Financial Independence

Posted on March 18, 2018

How can you live within your means, pay off your debts, start investing, and save money for your future?

My answer to that question starts with a quote by Dave Ramsey, and I will paraphrase him:

"Live Intentionally."

You have to mean it. You have to wish to pay off your debts. You have to desire to stop making new debt. You gotta be hungry about living within your means and saving money. You need to be willing to start investing. Every step of the way is calculated, each progress has a purpose, everything you do is by design.

If you think about the actual meaning of all those steps in your life, and all the things you do, and how you prioritize each of these life goals, and translate it all into dollars and cents, congratulations, you will have a budget in your hands.

But how can you create a fail-free budget and stick to it? How can you be realistic about all that? Here are my experiences and thoughts about it.

Main Budget Buster: Irregular Expenses

The main reason why most budgets fail is because of irregular or variable expenses. One thing is when you rent your house for $1,200 per month. The same thing can be said about insurance premiums, cable TV subscriptions, property taxes, birthdays, car tune-ups, holidays, vacations, and so on. Car payments too, but they are stupid, and I will talk more about those later on.

There are also some other types of expenses that are variable, but not by much. What you spend on groceries is always around the same range. Telephone bills, utilities, and gasoline don’t vary that much as well.

The bigger problem when designing a budget are unforeseen expenses. How can you know how much you will spend on car repairs in the next year? Home maintenance unforeseen expenses? Medical bills? Did you know that 39% of Americans have ZERO in savings and a total of 57% of Americans today have less than $1,000 in savings? Are you part of that statistic? Even if you could reach a credit line, or friends, or family, are you willing to risk it? Or would you rather take control of your life?

I was guilty of not doing any of that in my first budget. While I had no emergencies at the time – and I was single, young, healthy, and didn’t need a car – I now understand how lucky I was at the time. I got broke due to other reasons, and I will talk about them later on.

How To Budget For Variable Expenses?

One way of solving this problem is to check your records – checkbook registers, bank statements, and credit card statements – and gather your own data. Use paper or a spreadsheet, as you prefer, and find out how much money you spent in everything that was not a fixed expense during the past 12 months. Group your purchases into categories that make sense to you, such as clothing, home maintenance, auto, entertainment, medical bills. Keep the number of categories as low as possible.

Once you are done here, you will have the best possible idea about your own expenses. Get each total, for example $900 in auto maintenance, and divide it by 12 to find you need to budget $75 per month for this category. While it isn’t perfect, it is already much better than guesstimating or simply ignoring entire expense categories in your budget.

Next, set up a separate savings account to put aside these funds. Suppose you need a new set of tires six months from now, and such tires will cost around $400. You will have built up $450 for your auto expenses, and you will be perfectly covered for this irregular expense. Much better than being surprised by a completely predictable event in your life.

Totaling your irregular expenses will also make you very aware of why your past budgets don’t seem to work.

If you can have an automatic deduction from your account into your savings account, it will be even better. This way you are adding one extra safety mechanism and ensuring you will stick to your budget over the long term.

How To Budget For Savings?

It is simple, and all it takes are three words. Pay yourself first.

As soon as you get your salary, set aside immediately what you budgeted for savings towards your future. It could be your 401k, Roth IRA, gold coins, cryptocurrency, real estate, whatever method you chose. The only thing that matters is that you do that first, and then you leave that aside, and go live within your means with what is left of your salary.

Meal Planning, Grocery List, And Cooking At Home

This is an age where there are many fancy restaurants, where many friends post their fancy restaurant meals on their Instagram profiles, and where TV and international travel have brought us access to all kinds of new flavors and new cuisines that we couldn’t even dream of.

While it is very tempting to go eat in many different restaurants, swipe the bill at the end of your meal, and only pay part of your balance by the end of your month – and I speak from experience from doing all 3 in quick succession – the periods I saved the most money in my life were those where I would plan my weekly meals, stick to my grocery list, and cook at home.

