Finally I got smart, set some financial goals, started reading books and magazines about money, listened to audios, and solicited the advice of an advisor. The biggest lesson I learned... You have the power of choice. Financially, with every dollar you make, you hold the power to choose your future. You can choose to live a few paychecks away from financial ruin or travel the path to be financially fit. I also learned that you are not the car that you drive. Rather your spending habits reflect who you are. Poor people simply have poor spending habits.
Below are 7 steps to help you on your journey to financial freedom, an Action Plan, and a snapshot of how I set up my bank accounts as an entrepreneur.
1) Create a Written Game Plan
Ok, so you know the drill. Every month you put it all into excel or Quicken or Mint.com or scribble it on paper. List all of your expenses for the month and don't forget to include a category for savings. The problem I’ve found is that most people think it really is a once a month project. However, most wealthy people look at their budget weekly, or even twice per week.
Log in your expenditures twice per week and re-evaluate where you are. This way you can right the ship before you end up at the wrong port. If you don't make this simple exercise a habit, you may find yourself cruising towards Someday Isle. You know, Someday I’ll get a grip on my finances, Someday I’ll save for retirement, Someday I’ll work on my budget.
Your budget will allow you to project where you are going, otherwise you will never get there. Keeping track of your expenses each week will help you avoid any surprises. After teaching thousands of students about how to win with money over the past two decades, I’ve found that most people live their financial lives by looking over the stern instead of charting a course to move ahead.
I’ve messed this up more than once. Luckily I didn’t run into an iceberg and sink my ship. I can’t tell you how many times I would get to the end of the month and ask, where am I? How did I get here? What happened? You have to look forward. Where there is no vision…
By the way, a budget doesn’t mean you can’t have fun anymore. Just add a line for Fun in your monthly budget. It’s a written plan that charts the course to where we all ultimately want to be…Paradise Isle. And look at it weekly, not monthly. It’s ok to make changes to the budget when you find yourself off course.
2) "Act Your Wage... you have to live on less than you make, you are not in Congress.” – Dave Ramsey
You will not prosper spending more than you make. While I did have a blast at times doing so, my wife reminds me that we didn’t really enjoy living that way. Choosing to live paycheck to paycheck to drive fancy cars; buying expensive things that we have since had to replace; and keeping up with the pseudo rich as if we had an unlimited supply, added way more stress to our already hectic lives.
Acting rich, living on borrowed money…it’s a terrible plan. That’s what most people do, but you don’t want to be most people, most people do not retire the way they had hoped. We found a better way. It’s so much easier to save money when you aren’t paying Visa for your lifestyle. I know, I know… it’s “everywhere you want to be”. But, it’s the expressway to Someday Isle. That’s not where I want to be, how about you?
3) Get and Stay Out of Debt
When you don’t have any payments you don’t have any distraction. At one point, in my twenties, I had six different credit cards. It’s not much fun working to pay off debt. I thought I was destined to work for Visa, Discover, MasterCard, and American Express forever.
According to Dave Ramsey's book, The Total Money Makeover, when interviewed, the Forbes 400 (the 400 wealthiest people in North America), 75% said that the #1 way to become wealthy is to get and stay out of debt. No car payments, no student loans, no credit card payments. To be debt free. What would it feel like to have no payments? Think about how that resonates. When you don’t have any payments, it’s a lot easier to become wealthy.
If you have debt, it’s time to make a plan. Put it all on a spreadsheet and get to work. There are several versions of the debt repayment plan called the Debt Snowball. You can either start with the highest % rate or, and I find this much more exciting, start with the smallest debt first. Ramsey suggests paying the minimum payment on everything but the smallest debt. Then attack that debt with any extra money you have. Once your smallest debt is gone, add that payment to your next smallest debt and attack. I love Ramsey’s explanation. “But, doesn’t it make more sense mathematically to start with the highest interest rate first? If you were good at math, you wouldn’t be in this situation, now would you?” By paying off the smallest debt first, when it’s gone, you get that win. It feels great! It gives you momentum! Set a goal to pay off your smallest debt by a certain date and GO!! You will have to make sacrifices. Don’t eat out. Work extra hours. Do whatever it takes. It WILL be worth it!
Set a goal to pay off everything except the mortgage in 18 months or less. You would be surprised at what you can accomplish if you have a plan (aka. a budget) and do the Debt Snowball. You can ride the mortgage out; since you’ll need to start saving once your other debt is gone. Another great resource for a debt repayment plan is Credit Karma.
4) Save Money
Once you’re out of debt (except the mortgage), Step one is an emergency fund. According to most experts, you’ll need at least three months of your household expenses in a savings or money market account. Six months is ideal, but three will get you started. Look at your necessary household expenses. The ones you would still keep if you lost your job. Think about it, if you lose your job, and you have no debt, and no car payments, and you have $18,000 in the bank, it’s a different kind of place to be.
