Six Steps to Financial Freedom, Step One
“The fastest way to build wealth is to eliminate debt.” Dave Ramsay
Before I started in this business I was a financial basket case. In 2005 I was over $150,000 in debt. My house was underwater, I had 5 credit cards, all maxed out, two car loans, and had started to frequent a payday lender in order to put food on the table. I hit rock bottom in September of that year when I received a registered letter from my mortgage company informing me I had 72 hours to make two mortgage payments and pay a bunch of legal fees, a total of about $3000, or they were going to foreclose on my house.
Thankfully I found a family member who was willing to step up and buy me out of that particular bind but I was still forced into a Proposal in Bankruptcy by November of that year. For those of you who don’t know, a Proposal as it is sometimes called is the provision within Ontario Bankruptcy Law that allows consumers to surrender all unsecured debt for pennies on the dollar while sacrificing their ability to arrange any further debt for a period of seven years. Under a Proposal secured debt is not affected so I was able to keep my house and my cars but for all intents and purposes until very recently I lived completely on cash.
It was in going through that process that I started to get interested in how money and in particular debt actually works. In a weird way I credit almost losing my house with putting me on my current the career path. The more I looked at it and the more I experienced it I realized a few things.
1 – This isn’t all that hard.
2 – Not enough people are doing it.
3 – I can make a business helping people understand money and get out of debt.
That’s where the six steps come from and step one is the simplest, most obvious and paradoxically the hardest one for people to achieve.
Debt is quite simply, BAD! There is no such thing as good debt and the sooner you get out of debt, or at least get control of your payments the better off you will be.
It all comes down to the magic (or curse) of compounded interest. Take your typical credit card as an example. I have a Mastercard now that I use very sparingly and do my best to pay off at the end of every month. But if I don’t pay it off the interest charged on that account is 14.9%. On a balance of $1000 that would be $149 per year or $12.42 per month. That doesn’t seem like much but consider that the minimum payment on that $1000 or rather $1012.42 is just $22 and would leave me with a balance of $990.52. Interest would of course be added to that bringing my balance back up to $1002.82. So now you can see I would be into the third month of paying only the minimum payment before I make any progress on the principle at all. My credit card company very helpfully posts a Minimum Payment Notice at the top of my bill which tells me that if I make only the minimum payment it will take me an estimated 35 years to pay off my entire account.
Now a lot financial advisors will tell you the fastest way to build wealth is to pay yourself first, meaning put money into savings where it will earn interest. Frankly I disagree. Or at least I agree only to the extent that you are already out of debt or paying so little in interest as to be insignificant.
There are very few investments that will earn you more interest than you pay on your debts. Traditionally your primary residence is the only thing you will purchase that will increase in value faster than the interest paid on the mortgage, but that’s a discussion for later in the six steps. For now you need to take control of your debt. The interest rate game is rigged so that other than on a residential mortgage you will always pay more on the money you borrow than you will receive on the money you save.
Back to my credit card example; if I had $1000 cash and were to follow the traditional “pay yourself first” advice I should put that money in an investment. The average balanced investment portfolio in Canada today is returning 6%. So at the end of the year I would have $1060. If I then took that money out of the investment and decided to pay my credit card off with it I would still owe $89. And a month later I would receive a credit card bill for $90.11.
When you have debt, especially debt that is charging interest at a higher rate than you can earn saving money, pay yourself first is bad advice. Pay your high interest debt first, or better yet, don’t go into debt in the first place. In that way you will have more money to invest later.
For more information on the Meekonomist approved plan for getting out of debt click on The Meekonomist Manifesto above or write to email@example.com