How Severe Is Your Debt Emergency?

This is a guest post by Brian Groener. Read more about him after the post.

If you’re in debt, you’re not alone.

In fact, millions of Americans struggle with debt. The average household owes somewhere between $5,000 – $10,000 in credit card debt alone.

Want to know the largest destroyer of wealth? Well, you found it. Debt.

In my opinion, there are three ways debt should be mentally categorized. Each requires different levels of action. Let’s take a look at them and how to deal with each one.

Value Backed Debt (i.e. Mortgages)

Large purchases, such as a house, are generally an individual’s or couple’s largest lifetime investment and source of debt. However, it’s important to realize it is both an investment and debt.

Included in your monthly payment is the principal and interest you owe on the loan. This kind of debt is backed by something of value.

So, if you want to wipe this debt away, you can pay it off over time or you can sell the item. If the value of the item doesn’t change over its life or it appreciates, then the balance due on the loan can be paid back through a sale.

Not many people have hundreds of thousands in cash to make these purchases so debt like mortgages are carried by millions of Americans. It’s normal and relatively safe.

If you have extra cash lying around it may make sense to invest it, but if the market looks shaky or you want a guaranteed return on your money, put it towards a higher principal payment.

It should be mentioned, of course, you can lose value on the purchase through depreciation or outside circumstances. This is also known as going “underwater” on the loan, causing you to owe more than what your purchase is worth.

The sooner you can get any type of debt out of your life the better. However, this generally doesn’t happen therefore it shouldn’t keep you up at night.

Severity (1-10): 3

Self-Investment Debt (i.e. Student Loans)

Seemingly, one of the main ways to get a solid job is to go to college. Although that is beginning to change, there is almost always value behind education.

Going to college can be extremely expensive, but like the previous category, it is typically seen as an investment. Instead of being a physical item you can get your money back on, the return on investment on self-investment debt is seen in career earnings.

The scary part about loans like this, particularly student loans, is that they will follow you to the grave. Even though the interest rates may not be astronomical, they must be paid back.

Without a physical item to sell  and wipe out the loan balance, you need to work and save to pay this back.

There is no easy way out except for old fashioned responsibility. Until it is paid off, self-investment debt will continue to be a sizable liability and will agonize you constantly. Move on it urgently.

My recommendation would be to pay this off before you even begin investing.

Severity (1-10): 6

Consumer Debt (i.e. Credit Card Debt)

We’ve made it to the final level. Consider it to be worse than the plague. Let me just make it crystal clear. Consumer debt is that dangerous. Here’s an example.

Joe recently graduated college and got a job to give him some experience in his field. Unfortunately, it only pays $30,000 per year. Since he just earned a degree and landed a position doing what he studied, he is feeling accomplished.

He wants to reward himself so he decides to go shopping. Joe splurges on some items he has had an eye on since he was 15. For this privilege, Joe now owes $25,000. That’s only slightly less than what Joe will make his entire first year at work.

He decides to use up his life savings of $10,000 for a down payment and takes out a high interest loan on the remaining $15,000.

That loan is to be paid off in 12 months at a 10% interest rate. Since Joe only makes $30,000 per year, he owes over half his salary to this loan thanks to interest payments.

Although Joe has put himself in a tough position, the smartest thing he could do now that he has taken out the loan is to try to live on as little as possible. This will allow him to get that loan paid off in full according to the payment plan.

Sadly, this only leaves him with less than $1250 per month to get by.

If Joe put the balance on a credit card instead, his situation could be even worse. Credit card companies will allow you to leave a generous portion unpaid but then charge extraordinarily high interest rates, think 15% or higher, on the remaining balance.

The interest accumulates until all the debt is paid off. The less you pay off and longer you let it sit, the more you owe, creating a snowball effect. It’s like putting your money in the stock market with guaranteed returns of -20% annually.

Not a great idea.

Let’s say he bought some expensive clothes, electronics, and a vacation with the $25,000. Although there are some “physical products”, they are not something that can be sold back to anyone at nearly the same price, if they can be sold at all.

That’s the differentiation between this type of spending and value backed debt. You should attack consumer debt as aggressively as you possibly can.

By using your savings to pay down consumer debt you may essentially be earning 15-20% returns on your money by paying it off.