Not only I saved much more money, I also learned how to buy good food at lower prices, I learned how to cook (which became a new hobby for me, since I got to practice it 3 times a day), I ate cleaner (which became an obsession), and I even lost weight – 7kg, or a bit over 15lbs, in 6 months.

Eating out often will eat your money too!

Budgeting For Entertainment Vs. Paying Down Debt

While it is important to have fun in life, you only live once, fear of missing out, and all that, remember one thing: you are not entitled to have fun.

Life isn’t fair. If you were dealt a bad hand, there is no one to blame. You have to accept it for what it is. No good or bad.

If you simply ruined your finances too early in life due to not knowing any better or simply wanting to life beyond your means, that is still your mess to sort out and pay. It is your responsibility, and no one else’s.

The sooner you accept those facts, the freer you will be to start enjoying life like you never had before.

I know all that by experience. I got broke due to 3 things, and now I get to talk about 2 of them: eating out and getting new stamps on my passport, both of them more often than I could afford. I didn’t have a purpose living. I was just browsing around, killing time, and spending away my future.

In the meantime I found my purpose, and things changed for the better.

I have learned how to cook. I have taken many great photographs with my cell phone camera. (By the way, all simply using the same 2012 iPhone 4S.) I bike. I fix things around the house.

What do all these things have in common? They bring me joy and they are virtually free of cost.

Pay Your Mortgage (Much) Faster

Bear with me here. Imagine you just bought a $250,000 house in St. Louis (MO) with a 20% down payment, or $50,000, and you financed the remaining $200,000 at 3.94% yearly interest rate* for the next 30 years. Your monthly payment is $947.93.

But what if you quit drinking one coffee a day? Let’s imagine a $3.65 Caffe Latte Grande from Starbucks, every day, on workdays. By making a simple average of 22 working days in a month, and multiplying that by the innocent $3.65, you would get a total monthly savings of $80.30 every month.

Put those $80.30 towards your principal every month and you will make a total of $24,170.30 in extra payments, instead of giving your hard-earned money to someone else. You will also pay your home 4 years and 1 month faster and save a total of $21,964.37 in interest payments.

It is that simple. $80.30 a month. Perhaps you don’t drink coffee, so you could eat out (or order take out) less often. Buy less clothes. $80.30 is not a lot of money, but it will compound and save you a lot more over the course of time. If you cannot find $80.30 to cut in your budget, either you are not trying hard enough, or you need to find a better paying job.

A warning, though: if you are disorganized with some cash, you will also be disorganized with a lot of it. The only difference is that you will dig yourself a bigger hole, and much faster.

You have to live with purpose. Every dollar of yours needs to have a pre-defined destination. If you don’t do that by budgeting, your money will simply escape through your fingers.

Dave Ramsey's 7 Baby Steps

I have to say, I really like Dave Ramsey’s approach to financial independence. He has helped many people throughout the years. Everything he talks about personal finance makes sense. Every now and then he also talks about human psychology and how it relates with money, how it creates problems, and how to overcome those obstacles as well.

He has created the 7 Baby Steps as a foundation to financial independence. Here they are:

Baby Step 1: Save $1,000

Sometimes life simply happens, and you cannot plan for everything. The first thing you need is an emergency fund to protect your planning against those unexpected things you just can’t plan for. This way you ensure you will be able to stay on track towards paying debt and saving money towards your future.

Baby Step 2: Pay Off Debt

This is one place where his understanding of human psychology shows. He recommends paying off debt with the Snowball Method. In others words, you have to list all your debts and prioritize them from smallest to biggest balance. Make minimum payments on all debts, and direct all extra cash towards the smallest balance. The psychological effect of paying something, and feeling relieved of one less burden to carry around, is much stronger than saving pennies by prioritizing the debt from highest to smallest interest rate, as per a purely numerical approach. Once completing this step, the only debt remaining will be your mortgage – more about that in a moment.

