The only personal finance chart you need …

When I’m not blogging, you can often find me hanging around on Quora, the brilliant question and answer site …

… and, that’s where I found Chris Han’s personal finance chart (to the left).

Chris says:

  1. Wealth is the shaded area in the diagram.
  2. You can increase the shaded area by increasing the slope of the green line, or by decreasing the slope of the red line.
  3. Decreasing the slope of the red line becomes significantly harder over time as you grow accustomed to your lifestyle.

Chris is right, but he needs to add a 4th bullet-point, and it’s the same observation that I made when I used a similar chart in this post to explain how businesses should manage their finances for growth:

4. Notice that it is easier to grow Wealth dramatically by increasing the slope of the green Income line than it is to decrease the slope of the red Expense line.

So, let’s break this down …

Regular personal finance will tell you to concentrate on the red (expense) line.

These authors will say that frugality, paying yourself first, and debt reduction (thereby, reducing your interest expense) will increase your wealth through the combined effect of:

– Decreasing expenses, and

– Time.

Decreased expenses allow you to save more, and time allows the full effect of compounding.

Voila! 40 years to fortune!

But, I think that you give up too much for too little, if you follow their advice:

First of all, you give up too many of life’s little pleasures now for little-to-no-reward later (if you can’t afford the lattes now, you sure won’t be able to in retirement).

Next, you have to wait – hence work – for far too long.

Instead, you should focus on the line that they are missing: the green (income) line. If you take my advice, you will concentrate on:

– Increasing your income,

– Using that increased income to build up a larger investment pool, quicker,

– And, aim to get better returns (hence, even more income) through better – and, more leveraged (i.e. using even more debt) – investments

Of course, you can’t simply ignore expenses, but they are best kept in control through delayed gratification, which means:

– Waiting to make purchases; the more major, the longer you should wait, and

– Not increasing your lifestyle (hence expenses) as your income increases.

It is this combination – increased/reinvested Income and controlled/slow-growth Expenses – that can quickly create a huge wedge of Wealth.

This is a very useful chart … you will do well to remember it.

Where’s the emergency?

When you get pulled over by the police for speeding, they often ask: “Where’s the fire?”

And, when anyone tells me that they have 3 to 12 months living expenses sitting in a CD, I have to ask: “where’s the emergency?”

The assumption is that you will have unexpected expenses at some time in your financial life, and you will have to come up with a way to fund them without having to sell the kids or the dog … but, definitely not your boat!

So, the questions are: Do you need an emergency fund? If so, how much should it hold?

Today Forward presents an interesting way to look at how much to hold in your Emergency Fund:

According to the author:

If you have a full year’s worth of expenses set aside, only once every 33 years would an emergency come up that would wipe out these reserves.

Basically, you look at the chart to see how often you would tap out the fund according to how large the fund is (i.e. how many months of expenses do you have set aside as an ’emergency fund’?):

  • 0 months = 100%, guaranteed to have problems
  • 1 month = 70% chance (or every 17 months)
  • 2 months = 49% chance (or every 2 years)
  • 3 months = 31% chance (or every 3 years)
  • 6 months = 10% chance (or every 10 years)
  • 1 year = 3% chance (or every 33 years)

But, these are hypothetical numbers; what is the real-world chance of an emergency cropping up?

Well, the Pew Research Center set out to find out the answer to that exact question …

… and, it was 34%

Only one in three of the 2,000 families surveyed had a ‘financial emergency’ in the past year.

Combining that with the graph above, and it would seem that you would need about 3 months living expenses set aside.

However, I think it’s also important to answer one more question: how much will the average ’emergency’ cost?

Well, the Consumer Federation of America found the figure to be surprisingly low:

Households … typically report unexpected expenditures annually of only $2,000.

What are these unexpected (or ’emergency’) expenditures?

The Pew Research study found they typically fell into the following major categories (which add up to more than 34% because many families reported more than one category as having occurred in the same year):

Given that the chance of an ’emergency’ is so low (34% in any one year), and the reality is that most are affordable (~$2,000 in any one year), why carry an emergency fund at all?