In all seriousness, you need to treat consumer debt like the emergency it is. Cut out unnecessary spending. Work a part time job to generate extra income. Sell old items that have value. Rent out an extra room in your house.

The list could go for quite a while. There are an infinite number of ways to make some extra cash. The hard part is forcing yourself to take action.

Severity (1-10): 10

The sooner you fully appreciate and learn to control debt, the more power you have over it and your financial situation. Often it requires nothing fancy, other than working hard and saving.

Achieve the freedom you deserve and lead a stress-free life by getting started today.

Brian Groener blogs at Get Money Got Money. He recently graduated from university and is currently working as an engineer just outside Philadelphia. Although he enjoys his job and has just begun his journey to financial independence, he is also an outdoor and travel enthusiast which he plans to pursue further once he has reached financial independence.

Why Financial Freedom is the Ultimate Hobby

Today’s post is by DJ. You can read more about him after the post.

Whenever a casual acquaintance asks me a question about my 401(k), investing, or pretty much anything having to do with money, it becomes pretty clear, very quickly that I have a lot of experience in this area.

Sometimes they’ll ask: “How did you learn so much about money?”

I like to tell them simply “It’s my hobby”.

Financial Independence As A Hobby

To be more specific, making “money” your hobby is not always about gaining as much of it as you possibly can.  That would be hoarding. Instead, there’s a more fundamental and fulfilling goal at work here: The act of one day becoming completely financially independent.

This is has been, in my opinion, one of the best hobbies I can pursue. It’s something that will not only enrich my own life, but also those around me and possibly those for generations to come.

“But how can this be a hobby?” you might ask.

Consider for a moment about what a hobby really is.  Hobbies are the things we do to fill our time. They are something that we enjoy and get some sense of satisfaction from.

Some hobbies don’t do much to enhance our lives. Like the time I’ve mastered the video game “Street Fighter II” in middle school. Or like other times when I get caught out in a binge-watching vortex of some TV show season on Netflix.

Other hobbies can have a tremendous amount of positive influence on our lives.

  • An athlete who perfects his body and improves his health.
  • An author who writes a book.
  • A student who goes on to achieve a degree or eventually a doctorate.

I put the pursuit of financial freedom in this category because of all the great things that can come from it.

What sort of benefits?

Making Employment Income Irrelevant

For starters, there’s the eventual possibility that your employment income will become irrelevant.  Rather than be tied to a job because you absolutely need the money to pay your bills and live, all of that will go by the side once you’re financially independent. From then on, you’ll work on only the things you want to work on.

How is that possible? 

It’s thanks to the way that retirement planning works.  You’ll be able to theoretically live out the rest of your life using the passive income that is generated from your nest egg.  Those monetary withdrawals will constantly replenish themselves with the gains you make every year from your investments.

You’ll create the ultimate money-making machine to which you will be the direct beneficiary of its output.

Puts You In Control

The pursuit of financial freedom is also something that is that YOU can control.  Not anyone else.

No one can take this endeavor away from you.  It’s not a project that can be assigned to someone else, and it’s not something you can be deemed unqualified for. Anyone can do it!

You Decide How to Get There

Much like how a person who chooses to lose weight will eat differently and exercise more, how you decide to pursue financial freedom is completely up to you.

They are many roads that will get you there.  It’s up to you to select which one is the best fit for you, your lifestyle, and what you’re willing to do to get there.

Exercise Your Creativity

We tend to think of only artists and dreamers as being the creative types. But make no mistake – reaching financial independence can also demonstrate a great degree of ability to be creative.

It’s all too easy to follow the worn-out wagon-wheel paths of daily life.  To really make a difference with your money, you have to know you have to be willing to do things differently.  You have to THINK differently.

That takes commitment and discipline.  That takes thinking outside of the box.  That takes trial and error to find out what worked and what did not.

There is a definite “art” to be coming independently wealthy.

The Chance to Succeed

Many of us do not find the fulfillment and sense of conquest that we inherently are looking for in our daily jobs.  We get passed up for projects that we wanted to pursue, or left in the shadows when it comes time for a promotion.

Improving your financial success is a position that anyone can apply for.  There are literally millions of openings!   The only barriers to success are those that you create yourself.  Remove them, and nothing will stand in your way.

How Do I Become Financially Independent?

The simple answer is that you may be closer to achieving financial freedom than you think.

