Your Finish Rich Plan - A Personal Finance Blog

Archive for June, 2008

Finish Rich on a Shoestring

Like I pointed out in my previous “Finish Rich on a Shoestring” article, most people are well aware that in order to improve their financial situation and even become wealthy, they need to leverage the power of compound interest. The problem is, we tend to be on the wrong side of interest compounding. When you carry credit card debt, compound interest is working against you, instead of for you. You need to take the necessary steps to curb your spending and clear out some money that’s you’re going to use to pay off your debt. Then, it will be time for you to start investing toward that financial success goal.

One of the main reasons why people don’t invest is that they think they need some kind of lump sum in order to get started. They don’t realize that they can start investing for as little as $100/month in some index funds that offer both a healthy return and the relative safety of diversification.

If you’re unable to follow that simple approach to investing, it’s either because you’re already living on more than your income each month (and as a result the extra money to invest is just not there), or you subscribe to the theory that investing is complicated. It can be, but it doesn’t have to.

Many of us make a lot of money as we progress in our careers. Many people earn a monthly income of thousands of dollars and some even much higher. Despite the big money, they are not much different compared to minimum wage people who earn a few hundred dollars a month. At the end of the month, these people who earn thousands of dollars are just as broke as everybody else. This is because, the more they earn, the larger the debt that they can accumulate. For example, bigger house, bigger car, fancier gadgets that only end up leading them to bigger debt than before.

You can follow those seven tips plan to save a regular amount of money that can be used first as debt repayment money, and then as wealth building money:

1. Reduce your entertainment spending - chances are, you don’t know exactly how much you spend on entertainment each month, and the total is probably higher than you would guess. Smaller expenses like going out to eat or to the movies can add up quickly, especially if you are paying for two (you and your spouse) or four (you, spouse and two children) people each time. Try making your own coffee in the morning instead of going to Starbucks to get your buzz. Or make your own coffee several days a week and reward yourself with that Latte on Friday. What can you sacrifice to help your investment budget?

2. Sock some money away. The truth is that life is expensive and problems or emergency situations will arise and drain your bank account. It doesn’t matter how little you decide to put away for the future. For young people, the biggest factor on your side is time. Small amounts of money add up over time, and if you factor in compound interest, the twenty bucks a paycheck you put away in a 401K can turn into a nice chunk of money. Or, a smart and easy thing to do, if you have direct deposit through your work, is to have some money automatically diverted from your paycheck into a savings account.

3. Watch your food spending. To get it under control, make sure you plan your meals in advance each week and buy accordingly, never go food shopping while hungry or without a list, and don’t make the mistake of aimlessly wandering up and down every single aisle in the supermarket. Calculate how much your shopping will total and take that amount in cash - do not have a debit or credit card with you. If your shopping exceeds the amount of cash you have, replace some less essential items. Buy cheaper brands of cleaning products, toilet rolls and alcohol. Arrange alternative celebrations for birthdays and ring a friend when upset - don’t treat food as a reward or comforter.

4. Buy less ‘treats’ and impulse buys - do you have a gym membership? When was the last time you used it? The majority of people who have a gym membership will actually pay less over the course of a year if they cancel the membership and pay for each gym session as they attend. Cancel your membership now - unless you really go several times every single week. Consider your magazine and newspaper subscriptions. How many of these can you access free online? How many do you not even get around to reading properly? With the amount of free information available online, there is rarely a need to pay for any magazines or newspapers. How often do you buy CDs or DVDs? Most CDs can be purchased at a lower price online, and as most DVDs are watched only once, switch to renting them for a fraction of the price. If you’re wondering how you will manage without these ‘treats’, consider if you are trying to hide from some real pain that can be better managed.

5. Stay away from the ATM - give yourself a weekly budget and withdraw this amount at the beginning of the week. Then hide your credit and debit cards and force yourself to spend just that amount. This will force you to closely examine your spending and will change the way you think about money and spending. This will also help you avoid the overdraft fees ripoff.

6. Pay off your credit card debt. The interest rate on credit cards can be up to 22%. That means if you carry $100.00 on a bill over into the next month, you will now owe the credit card company $100 plus interest. And guess what, next month’s balance is going to be calculated not on $100, but on the new, higher balance, resulting in ever-increasing balances. No matter how much those credit card commercials claim they can improve your life and make it more enjoyable, the credit card company is not your friend. They want your money. So pay down your debt as soon as you can and before you put money in savings. If you are paying 15 percent interest on a bill to a credit card company and at the same time are only earning a 3 percent return on money in your savings account, it makes sense to pay off your debt first. The amount you owe will easily eclipse what you are earning. If whatever interest you earn is less than the 15 percent I use as an example, then whatever you are earning is not really earnings. Your net profit will still be negative. Get rid of credit card debt so you can start really saving money.

7. Use your credit card wisely. A credit card is essentially a card that allows you to take a loan out of a fixed amount of money, your credit limit. Credit cards are also a good way to build up your credit. If you have a record of paying off your credit card bill in full and on time every month, then your credit score should get better. Another advantage of paying off the bill in full and on time is that you will be able to avoid paying any interest on the money you borrowed. If you pay attention and are careful with how you use your credit card, then it can be a good tool to help improve your credit. Try putting one purchase a month on a credit card and paying the bill on time consistently. Some credit card companies even offer incentive programs like airline miles or cash back on certain purchases. The credit card I use credits me a certain percent of all the money I spend at certain gas stations each month. Getting money back is even better than saving money.

By following these seven steps, you will have an extra amount of free cash each month that can be used for investment purposes.

Remember that wealth is your net worth. Income is larger than expenses equals wealth if you invest the extra money. On the other hand, spending more than you make only leads to headache, and eventually bankruptcy. Learn to cultivate the habits of the wealthy and not those of the spenders and you will be on your way to financial freedom sooner than you think.

People who are always working out know that the body only grows when it’s stretched beyond its comfort zone, so they will always exercise until their body feels the pain. The same thing goes in the financial realm. You will never grow your wealth to high levels if you are not willing to leave your comfort zone. By investing your money and taking (calculated) risks, you will definitely be in the uncomfortable zone. And by being in that zone, you’re growing, and are thus more likely to achieve your financial goals.

If you read some of the self-help and the ‘how to get rich’ books, they tend to point to one same point and that is if you want to be rich or successful, think like a rich person or successful person. The secret to that is just by looking around you. Look who are your friends. Look who is in your social circle and you will found out that mostly the income bracket of people close to you is on average net worth as same as you. Associate with positive, rich and successful people as many as you can get and therefore it will create a new pathway for a new and exciting life.

In no time at all, you will have an investment plan prepared and will be on the road to controlling your own finances.

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