Let’s take a closer look …

Let’s say that you earn $50,000 and pay 25% tax. Since you keep an emergency fund, let’s also assume that you save 20% of your take-home. That means that a 3 months living expenses ’emergency fund’ for you is around $7,500.

Since you’re going to need to keep it in a CD (earning just 1%) instead of investing it (8%+), you are giving up at least 7% interest (or, $525 in Year 1) compounded.

On the other hand, you have a 34% chance of having an ’emergency’, which will then cost you $2,000. Where will that money come from? Well your break-even point on that expense, if you had to borrow it, would be 26%.

So, borrow it on your credit card for all I care!

[AJC: Actually, I do care … the key is to have a plan to pay it off within 12 months; if you do, then a 0% card set aside for exactly that purpose would be ideal. Borrowing against your home via a HELOC would be OK, too, as would borrowing against your 401k. Sure you wouldn’t like to do any of these things, but you are dealing with the unexpected so a little short-term discomfort is probably OK]

Now, the reality is that if you were merely going to stick the $7,500 in an index fund, and earn an extra $500 or so, then I would say just go for the emergency fund … for your peace of mind.

But, why have it lying around earning next to nothing, when it could be the seed capital for your new business or the deposit on your first piece of investment real-estate?

Oh, and if you’re worried about the possibility of losing your job, well, don’t (unless you have GOOD reason to) …

… I’m not sure how different these numbers are in the USA, but if you live in the UK (according to MetLife) you have only a 6% chance of losing your job in any one year. And, when you do, you have a 30% chance of getting a job within the next 3 months, or close to 100% chance in the next 9 months.

Rather than putting your retirement at risk by setting aside too much money for an event that has only a small chance of occurring, realize that:

1. Your money is always better off working for you, and

2. While you are able to work, you can always borrow (and pay back) enough to recover from any financial catastrophe that the typical emergency fund is large enough to cover.

That’s why, at least in my mind, the best defense is always a good offense 🙂

How to become financially secure …

When I moved to the USA, I was surprised to see so many old people (old, in the sense that they seemed well over ‘retirement age’) working the checkouts at supermarkets.

I was told that it’s because they need the employer health benefits.

But, soon (if not already) it will simply be because they need the money.

Right now, according to Wells Fargo, 1 in 3 Americans between the ages of 25 and 75 believe that they will be working until they are 80 years old. Not because they want to, but because they believe they will need to.

And, they are correct.

Unless you can live on just 50% of your current paycheck, so that you can save at least 50% of your income for the next 17 years (or, save at least 25% of your income, if you’re happy relying on Social Security for the rest of your life), you will simply not be able to afford to retire.

And, there’s yet another problem with these ‘save your way to wealth’ strategies: they all assume that you’re actually happy living on your current after-savings income. Well, are you?

I didn’t think so 😉

That’s why I decided to fly in the face of commonly-accepted personal finance ‘wisdom’ and start blogging here …

I think that true personal financial planning starts with just two questions that you need to answer very, very honestly and carefully because they will set your whole Financial – indeed Life – Strategy from this point on:

1. How much income do you want when you begin life after work?

2. When do you want to begin life after work?

Together, these two answers will then direct you to everything else that you need to know:

How much do you need before you can retire?

This is called your Number, and is very easy to work out in two simple steps:

STEP 1 – Double your answer to the first question for every 20 years in your answer to the second question.

Let’s say that you decided that you want $25,000 a year income (in today’s dollars) in 30 years time. You would double that to account for the first 20 years ($50,000), and add another 50% for the next 10 years ($75,000).

This is simply to help you account for inflation …

If inflation averages just 4% for the next 30 years, you will need to earn $75,000 a year in retirement just to maintain the same spending power as $25,000 today!

[AJC: because everything will cost 3 times as much by 2032. Imagine: gas at $10.50 a gallon; $7.50 for a loaf of bread; etc.].

STEP 2 – Multiply by 20. Multiply your Step 1 answer by 20.

For example, if your inflated income goal was $75,000 p.a. in 30 years time, then your Number would be $1,500,000.