The Simple Math

For example, if you think it takes a couple of million dollars to get there, then this is the first misconception.

The simple math to financial freedom is that you really only need about 25 times the amount you plan to live off of every year. Save up this amount, and there’s a good chance you could be set for life!

However, it doesn’t have to end there.  Like many interesting topics, there is more to gain out of the pursuit of financial independence the deeper you are willing to go.  These are valuable bits tricks that you can use to optimize your plan and help you get there sooner.

The Safe Withdrawal Rate

For example, that 25 times projection that we just mentioned comes from something called the 4 Percent Rule safe withdrawal rate.  This is the notion that a retiree can make a 4 percent withdrawal based on the initial portfolio value every year for the next 30 years with inflation adjustments with a high degree of success.

However, as I’ve come to learn from many great financial gurus, there are many ways that you can go about improving upon the strategy to safely use an even higher safe withdrawal rate.  That means being able to do more with less, which again then gets us closer to our goal.

Refining Your Target

On top of perfecting your withdrawal strategy, deciding how much it is that you will need in order to cover your living expenses that could have a big influence.  Keep in mind that this number could be vastly different from how much money they’re currently earning right now.

There are a number of early retirement bloggers who write about exciting and fulfilling lives living off of less than $40,000 per year.  While that number may or may not work for you, the important thing to understand are the implications of your decision. Every extra $10,000 that you think you’ll need in order to achieve financial freedom means saving up an extra $250,000 more in your nest egg.

Is all that extra effort to save up a quarter of a million dollars really worth the price of your freedom? It’s a very important question to ask yourself.

You can find out a lot more about these topics along with a ton of other useful tips inside my latest book “Early Retirement Solutions: How Much Money Do I Really Need to Retire & Achieve Financial Independence?”, available both in ebook and print formats.  Please feel free to check it out along with my other books on my author page at Amazon.

What does building financial what does the pursuit of financial independence mean to you? Aside from the pure monetary gain, what do you get out of it, and what do you feel you are building towards?

About the author: DJ is the guy behind the early retirement blog My Money Design.com.  He is also building up his latest endeavor 1000 Ways to Save.com, a website that is devoted to individually coming up with over one thousand easy and creative ways that we can all save more money towards our goals. Feel free to connect with him at either of the sites.

Do Something Big This Year – This Idea Will Change Your Life

Today’s post is by guest contributor Kathleen Celmins. She has an awesome goal for you to commit to and a great system to make it a reality. I won’t steal her thunder, so read for yourself. I’ll add some comments after she’s done.

save 50 perecent of your income using this courseDo you make resolutions?

You know the ones I’m talking about.

They’re the ones you make on New Year’s Eve after a few too many glasses of champagne.

You have big plans for the year… which mostly fade away as fast (if not faster) than the hangover from the night before, leaving you with more or less the same year you had last year.

Why Resolutions Don’t Work

I think it’s a problem with resolutions themselves, not the intent behind them.

When we make a resolution, we’re essentially letting ourselves off the hook if we don’t succeed.

We know resolutions fail, and we know why.

Our hearts are always in the right place. We want to be better versions of ourselves, right? But we get ambitious, and everyone knows that ambition and willpower fade quickly, leaving us about where we started.

Make A Goal That Will Change Your Life Forever

It doesn’t have to be that way. This year, instead of telling everyone you’re going to compete in a triathlon when you don’t even know how to swim, do something bigger. Something that will change your life.

Decide to save half your income. Not just this year, but for the rest of your life. Set up systems to make it automatic, then see how much of your own money you can keep for yourself… forever.

Hi, I’m Kathleen Celmins, and I’ve been saving half my income for the last three years. And no, I am not raking in the dough. In fact, the first year I kept track of my savings (and I include debt repayment AS savings) was 2012, and at the end of the year, I found I’d saved 47% of my $30,000 salary.

That’s right … 47% of just over $30,000.

I thought about how hard it sounds to save half your income, and how, without setting out to do it (I was heads-down focused on getting out of $25,000 in credit card debt instead), I’d done almost that.

What if I could keep that up once I’m out of debt?

What if we all could?

That could change the world.

