Climbing Up the Financial Ladder

As you work to improve your finances, some things will become much easier. For example, creating a realistic budget for us took some time to figure out, but now it’s pretty easy to manage as we’re becoming accustomed to our needs and spending habits.

The other side of the coin is that, as you progress, you’ll find that you’ll encounter some situations you hadn’t thought of before. If you have successfully paid off your debt after years of work and have an emergency fund in place, what do you do next? Do you invest all that money for retirement or do you pay off your mortgage sooner?

I wanted to highlight some of the specific hang-ups people have with building up their finances. Some may be very familiar to you, while others could be challenges you’ll face down the road. I’ll also include some ideas as solutions to those problems.

Developing a spending plan

Having a budget or a spending plan is important if you want to build your net worth. You need some sort of accountability for how you handle your cash flow.

There are two big issues with budgets that I’ve seen (and experienced). While they may seem daunting, you can overcome them.

Making plans, but not following through

You can whip out budgets and spending plans quickly and easily. You’ve read every personal finance book from Dave Ramsey’s “Total Money Makeover” (which you memorized) to J.D. Roth’s “Your Money: The Missing Manual.” You know exactly what you need to do.

Unfortunately, many people stop right there, and don’t wind up doing anything different. They may have the best spreadsheets and the know the numbers, but actual change doesn’t happen.

Fix it: Be accountable to someone. Share your goals with your family or friends and create a buddy system to help you stay on task. For myself, I’ve found that writing a blog has been extremely helpful.

Perfectly planned budget

You’ve written the ‘perfect’ budget, with very penny accounted for and no unexpected cushions included. Unfortunately, you and your family love to eat out, but you’ve budgeted nothing for that category. You believe you’ll be gazelle intense and will NOT eat out at all. Two weeks later, your budget is broken.

Fix it: Base your budget on your real life, not the ideal situation. Do you have an older car that needs repairs from time to time? Set up a recurring payment that you transfer into savings for when it happens.

If needed, use a tool like Mint or Quicken to keep track of all of your transactions.

Paying off debt

You’ve reached a point where you’ve had enough and want to be out of debt as soon as possible. Besides getting started with reducing my debt, I had a hang up with my debt snowball.

Where to start with your debt snowball

People can have a hard time figuring out what debt needs to be paid first and how they should pay their debts off. I wasn’t sure if I should pay off my credit cards first, or if I should pay off my car loan (both had bad rates).

Fix it: Figure out YOUR priorities instead of adhering to some financial guru’s view. If you have a family loan at 0% that you want to pay off vs. a credit card debt at 23%, that’s your choice. Just take action.

The advantage of paying off your smallest debts first is that you’re getting some quick wins, which can spur you on to continue with your debt reduction plan.

On the other hand, if you pay of the highest rate first, you’ll save money in the long run. Only you know what would work best for you. That’s the benefit and responsibility with personal finance.

Building savings

Sooner or later, you’ll want to stop be reactive (eliminating debt) and start being proactive (building your savings). Two of the most common issues are having too small of an emergency fund and having no plan to save.

Inadequate emergency fund

People don’t save enough because they aren’t realistic with what their needs are. They imagine that it will be fixed magically or by someone else. Instead, some people put themselves back into debt by using credit cards to bail them out.

Fix it: Review your budget and see how much you really spend. Choose how many months you would like covered if you lost your job. How long do you think it would take for you to get back on your feet?

Go ahead and set up a transfer into your savings account to cover for those unexpected expenses, and don’t touch it unless you’re facing a true emergency.

No structured savings plan

As you get familiar with building some savings, you begin seeing that there is more than just putting aside money. You have goals for your money. Many of us will have the a lot of the same expenses – people get married, buy houses, take vacations, etc.

Fix it: Planning ahead and saving for these events makes financial sense, even if they are years away.
How can you accomplish it?

  • List all upcoming expenses. Do you plan on buying a house within the next 5 years? Do you want to travel to Italy next summer? Write down all your future plans on paper to make it concrete.
  • Research the average price for each. Look online, ask friends, or check sources to see about how much you should put aside for each goal. A wedding in New York City is probably more expensive than most places.
  • Automate your savings.
    Go ahead and transfer a set amount from your checking account into savings for that specific purpose.

Worst case, you won’t use the money for the specific purpose that you envisioned, but now you have a nice chunk of money to spend on something else that you love.

Investing for the future

You’ve taken care of your debt, you have six months of savings, and you have monthly transfers for the dream car you always wanted to buy. Now you’re trying to optimize your investments. What are some problems you may encounter?

Following the latest stock tips

Some people love invest in hot stock picks. Every month, personal finance magazines highlight the best funds to buy or the top companies to add to your portfolio. TV gurus are even worse, as they do this on a daily basis.