This is how much you would need to have saved up over 30 years, so that – in theory – you can retire on your own resources (for example, you would not need to rely on Social Security).

But, I’m guessing that even if you are earning $25,000 p.a. today, that this is not the amount you chose for Question 1.

I’m guessing that how much you really want to earn (i.e. the minimum amount that you feel would make you happy, healthy, and financially secure) is more … probably a lot more … than you are earning today.

Worse, you probably won’t want to wait 30 years to get there. I’m guessing that you want to stop needing to work (as opposed to having the financial flexibility to choose if/when you decide to work) sooner … probably a lot sooner.

[AJC: this is not true for everybody; there are plenty of people who enjoy what they’re doing so much that they cannot imagine doing anything else. This was me … until I did reach my Number and found out how much happier I could be choosing what I do – and don’t – want to work on each day.]

Plug your numbers into the above two steps and let me know (via the comments) what you come up with?

How will you get your Number?

To give you an example, I decided that my Number was $5 million and my Date (i.e. when I wanted to get there) was 5 years.

This was fairly simple to calculate: I decided that I needed $250,000 p.a. passive income (i.e. without needing to work). Since it was in just 5 years time, I didn’t bother adjusting for inflation (I could have added ~25%). Instead, I just multiplied by 20 … $5 million.

It’s pretty clear that I couldn’t save $5 million in just 5 years (after all, at that time I was still $30,000 in debt). And, it’s likely that you won’t be able to either.

[Hint: You would need to be able to save the entire amount of your desired income (Question 1.) each year for 17 years, earning at least 8% (after tax), in order to replace it in retirement.]

So, if you can’t save your way to wealth, what can you do?

It’s simple: you do two things:

1. Increase your income

There are lots of ways to do this: get a promotion; send your spouse back to work; get a second job; and so on. Necessity is the mother of invention … if you are really motivated, you will find a way.

However, my current favorite method is to start a part-time business. Why?

Well, it can grow in an unlimited fashion; it could even replace your primary income; it can create strong cashflow; if you pick the right kind of business, it can be started on your kitchen table.

My current favorite kind of part-time business is one that you can start online. Why?

Well, you don’t need much money and you probably don’t need any staff (at least, to begin). And, an online business can be so cheap to start that if you fail (and, let’s face it, you probably will) you can quickly and easily start another, and another, and …

2. Invest it all

It’s all well and good to increase your income and save as much of it (and, your current income) as possible. But, if inflation is running at just 2% (the last time I checked, it was 1.99%), and all you can get on your CD’s is 1% (Bankrate points to rates around 1.05%), then you’ve lost the ‘inflation race’ even before you’ve started.

It should be clear that it’s not enough to earn more, and save more …

… you also need to earn more on the money you save.

How much more?

Well, that’s when you need to plug some numbers into an online ‘savings goal’ calculator:

Here’s how to make it work; plug in:

(i) How much money are you starting with?

Do you have any money in your current savings that you can tap into: CD’s; index funds; 401k; emergency fund; etc.)? In my example, even though I started $30,000 in debt, I plugged in $1,000 as the calculator doesn’t work very well with negative numbers. I could just as easily have plugged in $0, but I chose $1,000.

(ii) How much can you put aside to invest each month?

This is your current rate of savings outside of your 401k + the entire income from your side business.

This is difficult, because the amount that you might generate in monthly income will probably change over time. There’s not much you can do about this (without finding a much more sophisticated calculator or spreadsheet), so I just chose an average of $10,000 a month (or $120,000 a year) as a nice, round-figure estimate of my expected savings (driven largely by the expected profits of my part-time business).

(iii) What is your Date?

This is how long you have until you need to begin tapping into your money. I chose 5 years.

(iv) What is your Number?

This is how large your investment account needs to grow. So, I plugged in my Number of  $5,000,000 and my Date of 5 years (as my end date).

