So, What IS “The Plan” For Personal Finance?

The plan will be different for everybody, and the problem with many “personal” finance gurus is that they deal in “general” finance rather than personal finance. While the advice is generally pretty good, it often overwhelms people, much like drinking from the fire hose.  The general advice you’ll hear is (in this order):

  1. Build a small emergency fund (~$1000 or 1 month’s expenses).
  2. Fund your retirement plan to your employer’s match.
  3. Pay off your debt
  4. Fund an emergency fund with 6+ months of expenses.
  5. Fund a Roth IRA to the annual Max
  6. Bump up your retirement plan savings to the annual maximum.
  7. Save into any tax-advantaged plans you have available
  8. Open a taxable investment account and invest in Exchange Traded Funds (ETFs) that track the market as a whole.

Most people have trouble with step 1, and will be lucky to get through step 3. Step 4 is a pipe dream for quite a few people, and the idea of maxing out not just one, but TWO retirement accounts sounds like grounds for an intervention because there is a lot of crack being smoked.

Let’s look at the near worst case scenario

So, what are you to do in this situation? How can you get through all of this when you’re only bringing home around $600 every two weeks? The answer a lot of people will get when they are honest with themselves is that sacrifices will have to be made. Whether it’s cable TV, the new iPhone, or your free time, if you are in this situation where you have this little cash coming in AND you have debt, you probably are either deluding yourself that if you keep on the treadmill things will get better, but the fact is that interest every month when you don’t pay off your cards is speeding that treadmill up, and eventually you’ll fall off.  An overdraft or two, and suddenly you’re eyeing a payday loan place just to solve the problem. Stop. Now. If you’re in this situation, let’s back up the cardiac arrest, take a few deep breaths and give you a rational plan to deal with this:

  1. Gather up all your monthly bills and pay stubs, pull up your online banking, too.
  2. Look at what you spend your money on, and decide what you want to cut.
  3. Keep cutting until your bills and expenses are less than your pay.
  4. Next, make calls to all of your credit card companies, and ask for lower interest rates.
  5. Add up all of your minimum monthly payments and monthly recurring bills.
  6. Open a new checking account, preferably without a debit card.
  7. Set up your direct deposit to go to two accounts: one for half the amount you got in step 5, and one for the remainder.
  8. You’ve now built a self-funding small emergency fund.
  9. The remaining money should cover your expenses (groceries, gas, etc).
  10. At the end of every two weeks, the night before payday, take any remaining money, and pay it on your highest interest account. You’ll pay down your debt a little faster and start to see some progress.
  11. If you’ve made it this far, and you’re still having some trouble making ends meet, go back to step two, and be honest with yourself.  Cutting cable TV alone will save you between 600 and 1200 a year.

“My situation isn’t THAT bad…”

If you just read the last section and didn’t cringe a bit because it hit a bit close to home, then you likely grew up with some good financial habits, or have had the income to mask some problems. So, let’s ask you a few questions:

  • Are you carrying any interest-charging credit card debt? How Much?
  • Do you have a car (or any other type that isn’t student) loan over 5%?
  • How much are you saving each month?

If you have more credit card debt than what you could pay off in your next two pay checks, after expenses, and you’re saving (rather than investing) money above a small emergency fund, congratulations, you’re throwing money away. Anything with an interest rate is considered to be “toxic” debt, and you should eliminate it quickly. 5% is used, because it’s generally accepted that returns on investment will be over 5%, so you would miss out on returns by paying off debts with interest rates under 5% faster than necessary if you were to use investments to do so.

I know you thought you were getting off easy, but you’re still in close to the same boat as the near worst-case folks, but likely without the constant fear of overdrawing your bank account.  Knowing this, you still need to budget, and get rid of the debt you’re throwing money away on. Your plan of attack should be to get organized (see above), and pay off the highest interest accounts first, working your way to the lowest accounts. If you can work without separate accounts feel free, but it will likely be easier to set things on auto pilot.

“Hah! Look at those suckers! I’ve got stuff together, straight cash for me!”

Oh?  You’ve eliminated all your toxic debt and are saving now? Have you optimized your spending habits to make it so credit card companies are providing you with interest free loans AND paying you for the privilege of having you use their card?  If not, you’re still leaving money on the table, just like those “suckers.” We’ll cover this more in the near future, but for now, if you’re at this point, life’s pretty good. Go check on your retirement accounts, and see if you can contribute a bit more in there for now, and we’ll get to the rest soon.

Until next time,  go  hunt down some debt!