Fix it: Ignore the hype and simplify your investments so you can stay on track for retirement. Focus on investing in low cost investments with solid returns like index funds. Also, you should regularly review your asset allocation to make sure your portfolio isn’t too conservative or too aggressive for your time horizon.

Pay off the mortgage or invest?

Some argue that you should invest any extra money that you have on hand since the stock market has returned a historical averaged of 11%. Others claim that paying off your mortgage faster is better since you’re eliminating a big expense from your budget and you’re saving interest from paying it earlier.

Fix it: Congratulations, friend, you have a great problem. Either option will benefit you. Investing the money while keeping your current mortgage can give you more money when you retire due to compound interest and the historical return on investing in the stock market. But paying of the mortgage gives you a guaranteed return, and can also provide you with peace of mind.

Thoughts on achieving financial freedom

The evolving nature of our finances is exactly why personal finance bloggers can write about the topic for years on end. It’s a dynamic topic. Everyone has to tackle their own financial issues and celebrate their personal victories.

I’d love to hear your thoughts. What difficulties have you faced as you’ve been working to improve your finances? Any tips for overcoming these obstacles? What about milestones that you’ve achieved? Is there anything you’d like to brag about?

11 Responses to “Climbing Up the Financial Ladder”

  1. Anonymous

    John, with a $600 debt paydown and $800 in savings per month that really amounts to a $1400 per month rate of savings. Apply my calculations about and you’ll have put away 500K put away by the time you are 60, assuming nothing other than a cost of living wage increase. If it’s actively managed into a business or rental properties over that time then you could approach 1.5 million in assets at that time. Actually, more if you learn what you are doing and leverage your real estate skilfully.

    Knowing what these numbers are and what kind of monthly investment needs to be make to make these numbers is helpful in staying on track by knowing what is at stake if you start to piddle your cash away instead of apply it towards your goals. If you don’t know that your current net $1400 savings rate amounts to 500K over your working life or 1.5 fully invested, then you’re much more likely to spend that $1400 on stuff that isn’t of much lasting value. Once you know what you can do with the money you’re much more likely to have a strong emotional charge that allows you to stick to your discipline.

  2. Anonymous

    PS. I believe that a standard rule of thumb is that you can take 3% out of your assets almost indefinitely, and 4% for 20 years. So if Amy and hubby have 1.2 million at retirement, they can take $36K per year forever or 48K per year for 20 years before it runs out. A good middle ground might be 40K per year, which allows for longevity past the age of 80.

    P.P.S–what I said about investment returns being incidental applies to paper assets, which are investments you have no operational control of (you can own stock in a company, say, IBM, but you can’t go into the warehouse and show them how to make it more efficient to increase your returns–you have no operational control)

    It does not apply to investments that are actively managed by you, such as real estate that you operate and maintain yourself or a business that you work in every day. Those are returns that you can count on to a much greater degree so I include investment returns calculations that involve such actively worked investments & businesses.

  3. Anonymous

    amy: I’m guessing you guys (Amy and Hubby) already have about 250-300K in 401 (K) money so that would make the picture better.

    Carol: It’s fantastic that you have 4K per month available to save. If investing it makes you nervous, just put it in the bank or in CDs. at 4k/mo at the age of 33, with no capital appreciation, that’s 48,000 per year savings and in 20 years you’ll have $960,000 in cold hard cash (2010 dollars. Increase your savings by the amount of inflation every year to make this work.

    Actually, you could invest this money in something like real estate by buying a multifamily rental property. Within 3 years you should have enough for a 30% down payment on a 500K multifamily unit. If that’s your cup of tea and the stock market makes you nervous you could earn somehwere in the region of 7% per year on your real estate investment, then cash out of them once they are fully depreciated if you like.

    This will up your total stake to{ P* (1+i)^n)-1)/i } or 48000* ((1+1.07)^20
    )/.07) or 1.9 million in 2010 dollars in 20 years. Of course, a lot of real estate investors hold onto their property until they are 60 so that will look more like 3.5 million dollars.

    My point is that if you and your husband start to learn more about money and investing, you are well placed to have more money than you probably realized was possible starting at your age and your amount of investable income.

    BTW, in that formula (gives the end amount for a repeated periodic investment for a given number of periods at a given periodic interest rate),

    P=principal (repeated investment per period, in your case $48,000)
    i=periodic interest rate, I am providing 7% because that’s a standard real estate return for actively managed properties)

    n- number of periods.

  4. Anonymous

    Amy, without knowing your overall financial scenario, I’d say that if you and hubby have only 40K in the bank and are only saving $1000 a month at your stage in life then it would be wise to find a way to double it. You haven’t said what your 401(k) balance is but for a couple I would think that having 1.2 million in 2010 dolars (excluding your home value) is pretty much where you’d want to be at retirement.