Then, here’s where it gets fun: I started playing with Interest Rates to find the rough point where the calculator said that I could reach my goal (i.e. 70%). If I plugged in any figure less than 70% the calculator showed a message that said: “Oops. Your savings plan goes into the red.” … so, this was just trial and error to find the lowest number that didn’t produce this message. For me (in 5% increments) the answer came to an annual ‘interest rate’ of 70% .

That’s it!

How do I know that this works? Well, I have the benefit of hindsight 😉

But, that’s not the point: the point is to show you:

a) Not only do you need to save (a lot) more than you ever thought reasonable, but

b) You also may need to earn (a lot) more on your investments than is possible with CD’s (<1% annual return, after tax) or index funds (<8% annual return, after tax).

So, this leads us to the last piece of the puzzle:

What should you invest in?

Most people invest in whatever gives them the greatest possible return (they are the risk-takers), whatever their family/friends/advisers recommend (they are the followers), or whatever they understand (they are people of habit).

Instead, I want you to consider a totally new way to choose your investments: invest in whatever investment produces the lowest rate of return that you require with the minimum risk.

This usually means comparing the ‘interest rate’ that you came up with when using the online calculator against this table:

[Source: 7 Years To 7 Figures by Michael Masterson]

So, at a 70% required interest rate, I had no choice but to start my own business (just as well, because I was already in one); but, I supplemented by heavily investing in real-estate and some stocks.

On the other hand, you may be lucky enough (because your Number is small enough; your date long enough; and/or the amount you can save monthly is large enough) to require a much lower interest rate …

… if that’s the case, you may be able to stick with your CD or Index Fund investing strategy. But, the chances are that you will need to push the envelope … a lot.

I promised in my last post that I would close this three-part series with my “strategies for real financial security”.

In this post, I showed you that the Number that means financial security is different for everybody, but I also showed you a very quick way to find yours.

That’s the starting point.

Then I showed you what kind of investment strategies you would need to follow, if you want to have any real chance of reaching your Number.

Now, it’s up to you to begin putting in place your plans to get there, starting with learning how to invest in stocks, real-estate, and/or small business.

For my part, I decided to start writing this blog (and, now my book) to help those whose required growth rate / interest rate is at the higher end of the spectrum, simply because most other blogs focus on those at the lower end.

If your required growth rate is high, as I suspect it may be, you have a huge job ahead of you

… but, if you don’t make the effort now, go back and read these three posts and you’ll quickly realize that you’ll have an even bigger problem later.

So, keep reading, keep commenting, and keep e-mailing me with questions [ajc AT 7million7years DOT com],  and I’ll do my very best to help!


There is no middle ground …

To me, making $7 million in 7 years (or some other Large Number / Soon Date) is not the goal … at least, it was never the goal for me.

My goal was always to become financially free and have the ability to live my Life’s Purpose.

It just so happened that, when I crunched the numbers, I found out that I needed to make $5 million in 5 years.

[AJC: now, thanks to my book, this process has been highly simplified, if you want to do the same]

I failed on the time frame, but ended up with $7 million in 7 years and promptly retired, at the ripe old age of 49. Now, I blog here (amongst other enjoyable ‘give back’ things that I do).

Fortunately, the goal for some is a lot lower.

For example, in my last post I showed that – if you are happy living on just 50% of your current income for the rest of your life (after adjusting for inflation) – you just need to save 50% of your paycheck every week for the next 17 years.

If this is you, then you need to be reading blogs other than this; you need to save/save/save, max your 401k, pay off all of your debt, and stay very frugal. After all, living on half a paycheck is not easy 🙁

But, what about the rest of us?

Well, I asked you to spend some time with an online retirement calculator; if you took my advice, you probably found something like this:

This means that a couple earning a combined $50k a year today (with 20 years left until retirement), saving a full 10% of their income, has only a 50% chance of their money lasting as long as they do … even if they receive full Social Security benefits for the next 40+ years!

Without Social Security, this couple has virtually no chance at all (1%) of their money lasting as long as they do even if they save 15% of their paycheck for the next 20 years. If they manage to save 25% of their combined pay for 20 years, their chances of financial survival are still less than 25%.