Systems Allow You To Save 50+ Percent Of Your Income

I realized saving half your income doesn’t have anything to do with willpower. Instead, by implementing a few systems, I was able to make it as automatic as tipping in a restaurant. So, with my business partner Joe Saul-Sehy (who you might know from the Stacking Benjamins podcast), I created a course.

It’s called Save 50, and it goes through five modules:

  • Module 1: Figuring out your magic number
  • Module 2: How to live on a shoestring without living in a shoebox
  • Module 3: Making life easier — increasing your income
  • Module 4: The mechanics — where to put your money once you’ve saved it
  • Module 5: How to stay motivated and save half your income for the rest of your life.

The course launched on January 1 — just in time to make a resolution not only that you can keep, but one that will change your life.

Will you join us?

Check out Save50 here.

Thanks Kathleen! I think it’s amazing what you have done in your own life saving so much of your income.

If you want to save 50 percent (or more) of your income, make sure to check out the Save50 course. Yes, it costs money, but it’s an investment in your future. Even if you save just an additional 1% of your income, you’ll more than likely pay for your investment in the course!

Photo by: 401(k) 2012 Text added by: Lance Cothern

Why Everyone Should Love Dividend Investing

The following was contributed by a fellow reader, Joseph Hogue, CFA. Read more about him after the article.

After six years of higher stock prices, it looks like the next couple of years could be a tougher road for investors. Questions on global economic growth and rising interest rates in the United States have led to volatile stock prices throughout 2015.

But one part of the stock market should continue to provide great long-term returns for your portfolio. Shares of dividend-paying companies won’t be immune to any wider stock market weakness but there are some powerful reasons to hold on tight to your investments in these companies.

What Dividends Mean to Investors

One of the best reasons to love dividend investing is what it means for investors and for the company itself.

Companies can ultimately do two things with profits, hold them for reinvestment in the company’s growth or share those profits as a dividend to investors. For younger companies, reinvestment and growth tend to be the focus with dividends waiting until further into the future.

When a company starts paying a dividend, it’s a message that management wants to prioritize investor cash return and sales will be sufficient for growth and dividends. For many companies, it’s a milestone that they have established their business and everyone can start reaping the rewards.

Besides sending a signal to investors, the dividend policy may even help the company run more efficiently. When the company sets its dividend amount, it is committing to pay out that much every quarter. That promise of payment can be a strong restraint on management excess and decision-making for projects.

Without the restraint on cash flow, management may decide it needs more perks or that it wants to invest in projects that boost its ego rather than the bottom-line.

There is evidence that this efficiency in management may lead to better returns for investors as well. The table below, from data provided by Kenneth French at Dartmouth, shows the annual return on non-dividend paying stocks against those paying out a regular dividend over 20-year holding periods from 1928 through 2013.

returns on dividend investing

Not only do dividend-paying stocks generally provide a higher return but they do it with less volatility and risk.

Dividend Investing as a Source of Passive Income

Researching for my book on passive income sources and the myths behind some of the strategies, it became clear that dividend investing was one of the best ways to create a steady source of income.

Since dividend-paying companies are typically more mature than others in the stock market, sales and earnings are usually going to be smoother. Investors aren’t compelled to check in on the stock everyday to see if shares have surged on new growth or plummeted on some management misstep.

The cash flow from dividend investing is nearly immediate with most stocks paying dividends every three months.

While the potential might not be as high as other passive income strategies like real estate or blogging, companies generally try to increase their dividend payout each year. This leads to a continuous and growing source of income for investors.

Though the passive income potential of dividend (income) investing fell short of bonds overall, the average return on dividend stocks is well above fixed income investments.

passive income scale bonds and loans

Dividend Investing as the Great Income Diversifier

The final reason to love dividend investing comes from an earlier post here on Money Manifesto. After nearly a decade as an investment analyst, two things have become crystal clear.

  • The economy will rise and fall, taking stocks and possibly your job with it.
  • No one can predict when the economic cycle will turn. The best you can do is to diversify your investments and your income to be ready when it happens.

It’s exactly Lance’s point when he talked about three keys to prepare for the next recession in a post last year. Having multiple sources of income, one of which could be dividends, is one of the best ways to protect yourself in the event of a layoff or just lower earnings.

While the average dividend yield from companies in the S&P 500 is just above 2%, some funds focused on dividend-paying companies provide higher payouts. The Vanguard High Dividend Yield ETF (NYSE: VYM) pays a 3.2% dividend yield and gives you instant diversification across 437 companies including General Electric and Microsoft.

