Hi everyone. Did you know that the average household income in Canada is about $70,000 per year? If you are reading this right now, chances are your household is above that so why do most people feel broke and live paycheck to paycheck? Not being on the same page with your spouse, trying to impress other broke people you’ll probably never meet and not following a plan are the most common.
Full disclosure: We’ve never had crazy amounts of debt, but we definitely spent everything we made the first few years on our own. Over time, I started to notice the bank account was trending downwards so one night I added up every penny we spent over the past month. For two people (and a dog) we managed to spend over $1500 on food, coffee and restaurants. Not to mention other ‘stuff’ and gadgets. We had some hard discussions and a few ‘debates’ but in the end got on the same page, made a plan and took real ownership of money.
Over the next few segments I’ll go through the steps and lessons I’ve gleaned from various sources, propose an action plan to follow and explain why. Don’t worry, this isn’t a scheme, scam or multilevel marketing.
Here’s what to do in this exact order:
- Change your mindset.
- Get on a written budget.
- Save $1000 in a mini emergency fund.
- Pay off all debt except your house from smallest to largest regardless of interest rate.
- Save 3-6 months of expenses in a real emergency fund.
- Start putting 15% of your gross household income into retirement savings.
- Pay off your house, send the kids to school and live your life on money not credit.
Step 1- Change Your Mindset
Close your eyes and imagine what you could do if you had no debt. No car payments, no credit card payments, lines of credit, HELOCs, short term loans or student loans. What if you had a paid for house! How much could you save and invest? What trip would you take? How could you better help out those in need? The credit card is the most marketed consumer product in history and its working. Debt has been so normalized but at the same time causes extreme amounts of stress for people…maybe it’s not such a great ‘tool’ after all.
There’s a famous study out there about marshmallows. This gist of it is that most kids would rather have one marshmallow now than wait 10 mins in order to get two. Our society revolves around not only getting one now, but taking another one on credit (but I get Aeroplan points!). Personal finance is 80% behaviour and 20% math and you can’t borrow your way out of debt. The upcoming segments go counter to conventional financial advice, the advice most people believe is correct. Most people make good money, spend all of it and are deeply in debt.
Step 2- Get on a Written Budget
When most people do budgets, all they really accomplish is recording everything they just spent. I propose that you do a unique written budget for each month before the month begins. Look through the windshield and not the rear view mirror. If nothing else gets done, at least have the basics covered, so write a budget in this particular order:
Food (groceries not restaurants)
Shelter (mortgage or rent)
Transport/Fuel
Utilities/Insurance
Almost everything else is a want, not a need (you have enough clothes already). By doing this you ensure that at the bare minimum you have eaten, kept the lights on and have a way to get to your job. Think of a budget as permission to spend, not a way to control someone else or deprive yourself of anything. If you don’t tell money what to do, you’ll wonder where it went. By doing a budget before each month begins, it also forces the conversation. Plan budget meetings where you both agree to what you will spend. It will take about three months to get the fights over with!
Step 3- Save $1000 in a Mini Emergency Fund
Ok, you’ve decided enough is enough and want to get out of debt. You’ve got in the habit of doing a unique monthly budget. The next step is to save $1000 to bridge the gap when life happens. This means cash in a regular bank account and not an investment (GIC, TFSA, RRSP etc.). It has to be accessible enough that you don’t reach for the credit card when the car breaks down. Stop all retirement or other savings and throw all the money you have at debt. I know $1000 isn’t very much, but you should be a little nervous and fired up about getting out of debt. Hard decisions will have to be made. For example, if the car breaks down, you might need to go to a smaller mechanic recommended by a friend opposed to the dealership.
Step 4- Pay off Debt Except Your House From Smallest to Largest Regardless of Interest Rate
I’ve lost my mind I know. Most people here will counter with the belief that you should pay off the debt with the largest interest rate first. Mathematically that’s usually true, but if you were doing math in the first place, you wouldn’t have borrowed money at 18% on a credit card to buy alcohol, coffee and stuff. List your debts smallest to largest and pay the minimum on everything but the little one. Throw EVERYTHING you can at the little one until its gone then move on to the next one and repeat. The mental win of seeing debts gone trumps the math (remember 80% behaviour, 20% math). Sell everything you can, have zero life and work as much as possible at this point. Don’t see the inside of a restaurant unless that’s your second job…you can make $2000 delivering pizza at night and weekends.