How does creating an emergency fund, paying off all debt, and paying yourself first actually help these people financially survive after half a lifetime of work?

In the above context, I don’t think it helps much, at all.

Really, most traditional personal finance boils down to: saving 50% of your pay packet for the next 17 years, or taking your chances on Uncle Sam looking after you for the rest of your non-working life. The rest is fluff.

If that doesn’t appeal, stick around for the final part of this three part series, where I’ll share my strategies for real financial security.


Why cookie-cutter personal finance does not work

Marie (speaker, blogger, investor) agrees with my simple plan for wealth creation:

I have to go with your 2 step plan. All my years in PF it seem to work best than the cookie cutter approach.

The ‘cookie cutter’ approach that Marie refers to are the approaches that I was talking about in my provocatively titled guest post at Budgets Are $exy: “Why Most Personal Finance Blogs Are B.S.“, and includes: paying off all debt; maintaining an emergency fund; frugality and expense-cutting; paying yourself first via max’ing out your 401k; and, so on.

[AJC: To be fair, I was asked to write something ‘feisty’ so you should head on over and read the article (and the comments) now …]

To prove any personal finance strategy you need to have an objective against which you must measure the outcome.

To me, that goal must be: financial freedom.

But, what does ‘financial freedom’ mean?

That depends entirely on you …

If your goal is to simply replace your income, say, within 20 years, and you can train yourself – through frugality – to live on a lower income than your peers then it is possible to save your way to wealth (simply defined as financial freedom, or having enough passive income to replace your then-current income from employment).

For example, MB writes about her 12 year plan to replacing her and her husband’s dual working income:

After a couple years of full-time work I started to wonder, how can anyone possibly tolerate doing this for 40 whole years?!

[Now] our number is somewhere in the $1-2M range depending on how many kids we end up having (if any). But, then again, we are saving >50% of our salaries.

By ‘training’ themselves to live on only 50% of their salaries – or 1/4 to a 1/2 less than their peers – MB and her husband accomplish two purposes:

1. They save a lot more than most people,

2. They live on a lot less than most people

So … they need a much smaller Number than most people and they’ll be able to reach that number much, much sooner than most people.

According to my calculations, if you start off earning, say, a combined $50k p.a. and are prepared to live off just $25k of that (assuming your combined salaries increase by 3% per year, and you get a very hefty 8% after-tax return on your savings) you will be able to retire on a combined $40k passive income in not the 12 years that MB is hoping for, but a still-healthy 17 years time.

The catch is that just 4% inflation would mean that you really have the earning power of a little less than $25k p.a. today.

In other words, to actually make this cookie cutter personal finance plan work, you need to be debt-free and be able to live on just half your current annual income for your whole life.

Is this you?

If not, I recommend that you spend a little time with an online retirement savings calculator and work out what income you would need in today’s dollars (i.e. assume you retire today) …

… then, leave a comment and – in my next post – I’ll explain what that means and what you need to do to get there.



The 2-Step Wealth Generation System

This is one of my favorite posts; a great place to start for new readers, especially if you follow the links …


The traditional approach to paying off debt and personal finance (interchangeable terms, it seems, according to the popular media) is simple:

1. Tear up your credit cards : pay off debt : get new credit cards : goto 1.

2. Pay off all of your bad debt : all debt is bad : goto 2.

3. Save 10% : use to build an emergency fund : dip into emergency fund : goto 3.

What is the point of all those “goto”s, you may well ask?

Well, ‘goto’ is an inelegant way of writing computer code … it’s something that programming dinosaurs used back in the Dark Ages [AJC: when I used to work in the computer industry; they had ‘mainframes’ in those days].

And ‘goto’ here means that each step in the traditional personal finance investment plan (as in the sample plan, above) is iterative …

… it never ends.

You never really get out of debt, human nature being what it is (self-defeating, or everybody would be debt-free). You never really get rich, making money being what it is (really hard, or everybody would be rich).

Here, instead, is $7 Million 7 Year’s Patented 2-Step Wealth Generation System:

1. Start Investing

2. Deal with emergencies as they arise

Of course, you will immediately see the flaw in the above: I haven’t created a debt reduction strategy, an emergency fund, or a pay yourself first plan.

