Perhaps one of the most difficult areas of creating a more simple life is getting one’s finances under control. In the U.S. particularly, many people seem to always expand their standard of living to just beyond their means, which piles on debt. There’s also an overwhelming amount of financial advice available, often conflicting. Sorting through it and actually taking action is difficult. I want to share my story of the path to simplification in the hopes that it might help someone else on their own path.
It’s Personal
We all take a different path to getting into debt. For many, it’s student loans, others too much credit card spending. I had historically done very well with money management, and managed to obtain an M.A. without incurring any debt whatsoever. Unfortunately, a significant relationship really shook up my financial life. I chose to overspend on everything, from food to lavish trips to home renovations to wedding expenses, believing this was sustaining the joy of the relationship and that future pay increases would easily allow me to pay it off. Looking back, it’s easy to see how this was a terrible decision on multiple levels, but it was also one of the lessons that I think I could only learn by going through it. It was an expensive lesson leaving me with over $25,000 in credit card debt at the time the relationship ended and as I was transitioning careers and looking for a new job.
Without a doubt, that was the lowest point of my life. I was hurting in almost every area: professionally, personally, financially. Over the years I’ve become a big fan of the Biggest Loser, and one of the messages of the show is that most people who put on extreme amounts of weight have some underlying, unresolved emotional issue. Even contestants who begin by angrily denying this end up discovering it’s true. I mention this, because I believe there’s a parallel to debt. Some people eat to deal with their issues, other people spend. I know I was spending.
If there’s one silver lining of hitting rock bottom, it’s that it allows you the space to rethink who you are and what your life is and will be. I believe that this is the moment for me that all of the philosophy I’d studied over my life truly started becoming personal. One question stood out:
What is the meaning of my life?
At about this same time, I had two transformative professional experiences that also affected me personally. I was able to completely develop my own philosophy course about the relevance of philosophy to daily life and teach it to gifted high school students. I also started working as intern for a nonprofit organization involved with education. I started to realize that the way I make money doesn’t just have to be about making money. I realized that my professional life could also be a source of meaning – it seems like a simple idea, but the two things had always been disconnected in my mind and my life. I spent a great deal of time reflecting on what I wanted me life to be like – in particular the kinds of things I’d want people to say about me after I had died. This shaped many of my goals and also led to the seeds that eventually grew into the mission of Philosophy Matters.
With a renewed professional goal, I also set about getting my finances back in order, which was harder and took longer than I had hoped. However, taking the time to craft my own purpose gave me the push and motivation to continually work toward that goal of financial freedom.
Spend Less Than You Earn
The absolute first thing you have to do is figure out a way to spend less than you’re earning. You can find ways to reign in what you’re spending or you can look for ways to make more money. Whatever works for you. But do something. I did several things:
For me, the biggest factor was getting roommates – an idea that I didn’t love but was absolutely necessary. I have also worked a minimum of two jobs the entire time. A main job which went toward my typical living expenses, and a side job that allowed me to direct almost all of the income directly toward paying down debt. The other biggest factor is my car. It’s not important to me to have the newest greatest vehicle, so I save up and buy something reliable but older. I got my most recent car for under $3,000. Not having a monthly payment on it is a huge help, and the insurance is also much cheaper!
Emergency Fund
The very first step I took in turning around my personal financial outlook was building up a buffer, or emergency fund. Most often, it’s recommended that this be kept in a separate savings account, possibly because it will draw interest, but really because it makes it less tempting to spend it. This buffer amount should be at least several months of income – more is better. In my case, because I still had debt to pay down, it was only a few months that I was able to build up. I also kept it in my checking account, because it provided a great sense of security seeing that balance, and I was never tempted to spend it because it represented so much security!
Pay Off Debt
As soon as that fund was established, I started putting everything I could toward my credit card debt each month. So let’s say for the sake of this example that my emergency fund was $5,000. At the end of each month, after all other bills had been paid, I would make a payment to my credit card that would bring me down to exactly $5,000 left in my account. So if I only had $5,300 after all the bills were paid, I would make a $300 credit card payment (above and beyond any minimums required, which I counted as part of my monthly bills).
There’s a lot of debate over different methods of paying down credit cards. Do you pay off the highest interest first, or use the snowball method and pay off the cards with the least amount on them? Honestly, I don’t think it matters that much as long as you just start doing something. If one method resonates with you more than the other, go with that one! For me, the snowball method felt best – there was definitely a strong reward in seeing a card paid off and having one less monthly bill.
Happily, the beginning of 2013 saw me pay my final credit card bill!
One irony quickly became apparent – my credit score dropped after paying off my credit cards. After some research, I quickly learned that showing some monthly balances on credit cards is important – you need at least 1% credit utilization to get the best credit score. For most people, using a card for monthly expenses and then paying it off at the end of each month should suffice. A problem easily solved.
Now What?
Finally being out of debt was and still is a huge relief, the product of almost four years worth of work and effort, and symbolic of finally being free of the burdens of a very bad relationship. I’ve moved to a brand new and wonderful city, although I once again find myself in transition career-wise. Luckily, the emergency fund I had built up was there to help with the transition this time, making it much less traumatic. The first step is to build the emergency fund back up, but what after that?
I checked out I Will Teach You To Be Rich, which had been suggested by many as being very readable, as far as financial books go. I’m drawing a few ideas from there.
Retirement and Interest
The biggest take away from the book is that growing rich means you have to earn interest on your money. It’s not simply about saving. This is one of those things that seems obvious once you know it, but something I had never put enough thought into. Saving for retirement is only possible if you’re growing your wealth.
The book was published in 2008, and kept mentioning high interest savings accounts as a place to start, citing rates up to 6%. When I started doing my own research, checking out some of the suggested banks and accounts, I had trouble finding anything offering even a 1% rate. Clearly this would be problematic, because the book emphasized again and again how important higher interest rates are, suggesting even 3% was lower than one really wanted. What was going on?
Further research turned up the fact that there’s a connection between housing/loan interest rates and savings accounts interest rates. Again – this made sense after I knew it. Banks make money by taking the money you deposit with them and loaning it out at a higher interest rate than the rate they’re paying you. That means interest rates must be lower than mortgage rates if the bank are going to make money.
Of course!
And while that’s good for those who want a home loan, it’s bad for those who are saving money. Still, even 1% is better than 0%, and rates will likely creep back up over time.
The book unabashedly supports a diversified retirement portfolio, and suggests investing no matter what the market looks like (caveat: if you’re young enough and can sustain some up and down swings of a few years.) Even the massive lows since 2008 have recently recovered. Of course, it is scary reading that many think the market will make another correction and head back down.
Still, the point stands. I don’t plan to retire for probably at least 30 more years. And any down turns should have sorted themselves over that long of a term. So I’ve opened a savings account to start building up enough money to make an initial investment in a brand new Roth IRA account, which needs a minimum initial invest of $1,000. What I am investing in? The book makes some good suggestions that simplify the process of choosing. I don’t want to get in to it here today, but you should check out the book if you’re interested.
Automate It
Probably the best suggestion in the entire book is to automate this process. Have a portion of your income automatically transferred into a savings account before it ever even hits your bank account. This simple step overcomes so many obstacles to saving, and psychologically, we’re much less likely to ever miss the money because we never see it! The entire idea is to spend some time setting up the initial system, and then it runs itself – and what could be more simple than that?
Once I get the system completely set up and going, I’ll plan to check back in and give an update.
But right now, I’m still enjoying the change of trying to build a positive rather than dig out of a negative.
