Tackling Debt

Getting your finances on track: budgeting

If you’re “underwater” financially, or really don’t know where to start, you’ll probably want to create and follow a budget for a while. Think of it like a pair of training wheels while you’re trying to learn to ride this bike called “money management.” Let’s take a hypothetical friend called Fred. Fred’s based in North Carolina, makes $70K annually, and often feels like he’s living paycheck to paycheck – hardly any money left in his bank each month.

$60,000 Annual Gross Income
$44,352 Annual Take Home Pay (after taxes)
$3,696 Monthly Take Home Pay (annual income / 12 months)

Monthly Expenses:
$900 Rent
$100 electric/water/gas
$150 Student Loan 1 (payment on $15K balance at 5% interest)
$200 Student Loan 2 (payment on $5K balance at 4% interest)
$100 Credit Card 1 (minimum payment on $2K balance at 23% APR)
$200 Credit Card 2 (payment on $5K balance at 18% APR)
$500 Food
$200 Entertainment
$50 Cell Phone bill
$170 Cable Internet/TV
$400 Car lease
$90 Car Insurance
$150 Car Gas
$200 Miscellaneous/Discretionary

Well, Fred’s not imagining things. He’s spending a total of $3,410 of his $3,696 take home pay, so when he sees his bank account go up by a paltry $286 each month it might be a bit depressing. How would he handle an emergency? What if his car broke down? What about a vacation? This unfortunately isn’t too far removed from the average American worker’s financial situation.

Creating this budget was a good first step in understanding where exactly Fred’s paycheck is going each month. There are some easy fixes to give Fred some breathing room, but there’s also going to need to be a shift in mindset if he’s going to be able to have some level of control over his finances.

Rather than focus on things he can’t easily change (like perhaps not leasing the brand new car that he went with), I’ll try to go over some changes we can make today. First up: Fred is paying out a lot of money in interest payments, but we’ll come back to that in a moment.

Fred needs to free up a bit of cash to take care of these debts that have his finances crippled at the moment. There’s not much he can easily do about the car lease at this point, and his rent and electric/gas/water bill are pretty decent for the area. But after some discussion, Fred agrees to stop eating out for every lunch/dining out often at expensive restaurants, and feels he can shave that food budget down to ~$200 by doing more grocery shopping and brown bagging some lunches. It was also discovered that the amount spent on entertainment is over-sized (going out for drinks with buddies often / every weekend) and could be cut back by ~$100. Finally, the cable/TV bill seems a little high. Turns out Fred doesn’t actually watch much content on the TV: he’s able to live without the cable TV package in favor of Netflix / Hulu / Amazon Prime video, or some other internet TV service, but needs the cable provider for internet access. That’s great! The internet-only package is about $40/month but he’ll be paying ~$10/month for Netflix.

Not a bad first pass. Fred was able to shave from his expense budget:
$300 in excess food expenses
$100 in excess entertainment expenses
$130 from the “gold-tier” cable package he’ll hardly miss
-$10 for his newly acquired Netflix subscription to supplement his loss of cable TV channels

That’s an extra $520/month in spending power Fred now has. Ideally, Fred should first build up a savings about 6 months of living expenses. He could build up more (up to 12 months) if he feels like he needs additional security, or has a family/dependents. Alternatively, if he’s single (which is what his budget/expenses are modeled after), and he is feeling very confident about the job market and his ability to find work if he suddenly lost his job, he could stop for now at 3 months to begin the next phase of wrangling his expenses.

Pay down the most “expensive” debts first (the snowball strategy)

There’s a few different ways to tackle debt, but first: “why all the fuss? My service provider says I only need to pay this ‘minimum balance’ of $50 or so. Isn’t that way better than (unnecessarily) paying more?” Well sure, we’d all like to pay less for services if we could, but what’s not so obvious is how the interest your provider is charging you works. Most debts have an interest rate attached to them. Each payment period, the provider is calculating interest on your remaining balance and adding it to the remaining balance that you need to still pay off.

