Warning: Reverend Norm is going off preaching about money again!
Are you on the brink of financial disaster? It sounds pretty ominous, doesn't it? Financial disaster! It's just crazy talk, right? But there are many, many people who are close to this and don't even know it. It may be that they don't have a clue, or maybe there's a little voice in the back of their heads that they just keep ignoring. They're going out for an expensive steak dinner in their freshly detailed BMW, and they really just don't want to think about their tiny savings account, or how much they have on their credit cards.
I recently read a story on a retirement forum of a real couple in their 30's, let's call them the Smiths (sorry to any reader named Smith, it's just the most common name in the USA), but these are real people nevertheless. The Smiths' friend relayed their story anonymously, and he was sad to do it:
- They had two good jobs, his in the auto industry and hers in nursing.
- They had a nice small house that they'd upgraded, with a patio, new kitchen, etc.
- They sold this house for a little over $100K and moved into a temporary apartment while their new $300K home was being built.
- During this time period, he lost his job and struggled to replace that high income, eventually settling on a much lower-paying job in a call-center.
- Without his lucrative job, the loan on the new house was frozen until he could basically double his current income. He could even lose his downpayment.
Now this is a tough situation, losing your job after having sold your house but before moving into your new one. But it gets worse:
- They still have a student loan.
- They cosigned a loan for a young relative.
- Their child is adopted, and the adoption fees were paid with a loan.
- They have a new car loan.
- They took out a 401K loan for the downpayment on the new house.
- We don't know about their credit card balances, but at this point I have a sneaking suspicion.
There are so many loans they're hard to keep track of, and I'm sure they would agree with me!
Then, there's the spending issue as relayed by their friend. It looks to me like they are simply ignoring the reality of their own situation. They take many expensive vacations, to places like Vegas, Disney, and others. Although I don't consider the home upgrades frivolous, they seemingly didn't do a lot for the value of that first house. Every weekend they go out to dinners and expensive events with admission, parking, and food & drink costs.
So, to sum it up, they are broke and they don't want to admit it. They likely didn't have any equity in their house (or not much) or they wouldn't have needed the 401K loan for the new one. For a long time they were, without acknowledging it (maybe not even knowing it), on the verge of financial disaster. It took one event, the loss of his job, to push them over the brink. At this point, their options are few. Until he gets a much better, higher paying job they're going to have to live in an apartment. That's not the end of the world, people do it all the time, but they were on the verge of having a big new home in the burbs! I suppose they should be thankful they're both working, but it's surely a big step in the wrong direction.
Avoiding Financial Disaster
Now we could get into a long discussion of ways to get out of this mess, but I'd rather be proactive instead of reactive. Let's talk about how to not get into this situation in the first place.
I'd probably start with a careful read of Dave Ramsey's "Total Money Makeover" book. It's done a lot of good for a lot of people by preaching about starting an emergency fund, getting out of debt, investing for the future, etc. That's all good information for anyone who's in debt and wondering how to get out of it and build a better future. Spoiler alert: spending is a pivotal part of the makeover!
And then make yourself learn enough about investing to start moving your financial life forward. This can be a process over many years, and you don't have to become Warren Buffet, you just have to know some basics and be willing to grow over time.
Spending & Budgeting
In this specific case, and honestly in almost all cases (even business & government!), it starts with the spending. Too much spending turns into too little savings. And too little savings means you have too little invested in your future. To address the spending, I will say that everyone should have a budget. Well, a budget in the sense that you know where your money is going. We don't budget every expense (by putting a cap on every spending category, etc.), we just keep track of them so we know where we can cut if we need to. If some category starts creeping up, you address it in one way or another. Eating out is an obvious one for us - one meal out costs the same as about 3-4 meals at home, and since most people eat 3 times a day that's 21 opportunities every week (1095 every year!) to save a buck, or waste a lot of bucks. Track your spending in enough detail that you know if it is going toward eating out, groceries, cable TV, clothing, utilities, different loans, etc. At this point you will know where all the money is going, and I can guarantee there will be some big expenses that are truly optional.
In the case of the Smiths, I suspect eating out is one of their larger expenses, as well as all those loan payments, including the new car they can't afford. Add in cable TV, expensive cellphone plans, and generally keeping up with their neighbors the Joneses, and they have been in trouble for a while. The Joneses are broke too, BTW, don't try to keep up with them!
But the Smiths' two incomes made them feel like they had it made. They had a lot of cash flow which made them feel good, but unfortunately there was more flowing out than in! In their case, they discovered that two incomes were no better than one because the spending was for two incomes and then a bit more. Now, if you have two incomes and you can truly live on one of them, your stress really starts to dissolve, and I reckon that should be a goal for all dual-income couples. It allows you to build up that emergency fund, get out of all debt, and start investing like you mean it. And that investing is for you, your family, and your future. It's so much better than yet another new car. This MarketWatch article is worth the short read - it explains how buying new cars is like setting $40K on fire every few years. The last new car we bought (our beautiful blue Honda Element) was in 2005 and it was cheap enough that we paid cash for it. We kept it for 12 years and still sold it for almost 1/3 of what we paid for it.
