This is the second in a series of six articles detailing information every person who wants to take control of their financial future should know.
We’ve all heard that “people don’t plan to fail, they simply fail to plan.” Up until now, students’ lives have been pretty much laid out—pre-school, elementary school…college, graduation. The first two decades of life have been prescheduled even down to a syllabus for each class.
Big Decisions Are Coming Up
By the time you reach the age of 21-22 a big shift is on the way.
Big decisions come to the front burner; for example, career, location, marriage, children, home buying, and financial planning all begin to transition from concepts to realities.
These all have enormous implications. Actually, many people don’t realize that their choice of a life partner probably determines their financial success more than any other factor. Divorces are financially as well as emotionally devastating. And, as much as a home costs, the person you marry and the number of children you have usually has a greater impact on your financial health than buying a house. The current estimate to raise one child is over $241,000, before college costs are added in (http://blogs.usda.gov/2013/08/14/what-does-it-cost-to-raise-a-child/)
Make a Plan
What is your five-year plan after you get out of college? After being focused on the goal of graduating for so long, many students forget that graduating should be the beginning of the next big phase of their lives.
Graduation has become an end in itself instead of a means to an end. Here are two examples.
Beth graduated from a well-respected liberal arts school with a degree in Comparative Literature. She went from teaching English in a foreign country at minimal pay to being a barmaid in Ireland to working in an after-school program in a large city while her parents paid her rent. Five years after graduating, she finally got serious about her future and started working on a Computer Science degree with firm job prospects. She is still living hand-to-mouth until she completes her second degree and starts a career.
Beth’s friend, Mary, graduated from a state school in public health, took on an internship at the local county public health department while completing her Masters in Public Health. Mary relocated to “where the jobs are.” While Beth is still working on a marketable degree, Mary has an advanced degree, over two years of career experience and now makes over $75,000 a year. Mary’s summation of her past years—“Keep your eye on the prize.” She and her husband own their own home and are now contributing over $24,000 a year to their investment, a.k.a. Prosperity Fund. Now that’s a five year plan.
Define Your Goals
What is your prize, and how do you intend to get to it? Have you invested the time to write down your goals? Just sitting aside a little time to write down your goals helps you focus your mind. Also, having your goals in written form serves to make them more tangible and easier to understand, contemplate, change and work towards. Mary’s other common sense advice—“always have a Plan B.” Sadly, most people don’t even have a Plan A.
Budgets and Financial Gravity
In order to contribute $24,000 a year to their own prosperity fund, Mary and her husband quickly adapted the oft-disdained but effective planning tool called the “budget.” Budgets might seem boring, but being able to eventually afford the things you want is never boring. And, no matter how people try to ignore reality, you can never get ahead financially if you keep spending more that you earn.
We all know that credit cards have become the great financial crutch of society. In times of loose credit, people have racked up over $75,000 in credit card debt at very harsh interest rates of 20% or more. While making minimum payments, these people are often still making payments for dinners they enjoyed several years before, clothes they have long since donated, and fleeting experiences that happened far in the past. Obviously this is a brutal way of compounding working against you.
Our Friend, the Budget
Your greatest planning tool, of course, is a budget. Often disdained and ignorantly ridiculed, a budget requires you to sit down and write down your income and subtract your anticipated expenses. For example, if you make $30,000 a year, you must subtract rent, taxes, car insurance, phone, internet, food, clothing, and other expenses. A budget is a proactive tool for conquering your future. You can get a good idea, ahead of time, where you stand. And, if you are anticipating spending more than you will be earning, there are only two possible remedies: earn more or spend less.
A budget also requires constant monitoring. If you end up in the negative, you must either earn more money or spend less money—it is as simple as that. If you budget $500 for food in a month but end up spending $700, you must investigate, and correct, your $200 overage.
Saving $5,500 a year is a necessary component of a budget and a key ingredient for your future. That $5,500 is your gift to yourself and may come from your regular salary or extra jobs such as lawn mowing, babysitting, petsitting, or Christmas store sales help. Or, your savings may come from brown bagging your lunch, skipping expensive drinks, saying goodbye to movies and expensive concessions, living with several roommates, or having a “staycation.” You might even be able to “spend your way” to prosperity by getting a cash-back credit card and stowing those refunds into your own investment account.
People who want to conquer their financial future are aware of the “future value” of each dollar they earn or spend and the effects of compounding. If you spend $200 each month, $2,400 a year, on non-essential clothes or other items, you are effectively depriving yourself of over $300,000 in your future ($2,400 a year at a menial 5% for 40 years).
Gravity Wins Every Time
Many people have tried to beat the system—spending more than they can afford—and lost. And now, they are in their early 60s. They have no assets and a great amount of debt. They are facing diminishing health and job prospects. You simply are not as “marketable” at 60 as you were at 25. For a simple investment of $5,500 a year, and delayed gratification, smart people have ensured their financial future and are planning their next trip to Tahiti. The other group is worried about paying the tab at their next trip to the grocery store or gas station.
(Illustration by David Darchicourt)