This is the most difficult step for sure. The more you sacrifice, the quicker it’s all over. Realistically most people could be out of the mess under 18 months. A word on vehicles here. The rule of thumb is that the total of all your vehicles ( cars, trucks, boats, ATVs, dirt bikes, motorcycles or things to pull behind these things) shouldn’t add up to more than half your household annual income even if paid for. That way you ensure you don’t have too much tied up in stuff going down in value. I would also encourage you to make a game out of it, put a thermometer on the fridge and fill it in as you get closer to debt free. Tell friends and family why you can’t go to Mexico or out for dinner. If the broke people in your life think you’re crazy, it’s a good indicator you are on the right track.
Step 4- Save 3-6 Months of Expenses in a Real Emergency Fund
Ok, almost done. You’re out of consumer debt and not looking back. Time to bump up the $1000 starter emergency fund. I recommend 3-6 months of expenses because that ensures you have a large enough cushion to cover any emergency your family could realistically be expected to incur. Not more than that however, you don’t want too much tied up in an account not making interest. This money is insurance not an investment so don’t put it at risk. Keep it in a separate savings account getting 0.1% interest and not an investment vehicle (GIC, TFSA, RRSP etc.). Accountants, tax people and other math nerds will lose their minds! The emergency fund probably looks like $10,000-$30,000 for most families. By having this chunk sitting there, emergencies become inconveniences quickly.
If you don’t have a house already, here is where you would start saving for a down payment. Much smarter to move into a house with no debt and an emergency fund, but more on homes later…
Step 5- Start Putting 15% of your Gross Household Income into Retirement Savings
Remember stopping all retirement savings while getting out of debt and getting your emergency fund in place? You’re going to more than make up for it now. 15% of your gross might seem like a lot, but it’s not how little can you get away with saving, it’s how well off you want to be in the end. I would encourage you to look at pensions and retirements with real number and not percentages. Pensions also can’t be passed on to future generations. For example, once the smoke clears some government pensions are around $30,000 per year. Some make a big deal out of the fact that it’s indexed to inflation. Cool, but what is 1.5% on $30,000? Its $450…minus taxes and divide by 12 months…so yeah…
Every situation is different but just know what you’re talking about with real numbers to make good decisions. I’ll shy away from providing investment advice, but I encourage you to interview financial advisors. They should be teachers and help you make decisions with your money and future (most are salespeople for whole life insurance). If you can’t explain it to a 12 year old it’s too complicated for you. You also need to invest some time in educating yourself. It sounds cool to say that you have a guy, but then the guy gets blamed when the market shifts, when really it was a blip on the radar and you didn’t understand the big picture.
Step 6- Pay off Your House, Send the Kids to School and Live on Money Not Credit
Now you’re out of debt with an emergency fund and have gotten used to putting 15% of your gross income into retirement. Everything left over is going towards paying off the house early, saving or helping with kids education (if applicable) and enjoying life.
A word on houses here. I recommend that your house payment is no more than 25% of your take home income on a 15 year fixed rate mortgage…insane I know. This will mean less house initially but it ensures a pay off after 15 years and that you won’t be housebroke. ‘But have you seen the prices in Barrhaven?’ Yep, maybe you can’t afford to live there right now…
Going forward, I recommend Visa Debit cards. They will do everything a credit card does except get you in debt. It has the same zero liability protection from Visa and is accepted 99% of the places a credit card is. There are a few instances where it won’t work, but credit is what got you into the mess in the first place. Credit card companies aren’t evil but how do they make money? If you were on the board at a credit card and your bonus was tied to the company profits, you would never support a points or loyalty program that dug into your bonus right? No millionaire got there with points and if you can’t afford it don’t buy it. Stay tuned for a few more hot tips and opinions!
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