In my day job as Financial Security Advisor I get asked all the time if it is more important to save for the future or get out of debt. My answer is always an emphatic YES!
I’m a big believer in what some have called “The Snow Ball” plan for getting out of debt and saving for retirement. It works like this;
1 – Set Aside An Emergency Fund
Every financial planner will tell you that you need to have 3 to 6 months worth of your personal income set aside at all times to cover emergencies. For most this seems like an impossible goal and to put this as the first step to life-long financial security automatically makes most people say “that’s too hard, forget it.”
That’s exactly why it’s the first step. If you think setting aside just $1000 dollars in a permanent emergency fund is too hard then I am telling you right now, nothing else I can show you is going to get you to life-ling financial security. This isn’t remotely easy so if you can’t discipline yourself not to spend even a small amount of money when it’s just sitting there you may as well resign yourself to that fact that you will be in debt for the rest of your life and you will never retire comfortably.
But wait, I said 3 to 6 months worth of income, now I’m saying $1000. You make way more than that, and 3 to 6 months is more like $6 to $10 thousand. Agreed, the fact is the amount isn’t important right now, this is about starting to show some discipline with how you spend your money. If you can’t do the full 3 to 6 months right away, even if $1000 is too much, that’s okay. I just use that number as a staring point because for most people $1000 will cover the necessities of life for a long enough time to make additional arrangements. As you move forward you can enhance that to the full required amount at any time, the important thing is to start and that leads me to step two.
2 – Start Small
Once you have a small emergency fund set aside it’s time to start tackling debt.
Write down every debt you currently have and the balance owing on each one. Arrange them from smallest to largest. Then write down the minimum payment amount. Make sure you make your minimum payments on everything so as not to further damage your credit rating. Then with any excess money left over pay the balance on the smallest debt. Forget about interest rates or the most aggressive bill collectors, as you will see in moment, you will be tackling that issue soon enough. Once the smallest debt is completely paid off move on to step three.
3 – Do A Happy Dance
You have accomplished something significant! You are one step closer to being completely debt free and achieving life-long financial security. Enjoy it, for one month take that money you were using to service that first debt and do something fun with it but don’t dwell here too long. It’s important to move quickly to step four.
4 – Learn the Power of Compounding
This is where the idea of a Snow Ball comes in.
You’ve been living with debt for a long time; you’ve been making minimum payments on say 5 different debts, now you have managed to drop that number to 4. When you eliminated that first debt you had some extra money and you treated yourself to something you’ve been denied for a long time, like a night out with your spouse, or another small indulgence. That’s good, you deserve it. But now it’s time to take the amount you were paying on the first debt you eliminated and add it to the next smallest debt on your list. By doing this you accelerate the payments on that debt and will have it paid off that much faster! When that debt is gone you’ll have and even bigger surplus and an even bigger party!
If you continue to put the additional money on to that debt things will speed up even more. Discipline yourself to do this. It’s easy to find other things to spend your extra money on other than debt elimination but this is where the real power of this approach comes in to play. Before long you will be completely debt free and will have access to all of the money you’ve been using to service your debt available to you.
I personally started using this approach in 2005 when I was nearly $50,000 in debt. In just 4 years I paid off my all of my credit cards and my car loan and have been completely debt free for nearly 3 years now. It works, believe me and it has allow me to move on to step 5.
Bonus Step 5 – Invest in yourself!
I know I said there were four steps to Life-Long Financial Security but I lied. What you do with your surplus is up to you. You can live a very secure life if all you do is steps one through four but this is really where the rubber meets the road. Once you are completely out of debt what next?
Invest in yourself, that’s what!
Make the power of compounding work for you, not against you. As I said in step 4, you’ve been living on less than you earn for a long time already. The fact that you’ve been spending a lot of money servicing debt has taught you that it is possible to live on less than you make. Now take that extra money and put it away not just for a rainy day, like in step one, but for a time in the future when you won’t be able to work for a living. It’s not much of a stretch for many people to be spending $500 a month or more on consumer debt. Do you know how much $500 a month turns into if you invest it at 8% (a fairly reasonable historical rate of return, recent history notwithstanding) for 30 years?
It turns into $565,787! That’s more than double what you would actually be putting in. A pretty nice retirement nest egg if you ask me!
Bonus Step 6 – Give it away!
I know, I lied again but this one is where traditional financial security gives way to Meekonomics.
Ask yourself, how much is enough? Is there anything I can do to intentionally lower my standard of living so that others may simply survive? Did you know that invested at 6% a lump sum amount of $565,000 will give you an annual income of $33,900 per year FOREVER! That’s a King’s Ransom for the nearly 2 billion people on this planet who are surviving on less than $2 per day and without debt to service a pretty comfortable living even for those of us in the rich west.
The point is you don’t need it to last forever so you can afford to give the rest away. And that my friend is what being a Meekonomist is all about.