That’s simply because, if you follow my patented 2-step plan, you won’t need a separate debt reduction strategy, an emergency fund, or a pay yourself first plan!

Here are the principles upon which this strategy is built:

1. Paying off debt is investing

In previous posts, I’ve outlined my cash cascade; it works much better than any debt snowball, debt avalanche, or any other debt reduction strategy you’ve ever read about, because every single one of those ‘other’ plans works on the flawed assumption that debt is bad, therefore should be paid off as quickly as possible.

The reality is that 75% of your net worth should always be working for you … at the best possible after tax interest rate (taking your personal attitude to risk – and, your affinity to / aversion against certain types of investments – into account).

Keeping in mind that a dollar saved is EXACTLY the same as a dollar earned:

– Paying off a 13% (after tax) credit card instead of buying a 1% (after tax) CD certainly makes sense.

– Paying off a 4% APR (before tax benefits) home mortgage instead of investing in an income-producing property that may return 7.5% cash-on-cash (after tax benefits) does not.

2. Creating an emergency fund is your first emergency

Let’s say that you create a $10k emergency fund; let’s also say that this fund is big enough to cover all likely emergencies.

Haven’t you just created your worst case outcome?

That is, haven’t you just depleted your investment fund by $10k?

And, if you didn’t have the ’emergency fund’ in place, isn’t that exactly what you would otherwise only needed to have done, but only in the event of an actual emergency?

Wouldn’t it be better, instead, to invest that $10k so that it is always working for you, emergency (very unlikely) or no emergency (very likely)?

But, how would you deal with emergencies ‘as they arise’?!

Well, you could simply create a source of borrowings that you can tap into only when needed (e.g. a line of credit against your home; a redraw facility against your 401k; a 0% APR credit card, sitting there – unused – just for this purpose).

If you just start investing, you will soon want to become successful by investing more and more.

And, it won’t take you long before you you are cutting costs, paying off your credit cards, putting more and more aside, reading everything that you can about personal finance and investing, and so on …

… simply because you will want to invest more. It’s exciting and addictive.

That’s why these two simple steps will change your life, forever.

Go ahead, try it: my 2-step plan comes with a Lifetime 100% Compounded Money Back Guaranty 😉

Why the poor get poorer …

What’s your favorite excuse for not having $7 million? Let’s make it easier: what’s your excuse for not having $1 million?

It will probably be something to do with lack of luck, opportunity, income, and so on …

And, that may all even be true (but, if you keep reading this blog, you’ll find that all changes pretty quickly).

But, tell me what excuse anybody has for not being able to retire with a paltry $1 million in 20 to 40 years time?

Take a look at the chart above: people on low incomes are spending nearly twice as much on entertainment as they spend on saving for retirement!

Now look at the same comparison for other income groups:

That ‘saving for retirement’ ratio reverses as income increases …

But, take a look at those earning high incomes of $150,000 or more: they spend nearly 3 times as much saving for retirement as they spend on entertainment.

So, let me pose a question:

Was it their high income which allowed them the ‘luxury’ of putting away so much for their retirement?

Or, was it the same mindset that compelled them to begin thinking about their financial future that set them up to:

1. Increase their income so greatly, AND

2. Save so much?

I know what I think. How about you?

Stuffing the income genie back in the bottle …

As I said in my last post, I think it’s ironic that the time that you think about income the most is when you don’t have any.

And, that’s usually because:

– You’ve lost your job, or

– You’ve retired.

And, the second one only becomes an issue if – like most people – you haven’t really thought about how much income you DO need when you are retired. For example, this 2006 AARP survey (rather depressingly) showed:

One-third of workers (31%) have not yet saved any money for their retirement; 26% admit they are not confident they know how to determine how much money they will need to live comfortably in retirement.

… and, this is before the 2008 global meltdown!

Unfortunately, for most people, the retirement income decision is made in two entirely unrelated sets of decisions:

1. How much income will you have pre-retirement?

This one is not really a decision for most of us: most people receive an income that is simply based on opportunity.

