is calculated by deducting your liabilities from your assets. If you have more assets than liabilities you have a positive net worth, otherwise you have a negative net worth. Not good. To calculate your net worth, you will need to gather up your financial documents, bank statements, investment accounts, mortgage statements, credit card bills, loan documents, house and vehicle values, etc. Try to include everything; home furnishings, clothes, and don't forget the kitchen sink. This list of everything will also help you prepare for the next step; protecting your family and yourself. Put every bit of information you can find into your trusty spreadsheet and have it add up your assets and liabilities then subtract the liabilities from the assets. Did you get a positive number? I've included some worksheets on this site to help you calculate your net worth. However, if you are like me and have a lot of places you have stashed your money and have more pressing things to do then add and subtract numbers all day long, then you should try Personal Capital. I use it to keep track of my net worth, it's quick and it tracks accounts automatically using their website or app.
Now that we know where we are and where we want to go it's time to figure out how to get there. We need a spending plan to help guide our way. I know what you’re thinking “NO, I hate budgets!”. It's a spending plan, not a budget, so there's nothing here to fear. Look - this is as easy as figuring out your net worth - plus you should have almost all the information you need. So now, instead of writing down your assets, write down your income and instead of liabilities write down your expenses. Subtract your expenses from your income and you have your cash flow. Just like your net worth you want this to be a positive number. If it's not, keep reading - there are some things we can do to change that. As part of your spending plan, there are three important things you can do, have an emergency fund, reduce your debt, and reduce your expenses.
"I found the road to wealth when I decided that a part of all I earned was mine to keep. And so will you."
George S. Clason, Author of The Richest Man in Babylon
Life can sometimes be hard and it’s certainly full of risks. One of the biggest risks to a secure financial future is bankruptcy. It is very stressful and will keep you up at night. I've been there, done that. Those were some dark days. When times are hard having money in the bank can give you the time you need for you to get back on your feet. The typical amount of cash quoted as an optimal buffer is three to six months of expenses saved. That is great for when times are good and unemployment is low. But, to be as safe as possible, you really need 12 months of expenses up your sleeve. That amount will give you enough time to recover, even when the economy is troubled. I know some of you are freaking out right about now saying “There's no way I can save 12 months of expenses, I have to eat!”. Yes, 12 months is probably a lot of money that you don't have all saved right now, but the sooner you start the better off you will be. Start with as much as you can even if it's only $25 a month. Trust me I've been on both sides of this coin and the difference is amazing, you'll wish you had done it sooner. A key indicator of someone's financial health is their amount of savings. [box] In a recent survey by Google, only 29% of American had $1,000 or more in savings. If you have $5,000 or more in savings, then you are better off than 80% of the population[/box]
Debt can be a useful tool when used correctly, it can provide you with shelter or fund a new business. Used poorly it can drag you under. As we have learned from the previous section, debt lowers our net worth as well as our cash flow. If Cash is King then Cash Flow is Queen. Paying down debt and reducing your monthly payments makes your financial runway longer, giving you time to succeed. Once you have established your emergency fund it is time to reduce your debt and increase your cash flow. Credit card debt is notoriously sneaky. Minimum payments are typically 1% to 3% of the monthly balance, which means as you pay off your debt your monthly payment also decreases until you hit the banks minimum payment, $5 to $25. If you just pay the minimum payment each month, a $5,000 balance with a 2% repayment means you will be paying for 11 years, as long as you don't add any new charges to that card. You need to read your credit card statements every month. For several years credit card companies have been required to tell you how long it will take to repay your debt and how much you will pay based on the minimum payments. Here is a copy of that information from when I purchased a new laptop. As you can see, if I had only made the minimum payments a $2,667 laptop would have taken me 17 years to repay and ended up costing $7,427! Now how do we get out of this vicious cycle? There are various ways, you can read more ways in my Debt Repayment post, but here is a simple way, the Snow Avalanche:
Just like a business, we have a burn rate too. By lowering our expenses we can reduce our personal burn rate, which means we can build our emergency fund or reduce our debt quicker. If you have done both of those already it means you have more money to invest and build your wealth quicker. It also reduces stress and helps you sleep at night, and we could all use more sleep. I won't preach to you about the Latte Effect, but it is one of the simplest ways to give yourself a pay raise. You don't even need to convince the boss you are worth it, because you already know. Just like reducing your debt, reducing your expenses increases your cash flow. Be frugal my friend.
The last thing you want to do after you have worked so hard to build your wealth is to lose it all. You need to protect yourself and your loved ones. You will need several different legal documents. A Will to make sure your wishes are carried out and not what the government decides is best for your estate. A durable power of attorney, so someone can manage your affairs when you are not available for whatever reason. A Living Will and a health-care power of attorney are also important, so someone can make medical decisions when you aren’t able to make them for yourself. You will also need various types of insurance, Medical, Liability, Umbrella, long-term disability. Doing these four simple steps will get your personal finances in order. Getting your personal finances in order will grow your wealth, and not just monetary wealth but your mental and physical wealth as well.