Let’s take an example:
Fred owes $2000 on his first credit card. By paying $100 each month, he won’t have paid it off after 20 months. With that insane 23% credit card interest rate being factored in each monthly statement, he’ll actually be paying off a total of $2600 over 26 months. That’s the power of interest – Fred’ll lose an extra $600 over what he originally charged to the card for having the credit card company effectively “loan” him that $2000. Fred may infact have additional expenses to put on his cards which will only prolong the period until he’s debt free. It’s actually possible to stay in debt forever by naively continuing to pay less than the interest plus new charges applied to the card each month!

One school of thought is to pay down your debts in order of smallest to largest thus helping you arrive at a situation of having less “debts,” which some folk find to be psychologically beneficial and freeing. The method I personally prefer involves paying down your “most expensive debts” – basically: the ones with the highest interest rates. Those are the ones “costing” you the most each month to keep around. For Fred, after he’s established an emergency fund, he should have the original $286 of spare cash and the $520 he managed to shake out of his budget. By paying the minimums on his other debts, and “redirecting” that cash towards his most expensive debt, he could wind up with something like this:

$75 Student Loan 1 (originally $150 – $75 redirected)
$20 Student Loan 2 (originally $200 – $180 redirected)
$1311 Credit Card 1 (originally $100 … + $75 + $180 + $150 + $286 + $520)
$50 Credit Card 2 (originally $200 – $150 redirected)

Instead of taking 26 months to pay off Credit Card 1, Fred could buckle down and pay off that $2000 balance in $2K / $1311  = ~ 2 months, and then direct the money that went towards Credit Card 1 to Credit Card 2 (his next most “expensive” debt) and get that paid off in $5000 balance / ($1311 redirect + $50 already paying) = ~ 4 months.

Rinse and repeat: if the APY on his car lease is higher than the rate on his student loans, and doesn’t have much in the way early re-payment fees, he could tackle that next. Following this recipe, Fred could most definitely be rid of all of his debt in 2 or 3 years, and should switch to paying off his credit cards in full each month to never have to worry about interest payments on them again.

Of course Fred will have some additional expenses that he might need to push onto his credit cards over the months, but the fact still remains: that by controlling your expenses, and being mindful of saving more than you’re spending, you can rid yourself of crippling debt and set yourself up to begin building a nest egg to put towards a brighter future.

Money comes and goes, but time is finite

Imagine if you didn’t need to work to pay your bills or sustain yourself. If money wasn’t a factor, what would you do today? Tomorrow? 

Would you be hiking in a faraway country you’ve always wanted to visit? Or maybe you’d spend more time on a hobby you don’t really have the time for at the moment? Maybe you’d like to just spend more time with your loved ones?

Well, all of this is possible to pull off. There are countless folks out there who can count themselves as financially independent. They don’t need to work to sustain their lives, and the large percentage of them haven’t really felt the need to return to work after leaving the workforce.

I’ll pick on Americans as an example – most spend 40 hours a week working, with another (ideally) 56 hours/week sleeping. Extrapolate a bit and that’s over 50% of our lives spent on (for the purposes of this post) “involuntary” activities.

There’s a slew of other opportunity costs to the present-day worker’s routine as well. That day job is likely the reason you can’t pull off backpacking in “your-favorite-country” for a month. That most business are closed as you get out of work is why you need to sacrifice your lunch break or weekends to carry out your errands, further eating into time you could be spending doing more enjoyable things.

At some point, I had to ask myself: am I living to work, or am I working so I can stop working (soon)? Controlling your expenses and having enough savings so you can do things besides working at a job you hate sounds great on paper, but takes quite a bit of willpower and motivation. Money can be obtained in ways other than trading 40 hours of your week for a paycheck. And once your source of income is no longer a concern, you’ll find you might have more time than you know what do with.