    Sounds like at 750/mo expenses, 1200 per month pocket money (150/wk *2) and 1000 put into non 401K savings, plus a 15% of total salary applied to 401(k), you have a takehome pay of $3500 per month (combined). If you both retire at 60 you have 15+9 or 24 working years left. At your current rate of savings you’ll have 40K + $288K savings at that time, which is only 320K. Add your future 401K contributions of approximately $146K.(520/mo contribution over 24 working years) and you are up to a total of 466K total contributions at the age of 60. (add your current 401(k) balance for a better total figure).

    If you cut the $1200/mo discretionary spending in half or 2/3, you could add another 150k-180K to this figure and you may want to consider doing that. It’s also possible to extend your working years to 65 and that would increase the numbers substantially.

    If you haven’t really figured out what kind of life you’ll want to be living during retirement and the numbers you’ll need at retirement now is a great time to do it and to formulate a plan of action now to help realize it.

    BTW, these figures that I gave are slightly understated because they don’t factor in investment return. That’s intentional. I think for most people the most important part of their retirement funds is their savings, not their investment returns. The savings you can control, the investment return is completely out of your hands, so I personally count on my savings only and increase them 2-3% per year every year to account for inflation. This year’s $1000/ month becomes next year’s $1030 a month to keep in pace with inflation and all money needs are considered in 2010 dollars.

  5. Anonymous

    I’m in a similar situation to Amy. My husband and I have always been frugal, never had credit card debt or car payments, and have lived on one salary our entire marriage (we’re both 33), using my salary to pay down our mortgage. We just finished paying off the house back in June. Now we have a huge surplus of cash coming in every month. We always had a year’s worth of living expenses in savings so it’s not like we need to beef up our emergency fund. But beyond being completely out of debt, with no mortgage payment, and maxing out our 401k’s, I’m not really sure what to do with all this extra money (an extra $4k per month). I’m sure we should invest it, but I’m nervous about that.

  6. Anonymous

    It’s really great to read everyones comments that they are doing so well. It’s an inspiration to me. I’m working to be there too. Laura you laid out a great plan everyone should be doing. I’m starting in my 50’s to do these great things, with 3 in college I’m not going to get where I want to be. I’m glad you spoke so well of Index Funds and asset allocation.

  7. Anonymous

    DW and I are in the same place as TeamworkFTW used to be (relying on natural frugality, combined with automatic contributions to savings) but I have zero plans to change it. In fact I try to keep my eyes out for opportunities to turn money into happiness and/or free time at a reasonable exchange rate.

  8. Anonymous

    As a beginning saver, I guess I’ll weigh in on this one. I created a scratch-paper budget about a year and a half ago which eventually changed into a spreadsheet with expected expenses through the end of 2011. I’m saving about $500-$800/month and reducing my debts by another $600/month. My 401(k) is taking 5% of my income, which is enough to keep me out of the 25% tax bracket. The house has about 12 years left to pay off and my student loan has really cheap interest. Everything else can be paid off by the end of next year. I turned 30 on Sunday.

  9. Anonymous

    My husband and I are at the stage where I’m thinking, ok, what do I do now? House is paid off, car paid, no debt, just monthly living expenses of about $750 (excluding gas and food). We have about $41K in cash accounts, and retirement accounts that we contribute about 15% (we don’t like our 401(k) provider at work so we don’t want to contribute more). My husband will be 51 this year and I’m 45. We have substantial weekly allowances ($150 each per week) and we save about $1000 per month. I don’t have a “plan” for all the money I’m saving…I just obsessively save and yet I’m afraid to cut down my hours at work because then I can’t save as much!! It was different when I was sending every penny to the mortgage company…like, more exciting or whatever to see it go down!
    I just haven’t made a plan yet and it’s kind of strange.

  10. Anonymous

    We’ve been incredibly blessed/lucky/whateveryouwannacallit. We sailed through the first 6 or 7 years of marriage without a budget because we are both naturally frugal/savers and when we wanted to spend, there was always money there. Then, we put a budget in place – and holy cow we became dangerous! Once we put a plan in place to pay off the house early, save for kids’ college, etc, it kind of became a challenge for both of us to beat. Then we were like savings ninjas! I found myself looking at the bank statements every quarter (every month!) asking “where did all that money come from?!?”

    It really makes me wonder where we’d be sitting NOW if we had only gotten on the budget bandwagon years earlier! We could probably be millionaires by now! (in our mid 30s – we’re a quarter of the way there now) As frugal as we were, and as little as we make (less than 100K/year) we were apparently still spending a lot and had no idea! The budget spreadsheets tell us now!

    (and yes, we still have fun – we are just more mindful what we spend when we do!)

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