Step two, save up for the things you want or will eventually need to purchase. Now that you have no car payments, you can save that amount each month for your next car. How about the 20 year roof on your 14 year old house? You should be saving for it so you don’t have to go into debt to replace it in six years. In business that’s called a sinking fund. Your grandparents however, called it a rainy day fund.
Step three, save for wealth building. Did you know that $100 per month invested in a decent growth mutual fund in a Roth IRA (which grows tax free) from age 30-70 would be worth about $1,000,000! I bet you blew more than $100 on "stuff" in the past 30 days. Do you even know where it went? If you looked at your budget weekly you would.
- Let's start with buying a home. For most people, buying a home is the largest purchase/investment you will ever make. I would recommend no longer than a 15-year fixed rate mortgage. You can pay it off early simply by rounding up your payment each month. The extra $100-300 per month will go towards the principal. Many people have a 30-year mortgage, and then refinance once or twice to pay off other debt. They end up paying off the house in 40 years or more, and because of the extra interest they overpay for their home by a ridiculous amount of money. Once your 15-year mortgage is paid off, you’re going to find wealth building to be very easy. And if you still need the tax write off that the interest on your home gave you each year, just donate that same amount of money to charity. This way you decide who gets it instead of Congress. If you are about to buy your first home, here is something to keep in mind. Do not buy the nicest home in the neighborhood. It won’t increase in value at the same % rate as the rest of the neighborhood. If you’re really smart, you’ll look for a home that needs a little Tender Loving Care. You would be amazed at how easily new carpeting and some paint can transform a home’s appearance.
- If you are an entrepreneur, invest in your company. That is the #1 investment of the affluent.
- Roth IRA = $5500 per year that grows tax free.
- Single or Solo 401k / aka. Single K. You can invest up to $17,500 per year. Roth or Traditional style as long as you profit that much. There's no income limit, but you can’t have an employee that has worked for you longer than a year (making at least $1000) unless you are will to match a Single K plan for them.
- SEP (Simplified Employee Pension). This is Pre-Tax only. You can invest 19% of your profit or 25% of your salary if you are incorporated (or up to $51k, but you would have to be reporting around $400k profit to hit the $51k contribution). If you have had an employee for 2 years you are ok, but their 3rd year you must start and/or contribute to their SEP.
- Traditional IRA. You can invest up to $5500 per year (you can only do a ROTH IRA or a Traditional IRA, not both (unless you make less than $30k).
What to do after maxing out your Roth and SEP:
- Mutual funds; You have to love the power of compounding interest (the snowball effect that happens when your earnings generate even more earnings). You receive interest not only on your original investments, but also on any interest, dividends, and capital gains that accumulate—so your money can grow faster and faster as the years roll on. In the retirement accounts I mentioned earlier, the principal is allowed to grow for years tax-deferred or even tax-free. You want funds with the lowest fees. Compare yours at http://www.personalfund.com/
- Lifetime Income Plan: Not your everyday whole life policy. Here are two I would look into, but you have to do your homework. http://www.bankonyourself.com/process and http://lifetimeincome.com/
- Real Estate: If I had my twenties to do all over again I would buy a duplex, live in one half and rent out the other half. Or buy near a college and rent each room to students (an investment I actually have made). And if you’re ready to take the plunge, a property with 5-8 units is a good way to hedge your bets. Meaning if one unit isn’t rented, it won’t crush you like a 3 or 4 unit property can where one empty unit would lose you 25%-33% of your revenue.
Many people are afraid to invest in real estate, but that fear comes from the unknown. Here it is as simple as I can make it.
a. “The ABCs of Real Estate Investing” - by Ken McElroy
b. This book will teach you how to:
• Achieve wealth and cash flow through real estate
• Find property with real potential
• Show you how to unlock the myths that are holding you back
• Negotiating the deal based on the numbers
• Evaluate property and purchase price
• Increase your income through proven property management tools
II. Identify an Opportunity
III. TAKE ACTION!
Incorporate or not?
If you are an entrepreneur or self-employed, here are three reasons to be an LLC or S-Corp. (if you choose to be an S-Corp, one main difference is that you will have to file quarterly and annual meetings. You will need to record and report them). There is a tax advantage to incorporating if you are making at least $60k in profit or higher.
- You can pay yourself a salary and take distributions from your corporation. So if you take a $30k salary and a $30k distribution, you only pay taxes on your salary and not on the distribution (well, not nearly as much). 30k salary = 6.2% to Social Security and 1.5% to Medicare. You need to match that as an employer, but you don’t have to pay on the distribution. You will have to file as a corporation and pay quarterly estimates on that, so there’s a little downside, but it’s negligible.
- You protect your personal assets. Your house, life savings, etc.
- And the one few accountants like to mention, fewer audits. (That doesn’t mean you should try to cheat the system.)
6) Get the Right Insurance
Make sure you have the right insurance so you and your family are protected. This will actually be step one in the Action Steps you should take to get your financial life in order. Here are the 7 types of insurance that Dave Ramsey says you absolutely need.
