I have the same conversation with my Gen X clients all the time. We start digging into the details of their finances, and we see the debt piling up. And while certain debt is reasonable—particularly for appreciating assets like a home or business—racking up debt for depreciating assets does something most people don’t even realize: it depletes your buying power and actually steals your future earnings, effectively turning your dollars into zeros. And because it’s no myth that “you have to have money to make money,” those zeros impact your wealth over the long term—not just while you’re paying off that $50K Lexus.
In my December blog I talked about the power of invasive online marketing to sway our wisdom when it comes to buying stuff (lots of it!). Marketing’s goal is to turn almost anything into an impulse purchase. But the problem reaches far beyond marketing. I see many people—otherwise rational decision makers—buy themselves into a hole early on, and spend decades trying to dig themselves out at a time when, ideally, they should be building wealth for the future. The problem is a lack of understanding the true budget, versus what we think we should be able to afford to have or do. If that brand new (and well marketed) luxury item costs “only” $350/month, it can feel like a reasonable expense, even if the sticker price is far outside what’s reasonable for your own budget.
Start BUILDING your wealth—today
By being mindful of your debt-to-income ratio and leveraging your expendable income wisely, you really can start building your wealth now, regardless of how much debt you’ve already accumulated, and regardless of how much time you have to save before retirement. Here are a few basic steps to start making your dollars work for you, not against you:
- Calculate your actual income.
For many—those receiving a salary from a corporation—this is an easy task. If you’re an independent contractor or business owner, it can get complicated. Be sure your actual income reflects your “take home pay”—after taxes. If you need to use an average, err on the low side.
- Identify your fixed expenses
It’s true: few people actually have (and stick to) a budget. Even those who do often fail to identify every predictable and unchangeable expense. Start by listing the obvious expenses: your mortgage or rent, insurance (property, auto, health, life), utilities, food, estimated medical expenses, and car payments. (Note that luxuries like eating out, vacationing, and paying off existing credit card debt are not included in this bucket. We’ll get to those in a moment.)
- Identify upcoming expenses in the next 12-24 months.
Do you need a new roof? Is your car more than 7 years old? Do you have a child heading off to college? Whatever your needs, it’s time to start saving for tomorrow’s expenses today. Divide the total into monthly “savings buckets.” This approach helps you avoid taking on debt to pay for expenses as they arise and increases your future buying power. Even if your savings doesn’t cover the total cost, it can significantly reduce the amount of that car or college loan—and put more money in your pocket.
- Calculate your remaining expendable income
Once your fixed and upcoming expenses are covered, you can use the remaining bucket of money to build your wealth while simultaneously getting you out of debt. Subtract your total fixed expenses and your monthly “buckets” for upcoming expenses from your actual monthly income. You’ve now identified your true expendable income.
- Earmark 40% of your expendable income for paying off existing debt.
Debt can be an emotional issue, which is one reason people are often just as irrational about paying off debt as they are at accumulating it. It may feel good to take that $5k bonus and pay down a credit card, but unless you’re also building your wealth, your money is still not working for you. Identify all current depreciating debt and start paying it down. Now. You can get that same great feeling of accomplishment by charting out how soon your debt will be erased under your new plan—and without taking on additional debt.
- Earmark 30% of your expendable income for building your wealth.
Where this money is invested depends on how much you already have in an emergency fund, your time horizon until retirement, and other factors. Only your emergency fund should be sitting in an account earning 2% or less. All other assets should be allotted to longer-term, higher-earning appreciating investment vehicles. Of course, as your debt decreases, you can steadily increase the amount you’re able to contribute to building your wealth.
- Earmark 30% of your expendable income for non-fixed expenses other than debt.
This is the fun part. Some of this will inevitably go to less-than-exciting (but still non-fixed) expenses, but once those are accounted for, you can start playing a little bit. Set your budget for eating out (yes, this should always be a budgeted item). Saving for next summer’s vacation. A trip to Europe. Your child’s wedding. Whatever your dreams, budget for these “fun” expenses now.
The word “discipline” has gotten a bad rap in our culture. We tend to think of it as anything but fun. But when it comes to getting disciplined about building your wealth, this step-by-step approach can simplify your day-to-day financial decisions, reduce your financial stress and, most importantly, help get you out of debt and into that enviable position of having your money working for you to build a more secure financial future.
Ready to get started today? Contact me to schedule a time to meet. We can dive into your finances together and put a plan in place that works for you.