The one sure thing is that the stock market will both rise and fall. Whether it does the former or the latter over the next year won’t change the outlook and solid reasoning to hold a portion of your money in dividend stocks.

Besides being a great source of passive income and a way to guard against a recession, dividend stocks could provide some of the best returns in your portfolio.

Joseph Hogue, CFA is an investment analyst and author of The Passive Income Myth: How to Create a Stream of Income from Real Estate, Blogging, Stocks and Bonds. Join the community on PeerFinance101 for more tips on investing, managing debt and reaching your financial goals.

When Should I Start Saving For Retirement? Now!

Have you put off starting your retirement savings because you don’t understand things like IRAs, 401(k)s, tax implications and contribution limits?

Don’t be afraid. Although sometimes those things can get a little technical, there are tons of websites with easy-to-follow advice and solutions you can use.

However knowing when should I start saving for retirement is a little bit of a tricky of a question. Lots of people are waiting for a tap on the shoulder or a nudge to let them know when to begin.

Out of all the questions you’ll ever have about retirement, the answer to this one is about as simple as it gets – start now!

When to Start Saving

The reason you should start saving for retirement as early as possible is because you’re going to want to take full advantage of one of your greatest assets, “time”.

You’ve heard of compound interest, right? If you invest $10,000 at the age of 22 and have an average annualized growth of 8% annually, you could potentially have $273,666 saved up by the time you’re 65 without ever doing anything else.

On the other hand, if you wait until you’re 45 years old to make that same investment into that same account, you’ll only have $46,610 when you’re 65 years old.

Do you see how starting early can help your balance to grow significantly larger over time? It’s possible that if you start early enough you could have a very healthy retirement starting as early as age 55 and never have to worry about money ever again!

Don’t Forget to Pay Your High-Interest Debt First

Of course, there are a couple of exceptions to this rule.

First of all, if you have high interest debts, you should pay those off first before you start saving up. After all, the only way you can guarantee yourself to get a 15% rate of return on your investment is to pay off that credit card that charges 15% APR.

The second exception is lack of a “rainy day” or emergency fund. You should have some funds set aside to get by with three to six months worth of unemployment before you start putting your money into retirement accounts where it’s less accessible to you.

How to Save Money for Retirement

There are lots of good ways to achieve financial freedom: Budgeting, investing, earning money on the side, etc.

By far and large one of the best and simplest ways I can think to save your money for retirement: Automate it!

If your company offers a 401(k), have a portion of your money go directly out of your paycheck and into that account. That way you never even see the money or think twice about what else you could have spent it on.

If it’s an IRA you prefer, you can also set up automatic transfers from your checking account to your IRA for easy funding.

The best way to allocate your money is like this:

  1. If your company offers one, invest into a 401(k), up to the matching program limits. (This will depend on the company you work for.)
  2. Put the maximum into your IRA, which is $5,500 (if you’re over 50, it’s $6,500)
  3. Put the maximum into your 401(k), which is $18,000 (if you’re over 50, it’s $24,000) in 2015.

Roth Versus Traditional Retirement Plans

Now, it’s time to look at the different types of retirement accounts: Roth and traditional. Though there are several differences between the two, the most important is the difference in the way taxes are handled between the two.

Roth accounts are funded with income after taxes are taken out. This means that there are no upfront tax benefits, but you will not have to pay taxes when you withdraw it.

On the other hand, traditional retirement accounts are funded with income before taxes are taken out. This means that when you get ready to withdraw it, you will be required to pay the taxes on that income.

How can you decide which of these options is best for you? If you’re just entering the working world, a Roth account may be better suited for you since you’re likely in a lower tax bracket. However, if you’re in a higher tax bracket and anticipate living on less income during retirement, then a traditional account may work out better for you.

Though this seems complicated and you may not want to deal with it, it will be worth it in the long run. You will be able to ensure that your golden years really are golden. Even if you make some mistakes along the way, that’s OK.

The important thing in knowing when to start saving for retirement is to start right away. Regardless of whatever mistakes you may be afraid to make, the longer you wait the steeper the hill you’ll have to climb later in life.

This post was written by my friend DW from The Money Template, a personal finance blog that talks about all things money related.