Baby Step 3: Emergency Fund

Once you are done with your debt, it is time to build yourself a bigger cushion. Here you will save to build a full emergency fund, and the amount of cash here will vary according to your own budget: you need to calculate what is enough to last you from 3 to 6 months’ worth of your expenses.

Baby Step 4: Invest 15%

Once you got emergencies fully covered, and you have no debt, it is time to save for your retirement: put 15% of your income aside to build your dream retirement: go live near the ocean, or plant your own food in your backyard, or travel around the world 2-3 times a year, anything really.

Baby Step 5: Save for Kids’ College

What could be a better gift for your children than an early start on life without debt? When you reach this step, you can start saving money to pay for your kids’ college tuitions in 529 plans, or “qualified tuition plans”. This way, you are giving your child something most Millennials can only dream of – college education without debts. It is also a great opportunity to sit down with your kids and talk about financial responsibility.

Baby Step 6: Pay Off Your Mortgage

By now you have almost everything in your life taken care of and completely under your control. As a result, you can make extra payments and own your house earlier. How is that for true peace of mind?

Baby Step 7: Build Wealth And Be Generous

After building your entire life responsibly like no one else, it is time for you to reap the benefits of your discipline and hard work and live like no one else – where you increase your wealth even more and can even afford to be generous and donate time and money to worthy causes, help others, give back to your society, and leave an inheritance for future generations.

The Problem With Dave Ramsey

I strongly believe in Dave Ramsey has solid principles to help anyone to organize their lives, pay off debt, and save serious money.

However, his investment advice is really terrible.

During his radio show he often overestimates the interest rates for the investment funds he constantly pushes, plus he strongly pushes and sells his own investment advisors – who have little to no interest in your own good.

In other words, while Dave Ramsey has good advice on how you can start to make huge changes in your life, he offers bad advice on how to evolve into your financial journey. And here is where you can find the Lazy Portfolio approach can make a big difference.

Lazy Portfolio

Lazy Portfolios are super simple. Here is the brakdown on how they work.

#1: Save Money

Lazy Portfolios allow you to focus on the single, most important action for becoming a millionaire: saving money each and every month and letting it all under the massive growing action of compound interest. You achieve it by buying three low cost, no-load index funds, and never selling anything.

Yes, that's right, just as Warren Buffett, you buy and hold forever. By choosing good index funds with long track records, why in the world would you be interested in following the herd and losing your hard-earned money?

They also allow you to avoid getting desperate about the market in an eventual downturn and selling your stock in a downturn moment.

And they also avoid you trying to time the market and being smarter than everyone else in the room by selling everything in an allegedly all time high. (No one can predict such things. And even if they could, they would keep it a secret.)

Reasons could be big tech company will suffer an anti-trust law action somewhere, old too-big-to-fail company will go belly up, war somewhere involving two countries most people can't point on a map, some hurricane or earthquake or massive floods will disrupt production lines and cause problems to the economy somewhere else. Whatever is on that menu, you cannot predict it and you certainly cannot time the market.

The main thing is to save money every single month. Live below your means. Avoid debt like the plague. Run away from car payments. Pay your credit card in full MONTHLY like your life depended on it. (It does. Or you can wait until you turn 70 and see all your health bills piling up and no savings of any sort to cover them.)

#2: Rebalance

So, for the sake of simplicity, let's say you choose to follow the Three-Fund Portfolio approach, you picked your three low-expense-ratio index mutual funds and/or ETFs, and you start on January 2nd with equal weights split as 34% US Stock Market, 33% Bonds, and 33% International Stocks.

Comes December 30th and your ratios became 35% US, 30% Bonds, and 35% International. For whatever reason that will certainly be out of your control.

So, after your holidays, you will "rebalance", that is, sell 1% on US and 2% on International and buy 3% of Bonds.

The reason? Next year, perhaps International might do worse, and Bonds might perform better. And in the year after that, US might perform worse than the other two. For whatever reason.

The Reasons

Active traders pay fees, have higher costs and transaction costs, and pay higher taxes that eat up all their profits.

