Steps to Financial Independence: Step 2

Photo: Are you sitting in a pile of bills?  Are you ready to change your financial life?

This is the second article in a series on reaching financial independence.  Read more about the steps by following this link.  Other articles in the series: Step 1Step 3Step 4 and Step 5.

Our culture is a culture of want, want, want.  This culture leads to spend, spend, spend.  Families tend to spend more than they make and they don’t know how to say no.  This is how I lived my adult life for 8 years and I built up a lot of debt.  To have so much debt, has pushed financial independence further away from my future self.  I wish I would have known at 20, what I know now.  I gained the knowledge that debt is bad and it needs to be dealt with immediately!

My family history has not taught me well about how to handle money.  Both my father and my uncle use debt to fund their businesses.  My father owned his own business.  He used debt to fund the entire business.  My father gambled much of his wealth away and had to sell his business.  He still works at that business today, but he is just an employee.   My father now struggles to get loans from the bank and now uses payday lenders to make ends meet.  My father has not been a great example of how to build wealth and stay out of debt.

A man I once worked for used debt a lot.  He owns many businesses, and he made a statement that summer that stuck with me.  He said, “Debt is a tool that you use to make money.”  This statement is a bunch of malarkey.  A statement like this is an example of lies that our culture teaches us.  By paying monthly payments on debt, that is less money going towards building wealth.  Debt has never helped me make money.  My wife and I are building our wealth, because we are not paying monthly payments anymore.  This statements show the lie that has been taught to many consumers around the world.  The lie is that debt is needed to prosper.

Debt will not help you prosper, but it is way for the bank to prosper.  That is why banks are so willing to give loans for cars, credit cards and personal loans.  They make money on all the people who take out these loans.  Don’t think that you can outwit the banks.  The banks are multi-million dollar companies that have many people working for them to market credit towards consumers.  They have nicer buildings and nicer furniture

If you are in debt, the first thing you must do is get out of debt as fast as possible!!  This is not the time for fancy vacations, pedicures, massages, eating out and going to the movies.  All unnecessary expenses must be cut immediately.  Starbucks or other coffee places are no longer allowed.  Cable must be cut!  This is an emergency that must be handled with swift and extreme measures.  

This is the hike up the mountain in your financial journey.  It is not easy to cut things that you have become accustomed to.  It is not easy to sit at home on the weekends, when all of your friends are out on the town.  Drastic circumstances call for drastic measures.  Your friends have made a choice to stay in debt, but you didn’t.  You are here because you want to change you financial footprint.

I once reached this point in my life and I have been fighting and clawing my way out of debt!  I had a negative net worth all of my life until about two years ago.  The feeling of being free from debt is amazing!  The money builds extremely fast once debt is no longer a factor.

Every month that interest is being paid on debt is one less month closer to financial independence.  With financial independence being a goal, all possible money must be used for saving and investing.  For a person in debt, the money that could be used for saving is going towards debt payments every month.  Let’s use an example comparing two families with the same income.  One family has debt and the other family does not.

Both Families have the same following numbers:

Monthly Income: $4,700

Monthly Expenses (not including Debts): $2,300

Leftover: $2,400

Family 1:

Car Payment 1: $486

Car Payment 2: $324

Boat Payment: $200

Credit Card Payment 1: $20

Credit Card Payment 2: $100

Student Loans: $180

Personal Loan: $90

Total: $1,100

Leftover: $2,400 - $1,400 = $1,000

Savings: $1,000

Family 2:

Debt Payments: $0

Savings: $2,400

    Family 1 has lost out on $1,400 of savings a month, because they are financing a life style that they cannot afford.  This adds up to $16,800 worth of missed savings over the course of the year.  You can say, so what family one is still saving $1,000.  That’s not good enough!  Financial independence can only come with a high savings rate and a frugal lifestyle.  Family 1 has a 21% savings rate, which is not terrible, but family 2 has a 51% savings rate.  This family is saving over half of their income, which means that they won’t need as much savings when they retire, because they don’t have to support an over inflated lifestyle.

Let’s look at the opportunity costs missed by family 1 in ten years with an anticipated growth rate of seven percent.  Family 1 with a savings rate of $1,000 per month will have $173,084.81 in ten years at a seven percent interest rate.  This is pretty good, but let’s look at family 2’s results.  Family 2 is investing $2,400 a month for ten years at a seven percent interest rate.  Family 2 will have $415,403.54 in ten years.  By saving $1,400 more per month, family two has $242,318.73 more than family 1.  Family 1 has lost out on a lot of money in their net worth, due to the fact that they were financing a lifestyle, instead of living debt free.  

Family 1 is on its way to financial independence in just a few more years.  If true financial independence is your goal, then you must get out of debt as fast as possible and begin saving and investing coin.  We must sacrifice to reach the financial summit.

The above data was calculated by using an Excel spreadsheet and plugging the numbers into a future value calculator.