Thursday, June 4, 2015

Basics of Financial Independence: Paying off debts

2. Pay off any debts you have. Start with the highest interest debts and work down until all is paid off.
  • The second thing one should do on the road to financial independence is pay off all high interest debt obligations. Of course that begs the question, "What is high?" For simplicity, let's define "high" as anything 1 point higher than the current 30-year fixed mortgage rate (currently 4% so "high" would be 5%+). I think that should be easy enough.
  • Now that you have identified all your "high" interest debts, you should begin aggressively paying them off starting from the highest interest debt working downwards. Now of course you make minimum payments to all with the extra funds going towards the highest interest obligation until that is paid off, rinse-repeat. It also doesn't hurt to look into refinancing/consolidating these debt obligations under better rates when available. Often times a simple call can save mucho dinero.
  • Now that you're left with NOT "high" interest debts, what should you do? You can ratchet down a notch or three on "aggressively paying them off" but you definitely want to pay MORE than the minimum required payments. Remember, this is the "basics of financial independence" not the "basics of getting rich via leverage." I know this can be a challenge for someone who has a car loan fixed at 2% and/or a mortgage fixed at 3.5% while the stock market (S&P 500) has double-digit returns over the last X years, but keep in mind there are also 1, 5, 10 and 15 year periods where even a 50/50 balanced portfolio has lost or made very little money (see chart below for 15 year real return periods). In conclusion, while your debt obligations are fixed who knows what the next X years of market returns will look like?

Tuesday, June 2, 2015

Basics of Financial Independence: Emergency Fund

1. Set aside 6-12 months of expenses in a savings account as a rainy day fund.
  • The very first thing one should do on the road to financial independence is set aside an emergency fund. And the first step in this process is finding out your average monthly expenses. This can be accomplished the easy way by using an expense tracker such as Personal Capital or by manually adding them (housing, utilities, food, etc) up using pencil and paper. Either way, this step shouldn't prove that difficult.
  • The next step would be to find a savings account that offers you some return on your money since the best case scenario is that this money will never be used. Deposit Accounts is a useful website that can assist you in finding a high interest bearing personal savings account that suits your needs. Personally, I am biased towards credit unions such as Alliant Credit Union but you are free to find one that best suits your individual needs.
  • So is it 6 or 12 months of expenses? Personally, I recommend having 12 months of expenses set aside just because of the peace of mind it buys. For example, with only 6 months of expenses saved the average person will start panicking after 4 months of being unemployed. This can lead to rash decisions being made. One way to have the best of both worlds is to first set aside 6 months of expenses, complete the remaining 4 steps towards financial freedom, then circle back and increase the emergency fund to 12 months of expenses.