Wednesday, March 31, 2010

Financial Peace

Financial peace is an appealing idea. Basically it goes like this, having a financial situation is where you can do what you want. I am not talking wealthy or do whatever you want tomorrow, crazy rich. I am talking being able to quit your job tomorrow should you decide to. Being able to retire early or move across the country (to a free state;) or what not.

How could you become financially peaceful? Also how could I become financially peaceful?

My first thought is that savings are essential. It would not be very smart to quit your job (no matter how bad things got) if next weeks paycheck is needed to pay bills and buy groceries. No matter your income savings are essential. Savings let you have a buffer to ride out a sudden job change or move or whatnot.

The second is living below your means. It doesn't matter if you are a surgeon making 200k a year or a laborer making 20k. You need a buffer between what you make and what your normal expenses are. It is hard to pull your kids out of public school and put them in a private one if you can't pay for it. It is hard to scale back a bit at work in order to spend more time with the family if you can't afford the pay cut.

The third is avoiding debt. Lets say you find out about work's new Friday furlough program that starts next week. This means 3 day weekends which are nice and a 20% pay cut which isn't so nice. You go home and tell the spouse about this. First a 3 day camping trip is planned and then you look at the finances. Eating out a bit less and going from the super every channel even in languages you don't speak plan to basic cable or just an antennae are obvious choices. Maybe watching the cost of food a bit more and putting off some plans for new furniture will help also.

People with minimal debt can do a lot to cut their overall expenses. If need be these folks can live absolutely dirt cheap to get by through a rough patch that is longer than their savings will just absorb. However folks who have a car payment and a credit card payment and a store card and a HELIC to pay off find they can not cut these expenses without serious back blast. These folks would have the same problem our federal government is having now. They have so many expenses they can not readily do anything to cut or eliminate.

The great part of these three is that they are pretty realistic for most people. Maybe not easy or fun but doable. Everybody can make choices that help in these and avoid those that detract from them.

Of course having no debt and a paid off residence would help a lot. These are not so easy to attain. The vast majority of the benefits of this idea come from the first three. Also living and practicing them makes it a lot more realistic to pay off your residence and have absolutely no debt. Paying off the mortgage faster or buy a couple acres with a travel trailer or whatnot is not unthinkable given the significant amount of income that has now been freed up.


Chris said...

When your passive income > expenses then you are "wealthy." I think of this as "Personal Finance 201." You can't think about doing this until you've passes Finance 101, which means getting your monthly cashflow under control, establishing an emergency fund, and paying off consumer debt.

You can either reduce expenses or increase passive income to achieve this goal. Generally -- but not always -- passive income is easier to generate if you have savings.

Debt is not necessarily always bad. If its productive debt that puts money in your pocket its ok. For example, say you have a mortgage on a rental property that nets you $150/month after all expenses, or a loan for 2% that's invested for a 3% return. That's good debt.

Chris from AK

theotherryan said...

Chris, I dunno. To me "wealth" is something more of a quantifiable amount. Reducing expenses and increasing income are both good things to do. It takes money to make money, particularly when it comes to safer stuff where you earn a few points. 2-5% of a hundred bucks isn't much but 5% of 50k is something.

I would say some debt is better than other. Obviously high interest adjustable rate consumer debt is bad. Debt with a purpose like buying a home or starting a business or a real solid investment is better. Borrowing to invest has risk because you've got to pay it back regardless. In particular the rental thing gets risky because you have got to pay the bank every month for a long time even when nobody is in it or they don't pay. Figure a normal guy with a decent income and some savings who has a modest rental house can afford to make that payment now and then and it is worth it. However when that guy tries to have 10 houses it can and regularly does get ugly.

Chris said...

Stockpiling gold/guns/food/etc is better than stuffing federal reserve notes under a mattress but its still not an investment. Its better thought of as insurance against disaster, calamity, or hyperinflation.

In fact, a huge stockpile of stuff takes money out of your pocket every month. I don't know about you, but I find that I pay about 1.5% of the value of my firearms for insurance every year, plus the prorated cost of a safe, sq footage in my home, etc. If you go without insurance then you accept the risk of total loss in the event of the disaster most likely to occur to you (a home fire). Looked at from this perspective, under normal conditions, a stockpile of stuff incurs storage costs of about 2%/year; about the same as historical inflation rates.

I'm not a huge fan of "Rich Dad/Poor Dad" but one line that I did like was something like this:
Wealth is best measured by determining how long you can get by at a given standard of living without working.

Generate enough investment income and you can live indefinitely without working. Stockpile stuff and you'll always eventually run out.

I'm not saying not to stockpile stuff; I'm just suggesting that its better looked at as insurance than an investment.

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