But how do you get to the point where you can live on one income? I'm going to say it again, it's the spending! Honestly, it takes some willpower and motivation to make better choices. It still means buying the things you need, of course. It also means buying some of the things you want, after evaluating your financial situation, and deciding whether it is worth it to you today, and to your future self. Deb's mental process started with setting a longer term goal. In our case, it was an early retirement. With that in mind, if she saw something she wanted to buy, she'd ask herself if it was going to get us to that goal. You can guess how many things she didn't buy with the longer term goal in mind.
Albert Einstein once said, "Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn't, pays it." Compound interest can either work for you (by saving consistently throughout your life and letting it snowball) or against you (by letting it pull you further and further into debt). It's our choice whether we want to "earn it" or "pay it".
Everyone needs an emergency fund to take care of things like a job loss or unexpected medical expenses. These things are not in your control (much). When they happen, you have to react to them and a healthy emergency fund of 3-6 months of expenses* keeps you from financial ruin in the short term. It certainly keeps you from having to immediately start hitting up those credit cards and getting 401K loans.
* To get going, shoot for $1000. It will save you from most car and appliance repairs that you would have put on a credit card.
Wiping Out Debt
Once the emergencies are covered, you have to start whittling down that debt. All those loans the Smiths are carrying are keeping them from righting their own ship. Two popular methods are the Debt Snowball and Debt Avalanche methods. They are described very well in this Forbes article, but basically the Debt Snowball is better psychologically (by rewarding good behavior early), and the Debt Avalanche is better financially (by clearing the largest interest rates first). I don't argue with either one, I just want people to get out of debt. Either method you choose will make a big difference in your stress levels.
Saving & Investing
Everyone's situation is different and trying to go into all the possible investment options would take many blog posts and frankly, I'm not qualified to write them. There are many others out there who have a deeper understanding and are better at explaining it all than I am. But I will say a steady, preferably automated, investment process is essential. You can set up automatic transfers from checking to savings, for example. Once the savings balance hits a certain number, you can take that and invest it (leaving your emergency fund untouched of course). It's important also to diversify those investments, putting it into different categories like stocks, bonds, real estate, government notes, etc. Diversifying across countries, regions, and industries is also a good idea.
But you don't have to do that all at once. If you know nothing at all you can learn enough to open an account in Etrade and buy a total stock market index fund like Vanguard's VTSMX. With that, you will have invested in over 3600 companies. It has no transaction fees but requires $3000 to start investing in it. There are other funds and ETFs with different rules such as lower minimums, you just have to look for them. Then over time you can start to diversify into other investments, but you can learn as you go. The most important point is to start.
Living on Purpose
We all want to avoid the Smith's situation, or our own version of financial disaster. I think of it this way. I love sitting in the shade of a coconut tree. I love, love, love it, don't you? But how long can I sit under there before taking a big heavy coconut on the noggin? I don't want to find out, so I position myself so that I can get some shade but not get knocked out cold! It's worth a little extra effort I think. And so it goes with finances - the coconut is going to fall one day and you may as well be ready for it.
Remember for the Smiths, it could be a lot worse than still having two jobs and a place to live. But I like to strive to be better than walking on the edge of a financial cliff. The stress alone makes it worth making some changes. To do this, start by figuring out where your money is going, and check that spending. Then, start an emergency fund, and make a plan to get out of debt. Finally, get started investing and growing your net worth. Let your money work for you instead of letting it disappear on yet another shiny new _fill_in_the_blank_thing.
The person who originally relayed this story is a friend of the Smiths and had this to say: "Anyway, I wanted to share. I never suspected our friends were so close to a financial disaster like this. Goes to show how close many people really are to the brink." That about sums it up.
If anything in the Smiths' story sounds familiar in your own life, don't worry, because that won't help! But also don't keep doing the things you've been doing to get to that point. There are many, many people like you and the Smiths, and they may just need a little nudge in the right direction. My suggestion is that you think about your life, and especially about your future life. Then, take an action, a small one is fine, but make it repeatable, and steady. Set yourself up for a small success, and your small successes will start to turn into big successes. That's how it works; it's exactly how we did it.
There are no magic tricks, except what goes on in your own head. Live your life on purpose, with one eye on enjoying the present - that's very important - have some fun today (note: it doesn't have to cost a fortune). But you should also keep one eye on the future, the story you have in your head, the story you dream of writing in reality. This can be done, we're living proof!
TODAY'S SPECIAL: "Better Boat" by Kenny Chesney, because we're all just learning to build a better boat.