For example, you are presented with a new career opportunity; it may come from an employment ad you happened to see in a newspaper, or somebody contacted you (a friend, a headhunter), or it may be forced on you by a down-sizing at one company that leads you to start looking seriously.

In any event, you think you are lucky, because you score a new job with a 20% pay increase over your previous job!

But, you are not really lucky, because of the second – almost totally unrelated – decision that you then need to make:

2. How much money will you have in your nest-egg when you retire?

This one is really a function of:

a) Time: i.e. how long do you have until your retire – or, are forced to retire (through job loss, injury, circumstance)?, and

b) Accumulation Rate: i.e. what % of your income are you willing – and, able – to save?

The two choices are not entirely unrelated, as I previously claimed, because most people save a fixed % of their income (e.g. 2% with an employer match of some sort) into their 401k; presumably, this increases as your income increases.

But, virtually nobody – and, I mean nobody – really works backwards and says: “if this is my income today, and it grows at least with inflation – or more, if I am really clever and opportunistic – what does that mean at retirement?”

You see, post-retirement income is usually a function of pre-retirement income, give or take 20% or 30% according to most experts.

If you want to scare yourself, try this little calculation:

1. Take today’s income and then scale it up to an income that you realistically aspire to; for example, what income would you realistically like to have in 20 years time?

2. Double that number, because in 20 years (due to the effects of inflation), you’ll actually need double that amount.

3. Now, multiply that new number by 20

That, according to the Rule of 20, is how much you will need to have in your nest egg if you want to retire in, say, 20 years time.

I’m guessing that this will be a Big Scary Number.

So, let me give you two choices:

A. Control your income NOW so that you don’t have to worry about it in retirement

This is the frugal [read: boring, yet sensible for most people] way and it has two major benefits:

– By controlling your income now (i.e. not increasing your income dramatically), your frugality allows you to lower your final pre-retirement income expectations as well. When you plug these nice, conservative, frugal numbers into the above calculation you, hopefully, come up with a Slightly Less Scary Number.

– But, this doesn’t mean forgetting about opportunity …. no, absolutely the opposite is true: you still chase all of those increased income opportunities, but instead of spending more when you are lucky (!) enough to land one, you save – a lot – more, which gives you even more chance of reaching that Slightly Less Scary Number.

B. Put your income earning capability into overdrive

But, what if you could reach that Big Scary Number

Why, then you would be able to earn and spend as your income grew, and you would be able to keep spending outrageous sums of money (at least, that’s how it would seem to lesser mortals) even in retirement.

But, how can you do that?

Well, rather than focussing on cutting costs, you focus on controlling costs. But, far more importantly, you focus on ways to increase your income …

… ways to increase it even more than you previously had your sights set on (i.e. in question 1., above).

Of course, you then don’t spend the extra income, instead you save it … saving at least half of all future salary increases.

Not only does this allow you to rapidly accelerate your savings (dramatically bumping up the size of your eventual retirement nest-egg), but it also provides a huge income cushion allowing you to deal with short-term income setbacks by temporarily slowing your rate of savings (say, from 50% of your accumulated salary increases to a more ‘normal’ 10%) rather than compromising your underlying lifestyle.

The real safe wealth building secret is to:

Accelerate your income rapidly, but your lifestyle slowly!

So, what could you do to increase your income, even more than you have previously dared to hope?

Any one of a thousand things!

For example, you could chase even bigger work/business opportunities (that’s why I moved to the USA from Australia), or you could start a business (that’s why I left my high-paying corporate job), or you could do something ‘on the side’, or you could invest actively, or ….

This blog is obviously aimed at those who want to choose Door B.

And, far more importantly than greed, the real reason is that once you let it out (i.e. accept an income increase) it’s almost impossible to stuff the income genie back into that bottle …

… in other words, rather than trying to live frugally by focussing your financial plan on cutting costs and saving the little that’s left, it’s far better to prepare a plan that allows you to rapidly increase income and spending in a controlled manner, so that you can build in the buffers that allow you to preserve your lifestyle should things go wrong.

