If you haven’t already, subscribe to our newsletter here to get our articles directly to your inbox and follow us on Twitter, Instagram, and YouTube! In our Educational Series we will be taking a deep dive into different ways to invest your money in hopes that one or multiple of these methods strikes you as interesting and encourages you to invest your money to grow your wealth.
What do you mean by Financial House?
Your financial house is your overall financial well-being, which includes things like your debt to income ratio, average spending, credit score, saving, and investing. One of the first steps in getting your financial house in order is ensuring that you have a plan for potential emergency (i.e., unexpected) expenses. According to CNBC, only 39% of Americans can handle a $1,000 unexpected expense - imagine your car breaks down and the repairs cost $1,500..would you be able to cover this cost?
This week we will cover the difference between good and bad debt and how to evaluate your spending. Next week we will cover how to positively change your credit score, begin saving, and creating an emergency fund.
Evaluating your Debt
There’s a difference between good and bad debt. Debt is often associated with a negative connotation, but not all debt is bad. For example, a mortgage on a rental property could very well be considered a “good” debt if your home appreciates in value over time and you’re earning money through rental payments.
Bad debt, on the other hand, typically involves high interest loans such as credit card debt or student loans. Robert Kiyosaki defines bad debt as any debt used to purchase liabilities. A liability is something that takes money out of your pocket, such as cars, vacations, clothes, eating out, and unused subscriptions, among many other things. Kiyosaki also defines your personal home mortgage as a potential liability because the amount you pay in interest and other expenses may exceed the appreciation rate of your property. Additionally, when you sell your home the value of that dollar may be less than it was worth at the time of purchase.
Good debt can be defined as anything used to purchase assets. An asset is anything that puts money into your pocket, like stocks, crypto, rental properties, and much more. I personally do not recommend taking out debt for assets that do not actively pay you, therefore it isn’t a great idea to use debt to invest in stocks or crypto as that can be risky and you can owe money on that debt that could be more than the assets you purchased for them.
One of the first steps in evaluating your debt is separating it into “good” and “bad” debts. After you’ve identified your “bad” debts, come up with a plan to pay down these debts first. The math and analytical side of me believes you should always pay down the debt with the highest interest rate. This is called the debt avalanche method - pay down the highest interest loan first and then move down the line until all of your debt is paid off. Dave Ramsey has famously promoted the debt snowball method, which includes paying off the smallest debt amount first then paying off each of the next smallest debts afterwards. This is more of a play towards the psychology of debt. Essentially, paying off one debt at a time provides a psychological boost, so starting with smaller debts and progressively moving up provides more psychological boosts along the way. We won’t promote one method over the other, but we will ask our readers to take a moment of self reflection - if you respond well to periodic morale boosts, the snowball method may be best for you. If, however, you’re more analytically minded, the avalanche method may be best for you.
Evaluating your spending
Everyone hates budgeting, and I am no different. However, if you find yourself living paycheck to paycheck and consistently spending more than you make, it may be a good exercise to create and follow a strict budget. The first step in budgeting is listing out your known expenses and incomes. You’ll need to determine all fixed costs, including your rent/mortgage, approximate utilities, internet, groceries, gas, car, and potentially some others. There are ways to reduce these fixed costs by being conscious at the grocery store and not over buying food (sometimes it helps me to make a list prior to going), maybe trade in your new car with a high car payment for a used car, or even house hacking (which we wrote about previously). These are some ways to reduce fixed costs, but at the end of the day, when it comes to budgeting, your fixed costs should be relatively stable month to month.
There are some sunk costs which some financial gurus will tell you are all bad, but some of these bring you joy so I feel they should not necessarily be completely eliminated, just managed. Sunk costs include unnecessary eating at restaurants, excessive shopping, excessive drinks at a bar, and many more. I enjoy eating at restaurants and going out for drinks with my friends, but I try to limit the spending while I’m out. I try to limit going out to eat to once or twice per week and limit going out for drinks the same amount. Instead of going out to eat everyday, shopping at a grocery store and meal prepping can be a lot cheaper (and often healthier) than eating at most restaurants. Going out to a bar can be expensive, but bottle service is never a must and you can always just buy drinks for yourself or switch buying rounds for friends as long as those friends are kind enough to return the favor.
To evaluate where you’re excessively spending, you’ll need to look at your income, fixed costs, and sunk costs. Once you have these numbers, you’ll need to evaluate where you can minimize spending. Granted, it is always easier to justify eliminating the sunk costs, but it is more advantageous to try to reduce the fixed costs because those are monthly and usually do not go away for a period of time. Once you’ve set a budget, I’ve found it helps to have a goal, whether it's to save for something or invest a certain amount each month to reach an investing goal or something else. Goals help keep you on track! Budgets can be tiring and annoying, but at the end of the week or month or year, if you’ve kept on track with your goals, you’ll feel amazing. And along the way, be sure to treat yourself every once in a while! You’ll find that once you start hitting your initial goals, it becomes easier to hit them week after week, month after month, and year after year. This simple step of evaluating your income versus your spending will help you greatly going forward because the wealthy start by spending less than they make and living below their means.
Be sure to subscribe to get the next the final part of how to get your financial house in order!
If you’re new to stock investing, check out our introduction to stock investing series:
If you’re new to real estate investing, check out our real estate investing series:
Have a great rest of your week!
Brandon & Dan
If you liked this article, please subscribe to our newsletter and be sure to follow us on Twitter, Instagram and YouTube!
Disclosure: The article was written by Daniel Kuhman and Brandon Keys, and it expresses the author's own opinions. The information presented in this article is for informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock, asset, or cryptocurrency. Brandon and Daniel are not financial advisors. We encourage all readers to do further research and do your own due diligence before making any investments.