The “flame” withers and starts to die

I distinctly remember going through my final years in college lamenting “true” adulthood. My vision of post-college life meant more obligations in the form of waking up to be at some dead-end job at 9 o’clock in the morning, working on the (most likely) menial stuff day after day. Maybe this unromantic view of adulthood resulted from too much exposure to adults I knew to be tired, frustrated, disgruntled with work/life and with less of a “spark” towards the fun and creative activities I held close to my heart.

I know, I know: “you should strive to work in something you enjoy. That way, the work won’t feel like work.” I could hear that familiar line playing in the back of my head as I tried to figure out what I wanted to do with my life. “Are people actually happy just choosing a career and working on it until retirement around age 65?” I couldn’t help but think that from my observations and some healthy skepticism that more than a few people might be lying about the transition to joining the adult workforce.

I’d worked a few part-time jobs as a kid, and while I’ll credit a few of them with helping me build my social and professional network, I don’t especially remember any of them being incredibly fulfilling or something I’d wake up in the morning with a fervent desire to rush off to. I did them without much thought for the future and more out of an obligation to my parents / to help contribute to the “household.”

Much of my childhood up until that point had been spent on being a closet gamer and an otherwise normal/quiet kid with a handful of hobbies: cycling, chess- and tennis-playing. Barring a bit of first-world inconvenience, life so far had been relatively okay, and all I could wish for was to be able to wake up each day and have the freedom to do whatever the heck I wanted to do that day, be it getting up and going on a trip on a whim, or getting in on a marathon gaming session.

But back in college, reality had set in: the template for “life” seemed to be “graduate, get that well paying job, and work hard so you can retire around 65, and then you can live however you want.” That didn’t sound particularly better than my current level of freedom/happiness. Add to the fact that I’d be hopping into the workforce just off the heels of the 2008 recession, the devastated job market, the dismal earnings prospects for millennials, on-going talk of increasing the retirement age and social security vaporizing, and I hope you can see why I was a pretty unhappy camper.

I’d once convinced myself – having grown up on comics, video games, and wildly entertaining Saturday morning cartoons – that life would most certainly be some fantastical adventure full of following my dreams and doing amazing/ground-breaking things (or at least stuff that mattered to me), but it was starting to look more like it would be 50+ years of work, eat, sleep, repeat – and that was a pretty depressing thought.

Finding another way

My first job out of college seemed to confirm my fears. Getting that first job at a fledgling tech start-up (despite my studies having not been in computer science) felt like a lucky break – it was fun, exhilarating, synergized well with my childhood computer hobbies, and brought with it a whole set of amazing challenges that helped me to push myself, but I’d be remiss not to admit that there were some days where I wish I could be doing something else. The feeling of wanting the freedom to be able to choose what I wanted to do that day rather than working on someone else’s business/goals never quite went away.

hugely undervalued myself, my qualifications, and my skillset at the time and started as a software engineer making $50K in NYC. In addition to working my butt off (and what I can only describe as a serious fear of upper management losing me if I wisened up to the job market), I was quickly increased to $75K a year later and then $100K a year after that. I knew full-well how much harder other peers my age had it with regards to wages and the cost of living in NYC. I felt incredibly lucky to have made it to where I did at that point.

I’d always been naturally frugal and thrifty as a byproduct of my upbringing. I’d never owned a car (not really needed in NYC), didn’t really have any significant bills, was living with my parents at this point, and was able to pay off my ~$24K in college debt after about a year and a half.

Seeing the income add up in my bank account and how I could use this to fuel my passions and hobbies is what ignited the initial spark to save even more aggressively. I would discover a few years later that the official name for not needing to work to sustain one’s lifestyle is known as “financial independence (FI)” and boy was I hooked on getting there.

I’ve still got quite a ways before I’m fully FI, but I’m hoping to chronicle some of that journey here, as well as record some learning experiences and insights about frugality, saving, money management, and travel among other things.

Welcome to FIring on all Cylinders!