Debt Free Is Only the Beginning
A reader of our blog emailed us for advice about her debt free life. Here’s the situation:
“My spouse and I sold our house. Once we close, we’ll use the profit to pay off all our debt. That will leave us with leftover money and extra money each month. My question is how do we proceed from here to prepare for retirement?”
For starters, congratulations! It’s a huge decision to take such drastic measures to improve your personal financial situation. To sell a home to pay off debt is something many people would not do, but sometimes it is necessary.
Very often when people make a plan to pay off debt, they only think of their goal. They often don’t think about what to do after their debt is paid off. Since we’ve paid off our $51,000 of credit card debt, we’ve acquired up to $5,000 in new debt at various times. This is to say that once your debt is paid off, you must continue to be money conscious.
Below are our seven pieces of advice for you.
1. Learn why you got into debt.
Start this step now, not necessarily once you become debt free. Consider it your debt free pre-work. Don’t overlook it like your college course pre-work because to do so will cost more than your GPA.
How people get into debt is pretty standard. This usually happens because people spend more than they have or make, either at one time or over a period of time. The reasons why people get into debt, however, are as unique as each individual who finds themselves in debt.
Your reasons could be practical, emotional or both. You may feel indignant or embarrassed about your financial situation. You may feel alone or in good company.
The truth is that you must figure out why you got into debt. If you don’t, you will only address the symptom when you sell your house and not the disease. This step to become debt free is often overlooked. It feels hokey. If you don’t learn the reason(s), though, you’re susceptible to acquire debt again. It would be a shame to take such drastic measures to get out of debt only to repeat the cycle.
2. Reward yourself.
This may seem counter intuitive, but you just ended a tough journey and are about to start a new one. In our minds, these two milestones justify a celebration. Celebrate with something modest.
A massage may be in order, or a new article of clothing. Some people may want to buy a car accessory or a new video game. A celebratory dinner out is pretty common. You may want to throw yourself a small party or BBQ. Do something that you will enjoy and reasonably marks the moment.
Regardless of what you do, we think it is important to also tell others about your success. Not only is this a free way to celebrate, but may inspire others to take the necessary steps for them to achieve their financial goals. When you visualize and socialize your goals, as we say here, you disperse positive vibrations that reverberates back to you.
3. Put your extra money into a hard to reach account.
Put the extra money you will have after you close on your house and each month thereafter into an account that requires you to actually go to the bank in person to withdraw it. This should be an account without a debit card or bill pay. It should not be tied to another account that allows for easy transfers. It should be an old-school account and when you need the money you should have to ask a teller in person to give it to you.
For some or all of your extra money, this may be a temporary step. Extra money often burns a hole in our wallet. If you put this money somewhat out of reach you are less likely to regrettably spend it. In a few steps, we will tell you what to do with this money.
4. Decide what you want.
Dr. Stephen Covey advised in his book The 7 Habits of Highly Effective People to think with the end in mind. You didn’t become debt free to just stay there did you? So, determine what your goals and objectives are and make all your decisions based around them.
For example, after much thought and discussion, the two of us decided what we most want is to travel and save for retirement. Every other financial decision we make is based on those two goals. This is why our home is 1,000 square feet. This is why our cars are eight and twelve years old. We’re fine with this because we’ve traveled a lot, will travel more and our investment accounts are healthy.
Figure out what you truly want and focus with that end in mind.
5. Spend consciously.
In line with our previous suggestion, avoid unconscious spending. For many people, regardless of the reason they got into debt, unconscious spending is a bad habit. This is why a family of four has six cars and why people spend $100 at week at the grocery store in small increments.
When you are conscious or conscientious about your spending, you will make better financial decisions that will have positive, long-term results. You will improve your cash flow and feel as if you make more money now than in the past.
6. Save and invest.
You have expended a lot of energy focused on negative equity. Now focus on positive equity. Save and invest your money for short and long-term goals and the unexpected. The sooner you start this the better because of the three money magic tricks, time value, compounding interest and dollar cost averaging.
Below are ways to save and invest. They can be done in tandem, as financial independence is never a linear goal. If that’s not possible, do what you can.
a. Company Sponsored Retirement Accounts
If your employer offers a retirement plan, open an account if you don’t already have one. Contribute as much as possible that also allows you to stretch your money from paycheck to paycheck and invest for other financial goals. This will lower your taxable income (contributions are made with pre-tax dollars) and prepare you for retirement.
b. Individual Retirement Account
Invest some of the profit from the sale of your house in a Roth IRA. The maximum annual contribution amount for an IRA is $5,500 ($6,500 if you are over 50). Contribute and invest in this account yearly to take advantage of tax-deferred investment growth.
c. Personal Insurance Account
We assume that because you sold your house to pay off debt, you likely didn’t have extra money in an account elsewhere. With the “hard-to-reach” account you opened in step two, create a personal insurance account, more commonly called an emergency savings account. We strive for positivity. Save three to six month’s worth of living expenses in this account. Invest this money in a money market fund to get some return. This investment won’t beat inflation, but if you contribute to a retirement account your overall portfolio will beat inflation. Even $1,000 will give you peace of mind should anything untoward happen. Once you put money in this account forget it exists.
d. Savings Account
Once you have the above accounts, address other goals such as a newer-to-you car, a home purchase or other expenses. Often when people pay off debt, they neglect other necessities.
Address deferred expenses. For example, we held off on less-urgent car maintenance until we paid off our debt. We did our oil changes and tune ups, but didn’t replace our catalytic converter until our debt was paid off. We held off and that worked for us. When your debt is paid off and you have the cash address any deferred expenses.
Now may be a better time to rent than to own a home in your area. Do your research and don’t feel compelled to prematurely jump back into the real estate market. When you consider closing costs, maintenance, insurance, etc. in addition to purchase price, it may be wiser to direct your money towards retirement and other investments than real estate. If you decide to buy a house, save for the 20 percent down payment and buy one below your means. You will be much happier if you do.
e. Education Savings Accounts
Parents often feel compelled to help their children pay for college. This is a lofty goal, but don’t do so at the expense of your financial security. In today’s economy, it won’t do your family any good for you to have no money in retirement while your kids don’t earn enough money to pay off their residual student loans.
If your kids have a while until college starts, read this post about 529 Plans. In our opinion, this is the best way to financially prepare your kids for college. Whether your kids have a while until college starts or are already in college, buy them the #MoneyConscious Student. It is a worthwhile $3 investment.
To maximize saving and investing, read 10 Steps to Simple Investing.
7. Be money conscious.
In addition to our advice to spend consciously, be money conscious. As we said earlier, now may or may not be the best time to buy a home in your area. That is up to you to research and act accordingly.
You don’t have to buy a subscription to The Wall Street Journal, but know when and why food prices are up and adjust your grocery spending. Know when and why gas prices are up and adjust your driving. Know that a negative gross domestic product report may be a sign that the economy may get worse and prepare for that possibility. If economics bores you, read our #MoneyConscious Mash Up that is posted each Saturday.
This is our advice for you. We have tried to provide specific, actionable recommendations. Understand that you have overcome the hardest part by becoming debt free. These recommendations, as difficult as they may seem, will help you build a secure financial future. We have no doubt that you will see improvements in no time.
Let us know how it goes. Good luck!