Sunday, January 27, 2008

Building One's Financial House

J.D. over at the fantastic Get Rich Slowly is most responsible for the exponential acceleration of my self-education in financial matters and the main inspiration for this enormous positive life change and The Impecunious Investor blog. If you go to the About page on J.D.'s blog, he links to his first-ever post summarizing what he read from several finance books. This post spawned Get Rich Slowly. It also serves as a great introduction to people who wish to take control of their finances and work on putting their "financial house" in order. Read J.D.'s post, but I wanted to summarize here to outline where I am and where I am headed. The steps for building one's financial house:

  1. Prepare the Foundation: Eliminate debt, reduce spending, and increase income.
  2. Build the Framework: Establish an emergency fund, maximize retirement investments, and begin acquiring income-producing assets.
  3. Finish Construction: Be patient and disciplined. Resist incurring new debt, maintain good spending and saving habits, and simply wait.
  4. Move Into the House: Financial independence - when your passive income equals or exceeds your monthly needs.

At present I am actually doing a combination of steps one and two. Debt is actually not a big problem for me at the moment. A significant portion of my debt is interest-free (credit card collections and money owed to friends and family). This is also "feel-bad" debt, though, because I feel guilty about owing money to people I love, and I feel frustrated and annoyed at how I got myself into credit card debt. Nevertheless, it isn't a big negative on my bottom line (with the exception of needing to pay off my CC debt to increase my credit score). Most of my debt is my student loans, which is "feel-good" debt. Debt happens when you go to an Ivy League college and you aren't a blue blood. At the moment I have a standard automatic payment plan which is set to pay off my debt in about 14 years. I definitely want to accelerate this when possible to avoid paying all the interest over that period, but at the same time I want to take advantage of my relative youth and start saving. I have not incurred and plan not to incur any additional debt for the foreseeable future, and I have taken significant steps to reduce my spending, including establishing a monthly budget. As far as my personal income, I am looking to get a better job with much better pay, and at the same time I am looking into various additional income stream possibilities.

Concurrent with this first step is Step Two. I have already started building an emergency fund and investing in my new Roth IRA, both of which have automatic contributions. Instead of looking to see what I can spend my paycheck on, I am trying to see how I can save extra money here and there. And this is really what I want and need to focus on now: building my short-term and retirement investment assets.

The key is that the best time to start is NOW. No matter your age, income, or financial status, take stock of your personal situation and start walking down the road to financial independence. One day I was a spender; the next a saver. It happens just like that.


Anonymous said...

"Nevertheless, it isn't a big negative on my bottom line (with the exception of needing to pay off my CC debt to increase my credit score)."

Credit scores are funny and often misunderstood. While I don't know the specifics of your credit card debt, I question whether or not paying off your debt will necessarily increase your credit score. The most important part of your credit score is paying your debt on time every month, and unless you have a super-low interest rate you should also always try to pay more than the minimum amount that is due. The other factor has to do with the ratio between your AVAILABLE credit and your current balance. For example, if you have a $20,000 credit line, and you currently have an $18,000 debt, then your credit score is likely being negatively impacted by your debt load, and your score would thus be positively impacted by trying to pay more towards your credit card balance every month. On the other hand, if you have the same $20,000 credit line and only $2,000 of debt, then you should not have a problem with your credit score. As such, in this situation one should not be in a hurry to necessarily pay off this debt especially if it is being held at a very low interest rate (I believe you said it was at 0%).

-R.W. Buffett

Anonymous said...

"I definitely want to accelerate this when possible to avoid paying all the interest over that period, but at the same time I want to take advantage of my relative youth and start saving."

In most cases, it does not make sense to pay off student loan debt faster than the standard payment period. In the world of debts, student loan debt is considered one of the "good" debts, much like a mortgage (I know, any type of debt can be considered bad, but work with me). This is mostly due to the fact that the interest you pay is tax deductible (unlike a credit card), and the interest rate is likely quite low (also unlike a credit card). Paying your student loan debt on time every month will also help boost your credit score. So while it is always a nice feeling to try to pay off debt early and avoid paying extra interest, depending on the interest rate of your loan, I wouldn't get too concerned about trying to boost your payments any time soon especially if your money can be earning a higher interest elsewhere.

-R.W. Buffett

The Impecunious Investor said...

@R.W. Buffett: Excellent points, as always. As far as the credit card debt, you're right - I'm not in a hurry to pay it off because the small monthly payment works perfectly for me. That said, I'm still eager to get it off my record, if only for the psychological benefit. Maybe it won't affect my score as much as I think.

Re: Student loans - another good point. I hadn't even taken into account the tax benefit. And yes, assuming I can invest the extra money wisely then it makes sense to do so. I will take the $ I was going to put toward my loans into gold bullion.

Thanks for the comments!