Debt l Saving l retirement l investing

General Josh on 01 Jan 2009 05:31 pm

Introducing Nickeled and Dimed

Welcome to Nickeled and Dimed, a blog about personal finance and economics. For more information on me and this site, read the about page.

For my first post, I’m going to outline my plan for becoming “financially independent”. My plan is based on the strategies I have taken from several different personal finance books. While this is the plan I feel is best for me, it may not necessarily be what is best for you. It is important to remember that your journey to financial stability is unique to anyone else’s and a plan is only good if it works for you and is something you will follow through with.

Every example I’ve ever seen uses the building a house analysis, so I’m going to try something a little different and go with a boat metaphor.

So, without further ado, here are the steps I plan to take, listed in order of highest priority:

Pay Off Debt-Plugging the holes

Debt is the enemy of financial independence. It is the holes in your boat. If you assume a conservative seven percent long-term return in the stock market, and an equally conservative 14 percent interest rate on a credit card, the credit card balance you carry has a 21 percent opportunity cost to you. Over the course of two, five, ten or more years, that can add up to a whole lot of money.

Now I’m not going to sit here and preach to you that all debt is evil. Mortgages and student loans can be very good uses of debt. A car can be a necessary use of debt. A credit card, however, is almost never an acceptable use of debt to a financial fit person.

Not that credit cards are bad. When used responsibly they can be very good tools to build credit or even earn travel rewards and other perks. But that is not what we are talking about here. We are talking about using credit cards, or other short-term loans, to buy things you can’t afford right now. If the balance of your purchase will not be paid by the next billing cycle, you can’t afford what you are about to buy.

We will discuss the different strategies to paying off debt in a later article, but my personal preference is Dave Ramsey’s “snowball plan”, which is to pay them off from lowest balance to highest balance. I have found this is the most effective way for me, but most experts recommend you pay them off starting with the highest interest rate. Again, whichever method works best for you is the one you should follow.

By paying off, and keeping off, all credit card debt, you begin to plug the holes in your financial boat. So my first step is to pay off all my credit cards and short-term loans.

Build an Emergency Fund- The life jackets

Unexpected expenses happen. A well stocked emergency fund is your life jacket that can save you from disaster.

An emergency fund is a savings account you keep separate from all your other accounts and only use for unexpected expenses. Whether it’s a new roof on your house, a new transmission in your car or helping a friend or family member in need, all of us have plenty of expenses we didn’t plan for. Without a certain amount of money set aside for these unexpected events, we run the risk of starting our financial journey over by using debt to fund them (putting the holes back in the boat).

How much you should keep in an emergency fund varies from expert to expert. Most I have read tend to go with the three to six months of living expenses, but others are as low as simply 3,000 dollars and as high as a years worth of living expenses. But like everything else, it depends on your own situation. If your income is not stable or consistent, you probably want a larger emergency fund. If you have a consistent income and stable job, you can cut it down a little.

My second step is to build a 5,000 dollar emergency fund as my life jacket for unexpected expenses.

Invest in Retirement Accounts- The oars

A well diversified retirement account, whether it is a Roth, 401k or just a normal IRA, can be the oars that take your financial boat out to sea. With the magic of compounding interest, every dollar invested can be worth much more when you retire. Almost every study ever done shows that up to this point you were pretty much guaranteed to earn between 7 and 11 percent on a diversified portfolio in the long-run. And while past performance does not guarantee future results, and the recent outlook isn’t pretty, I’m still going to bet my money on over 100 years of history.

And on top of the returns on your investment, investing in IRA’s has several tax advantages. 401k’s allow you to use pre-tax dollars to invest with, while all gains in a Roth IRA can be taken out tax free. The differences between these plans will be covered in great detail in future articles, but whichever one you choose, you can secure a great financial future by investing early and often in a retirement fund.

My third step is to max out my retirement plans as my oars to row my financial boat.

Create Passive Income- Putting up the sails

Passive income is revenue created with little or no effort from you. It can be rent from property you own, dividends from your investments, money you make from your blog when you aren’t writing, or any other form of income you receive without working. Passive income is the sails that will allow your boat to move while you sit back and relax.

Creating passive income is the ultimate achievement in personal finance. The standard definition of “financial freedom” is having your passive income exceed your expenses. It is the ability to put your finances on cruise control and enjoy the ride.

So my fourth and final step in this journey is to create enough passive income to cover my expenses.

Summing Up- Setting sail

That’s it. That’s my plan to get my financial boat out to sea. I’m going to plug the holes by paying off my debt, put on a life jacket by building an adequate emergency fund, use my investment accounts as oars to row, and then put up the sails with passive income so I can sit back and enjoy the ride.

In reality it is much more complex than just following these four steps, and that’s why I made this site. You can expect all future articles to revolve around small pieces of these steps. Whether it’s ways to cut expenses, increase income, pay off debt, or save money on necessary purchases, everything here will revolve around the principles of this site. And to mix things up from time to time you can expect interviews, guest posts from other relevant people, questions from readers and other outside voices on ways to improve your personal finances.

Thanks for stopping by and please come back daily for new articles. I encourage you to discuss everything posted in the comments section below and feel free to send any comments, questions or story tips to centsabilitytowealth@gmail.com.

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