- Homeowner's/Renter's Insurance
In case something happens to your possessions, this insurance will cover your material belongings. If you have homeowner's insurance, be sure that you have guaranteed replacement cost.
- Auto Insurance
Never drive around uninsured! The key to auto insurance is to make sure you are signed up for adequate liability coverage. If you drive an older vehicle, crunch the numbers to see if it makes sense to drop your collision.
- Health Insurance
Never, ever go without health insurance—that's just asking for trouble! Check out the various options that are available to determine which one fits best for you and your family. Don't forget to check out options that offer a Health Saving Account (HSA).
- Disability Insurance
Make sure 65% of your current income is covered and try to buy insurance that pays if you can't perform the job you are equipped to do. (see more below)
- Long-Term Care Insurance
It may not be a priority for you right now, but 69% of people over the age of 65 will need long-term care at some point in their lives. Maybe it's not time for you to get this insurance, but do your parents need it?
- Identity Theft Protection
With identity theft on the rise, it's a smart move to protect yourself with the right insurance. Make sure your insurance includes restoration services that assign a qualified counselor to clean up the mess.
- Life Insurance
You need life insurance. Don't do anything else until you and your family are covered! Term life insurance is often the most affordable coverage because it offers protection for a specific number of years.
Disability Insurance: Go to http://www.zanderins.com/disability/disabilityeducation.aspx and click on Instant Quote. This is where I got my Disability Insurance from. It's not expensive and very necessary.
The need for disability income protection is crucial and is an essential part of your financial plan. It provides an income for you and your family if you have an accident or health condition that prevents you from working and earning a paycheck.
ACCORDING TO THE COUNCIL FOR DISABILITY AWARENESS:
- 61% of wage earners personally know someone who has been disabled and unable to work for 3 months or longer. 1 in 8 workers will be disabled for 5 years or more during their career.
- 65% of working Americans say they could not cover normal living expenses even for a year if they lost their income due to an illness or injury.
- The average individual disability claim lasts 31.6 months.
- The average disability payment from Social Security is $1,111 per month. 70% of Social Security disability applicants get denied.
- Illness cases 9/10 of disabilities. 90% of injuries occur off the job.
7) Leave it Better
I have a goal to donate $1,000,000 to charity. If you develop the right core behaviors, you will have a lot left over to give. We all know how amazing we feel when we do something good for others. I was walking to an appointment in the Rittenhouse Square section of Philadelphia, not far from the Liberty Bell. I walked past several "down on their luck" people looking for a handout, but I was too caught up in my own schedule to stop. Then I made eye contact with an elderly gentleman with leather like skin. In his eyes I could see he was broken. I stopped in my tracks and handed him $40. He got a little teary eyed on me. I think it made his day. Giving is the most fun you can have with money. You can’t do that when you’re broke. If you need the $40 to pay for a tank of gas because you’re broke, then you can’t give…and that’s why this is the last step. You have to get your house in order first. For now, give something you may have more of. You can give time; there are plenty of charities that need your time. You can give blood; there are plenty of people in need of blood. You can even give encouragement; most of the world goes to sleep every single night without an ounce of encouragement. Leave people better.
- Set up the right insurance policies. Especially Health and Disability.
- Create a budget for the month.
- Start your debt snowball.
- Save for your 3-month emergency fund. (6-months if it will help you sleep at night)
- Invest at least 15% of your income monthly.
b. Fully funded Roth IRA (consult your accountant / fiduciary / advisor / or even your bank)
c. Fully funded 401k, Single K, or SEP (or something similar – consult your accountant / fiduciary / advisor / or even your bank)
6. Save / Invest All Bonuses.
a. See step 5. 'b' and 'c' first.
b. This is a great way to save for a home or, if you have a home, for your rainy day fund (i.e. roof replacement)
c. If steps 1-5 are maxed, think about using bonuses for other investment vehicles as discussed earlier.
7. Pay off your home early (and/or save for your kids college fund in a 529 Plan or a Coverdell)
8. Leave it Better.
From Business Checking, you will also pay all of your business expenses. I do have an American Express card for my business, but you will notice that I don't have any credit cards personally. I like American Express because you have to pay it off monthly to continue to use it. And of course a Business Savings with 3 months worth of business expenses stashed away for a bad month or a slow quarter.
From Personal Checking you will take care of your Personal Expenses. You will also transfer money into your Personal Savings each month.
From Personal Savings you will fund your 3-6 month Emergency Fund, Investments, and save for a "Rainy Day" (i.e. new roof, car repairs, first home, etc.).
- John Wasserman, Author, No Shorts, Flip Flops, or Sunglasses: How to Get and Make the Most of Your First Real Job
For more on becoming financially fit, check out these blogs by Wasserman:
Financial Fitness Starts Here
Create a New Financial Paradigm
Strengthening Your Financial Core