After tax-returns of active traders are 11.4% annually, while buy-and-hold investors generate an average of 18.5% every year by doing much less messing.

Lazy Portfolios always win because they bet on every horse in the track. The entire sum of the market, over a long period of time, always goes up and always wins. And by spreading your money, even if individual stocks go down by a lot, everything else saves you, and on average you will always be better off.

Drive Free Cars

Remember how I said that Dave Ramsey gets some things very right, and other things very wrong? Well, the way he talks about car payments has opened my eyes.

A normal person drives a new car with a car payment. A normal person is also broke.

Recent statistics show that monthly car payments average $510 in order to buy cars worth $30,314. Average interest rates on a 60-month loan are 4.46%.

This is a disgrace!

But how do you break the cycle? Easy-peasy:

  1. First you buy a beater with cash and get rid of car payments - $2,000 or so.
  2. Then you budget and set aside money for car maintenance - let's go with $300 for brake pads  and $600 for a full new set of tires.
  3. Last, you set aside your current car payment and make a new car savings account - I will suppose the $510 American average.

By the end of the first year, you will have a car likely to still be worth $2,000 and $5,220 in your savings account - twelve car payments minus the $900 maintenance budget - for a total of $7,220.

Now you buy a $6,000 car, and you already have $1,220 for maintenance expenses. That's a damn good car upgrade in 12 months. Instead of making the bank richer, you simply did the math and took matters in your own hands.

The next time you are likely to have the same depreciation (ZERO) and another $5,220 in your savings account, even if you managed to buy a newer lemon with less miles that still ate up 100% of your bigger maintenance budget.

That makes a new-to-you $10,000 car, plus $1,220 already set aside in the bank for car maintenance stuff.

In just two years you managed to go from a $2,000 beater to a $10,000 car with "free" maintenance and "zero" depreciation. How is that for controlling your own life and getting rid of car payments once and for all? What type of car could you be driving 10 years from now?

Side Hustle

That is what the cool kids call it these days, and its definition is simple: make more money without leaving your current job.

There is only so much money you can save from your current income, but you can always find new ways of increasing your current income by adding additional income streams.

Perhaps your hobby is photography and you could take pictures of fancy homes for a luxury realtor friend of yours, or senior portrait pictures for younger cousins. Family portraits are a good source of income as well. Wedding photography is more serious, but there is serious extra money there as well.

Remember: it is a great excuse for buying fancy lenses, new gear, or upgrading your camera, as long as it all pays for itself.

Perhaps you like woodworking and you could make or refurbish stuff and sell it on Etsy or for buddies at work.

This is how you justify better drill bits and other new power tools, as long as they can pay for themselves.

Perhaps you love cars and you could be a detailer on weekends, get close and personal with luxury and exotic cars in your local area for a few hours.

You can even get more specialized cleaning products, as long as you have a steady flow of customers that justifies and pays for these expenses.

You could simply babysit or dog walk, you know. Uber or Lyft. You could become a tour guide or rent a spare bedroom in AirBNB, but those last two depends on where you live.

The main point here is simple. Find out what your skill sets are, think about your passions, and find a slot of time that you can devote for it.

Money Management Basic Principles

This already got really long, but these are essential principles if you want to live a balanced life without money concerns.

Here are the basic principles of pro-active, smart money management:

  1. BUDGET. You must know where your money is going. Every dollar must have a purpose - or you will simply waste it all away.
  2. PAY YOURSELF FIRST. Determine what you will save every month and stick to it. As soon as your paycheck hits your bank account, set aside your savings that will compound interest your way to your financial independence.
  3. AUTOMATE BILLS. If you made a good budget, then you already know how much you spend every month for utilities. Automate those and save time for other productive activities.
  4. USE YOUR MONEY FOR VALUABLE THINGS. What I mean is things that have lasting, or even everlasting, value. Pleasures can be very instant and fickle. Property, retirement, and education are things that remain with you.
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