But, which option would you choose?

And, what would you do do if dramatically increasing your own income actually became a financial imperative?



How to pay off credit card debt?

Last week, I asked our readers what advice they would give to Chris, who asked for help getting out of credit card debt:

Over the past 2 years I have watched as my credit card debt has risen to over 13K. I  have a very well-paying job, making 130K

The vote is in and, as the graph shows, just over one quarter of our readers thought that Chris should just continue paying off his existing cards.

But, why pay at 13% interest, when you can pay the same debt at 0%?

And, if it takes you one year to pay off the 13% debt, say, then you should be able to pay it off in just 10.5 months at 0%, so why pay more/longer than necessary?

Fortunately, just over half of you thought that Chris should transfer his debt to a 0% APR card. I like this strategy … as I said last time, a dollar saved is exactly the same as a dollar earned.

This means that Chris has just earned 13% after tax interest, simply by moving the debt to a 0% card!

Of course, that doesn’t mean that you should now go out and rack up a whole lot of expensive c/card debt just so that you can move it to a low – or zero – interest credit card 😉

Whilst a good first move, another reader (whose name is also Chris) pointed out that just moving credit card debt from one card to another is not really a debt reduction strategy; you also need to figure out how to pay the card off before the 0% interest period expires.

Even more than that, this reader advises:

Not only do you need to pay them off ASAP. You need to cut them up so you don’t rack up debt for a third time…No one should be putting a honeymoon (aka vacation) on a credit card without a clear plan to pay it off.

The other option that Chris offered was to pay off his credit card debt by borrowing against his 401k; Chris says that he can borrow the money effectively at 0% and pay it back at his leisure (the ‘loan’ is at 4% interest, but that is actually credited back to his own 401k).

But, another reader, Steve, pointed out one potential flaw in this strategy:

He needs to weigh against what he could earn (inside his 40k) against what he saves from paying off this debt, and what he puts back in. If he is paying himself 4% interest into this 401k program,but could earn 7% by not taking it out, [it] seems like a bad idea.

I don’t think it matters greatly which option Chris takes as long as he:

a) eliminates the 13% APR debt immediately (either by moving it to a new 0% card, or borrowing other 0% funds to pay it off)

b) has a plan to pay off the outstanding (now 0%) debt off as quickly as possible

c) has a plan to stop the debt from re-accumulating once paid off

The bottom line: if you find yourself in a situation like Chris, follow the 2-Step Wealth Creation Strategy that I outlined in a recent post and you won’t go too far wrong in your own financial life 🙂


Help a reader pay off their credit card debt …

What should this reader do?

View Results

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Help a reader out by reading this, then answering the poll:

When I first spoke to you, I had just paid of my cc debts and was working 2 jobs and saving a little money.  4 years later, and I have since moved from NYC to Miami, got married, just had a baby, and right now I am in the process of buying our first home. (Not an investment, but our primary residence.)

With all of the life changes that have happened, my savings is gone (we had to pay for the move, marriage, and honeymoon ourselves) and over the past 2 years I have watched as my credit card debt has risen to over 13K. I  have a very well-paying job, making 130K in Miami as a computer programmer, but right now I am the only source of income, as my wife is not working.

Anyway that is a quick catch-up with my life to date. And I have question for you.

Once I close on my house, my next move is to get rid of cc debt. Here are the 3 choices I see available to me. (Perhaps there are other ways, I am just not aware)

A. Pay it down heavily and hope to pay it off over 2 years.
B. Move it over to a 0% card for 15/18 months.
C. Take a loan out against my 401K to pay it off credit card immediately

Chris also wanted me to know that the “loan against my 401k is special in that the 4% interest I pay back is added back into my 401K account. So every penny I pay goes back to my pocket. There is no hit to my credit, since I am borrowing against my own funds, and it allows me to pay back less aggressively.”

What would you do? Please help me help Chris by choosing one option from the poll …

Note: if you chose ‘other’ please leave a comment; if you didn’t choose ‘other’, please still leave a comment 😉