You can’t get rich if you have debt. It’s that simple. If you borrow money for your lifestyle, you’re losing. You’re falling behind, and you won’t be able to catch up. Rich people do not borrow money for their lifestyle needs.
Let me clarify that. Some rich people do borrow money for investments. I personally borrow money to invest in real estate that makes me money. Some rich people do borrow money for things like their house. I have a mortgage on my primary residence. Some rich people even borrow money for things like airplanes and yachts, so they don’t have to liquidate other income producing assets. Let me say before I move on that this last type of debt is a disaster waiting to happen, and no one should borrow money for depreciating assets no matter how rich they are.
But no rich people (at least those who earned it themselves) who are continuing to grow their wealth EVER borrow money for day to day living expenses like food, clothing, cars, etc. Borrowing money to live is a disaster that will leave you poor and falling behind, without exception. I have seen rich people who inherit large sums go on debt binges and lose everything, but I’ve never seen a rich person borrow consumer debt and stay rich. It just doesn’t happen.
Therefore, it’s crucial that you immediately stop borrowing money, and quickly repay any debt you currently have. Let me take that a step further, it’s important that you get out of all debt before even thinking about taking on debt for appreciating assets like a personal residence or investment property. In fact, you shouldn’t even bother investing at all until you’re out of debt, because in the event of a job loss or other emergency, you’ll likely be forced to liquidate your investments, which may be down in value at the time.
Debt is an anchor on your income, and your income is your key to growing wealth. If you have a car payment here, a credit card payment there, a student loan payment over here, suddenly you can find 25% to 50% (or more) of your paycheck eaten up paying for the past. It’s like you’re making 25% to 50% less money at your job or business. You’ll have no future, and you’ll never get rich.
Most people who look rich to you, are in fact not. Most people in your neighborhood who drive fancy cars are poor. Most people who wear fashionable clothes are broke. Many people who have nice houses have less than $1,000 in the bank saved up. It’s crazy, and an important fact to understand and appreciate. There are many people, where you live right now, who are spending an enormous amount of money on things they can’t afford.
Why do people do this? I’m sure many books have been written on the subject by people more qualified than me to cover the topic, but I’m going to take a crack at it anyway. There’s a couple of reasons.
First, I think people get a rush from buying expensive stuff, sort of similar to a high from gambling, drugs, etc. and become addicted to buying more expensive stuff. I have met a lot of people who almost froth at the mouth when they talk about the expensive gadget, piece of clothing, etc. that they just bought.
Second, I think people do it to impress other people. An obvious cliched example is the guy who buys a car just to impress girls, but it goes way beyond that. It’s people making good salaries who buy expensive cars on credit, and give up $1,500 of their income each month to drive a “luxury car” to impress their neighbors. It’s men who buy $10,000 watches on a credit card in an effort to look more sophisticated. It’s ladies who drop $1,000 on a purse or $500 on a pair of jeans in order to look “fashionable”.
Third, I really think people buy stuff they can’t afford because it makes them feel rich. With credit cards, home equity lines of credit, and other means of access to borrowed cash it’s so easy these days, people are tempted to try to feel rich by means of borrowing money, as a shortcut to actually getting rich. As with most shortcuts in life, it doesn’t work, and will leave you worse off if you take it.
Debt always has a reckoning. Credit card bills and car payments take up a higher percentage of a higher percent of your income. Suddenly you’re having to put off paying that medical bill because all of your money is committed to paying creditors. Saving money? Not going to happen.
This cycle plays out over and over during the course of your life. Eventually a shock happens, like an illness or a job loss, and the house of cards falls. Now bill collectors are calling and knocking on your door. Perhaps your car gets repossessed, perhaps your credit cards get cancelled. That’s actually a good thing, because it stops the cycle, albeit painfully, and you might be able to get on the right course.
OK, let’s talk about what YOU can do to change your life and improve your financial security. How do you break the cycle of excessive spending and debt? What’s the secret? How do you shed debt and turn the corner to begin creating wealth?
When you dig yourself into a hole, the first thing to do is stop digging. You need to cut up your credit cards today. You need to stop trading in your car for a new one with a loan. If you’re in school, you should switch to a part-time program that allows you to pay cash over time. The first step to getting out of debt is to stop borrowing.
This is often a hard pill for people to swallow. For some reason the rationale for keeping credit cards always goes to emergencies. What if my car breaks down? What if we have a medical emergency? How can you possibly suggest that I cut up my credit cards and stop all forms of borrowing?
First of all, the vast majority of your credit card debt is due to excessive spending, not emergencies. It’s likely not medical bills and auto repair bills that are driving you under (although that does occasionally happen), it’s TVs, weekend vacations, excessive clothing, etc. You’re growing broke because you spend more than you make, not because of unforeseen circumstances. You don’t have money for emergencies because you don’t have an emergency fund, despite the inevitably unforeseen events that will occur in your life.
Now, candidly, there are a few situations where a medical emergency has caused bills that are insurmountable. In that case, you should reach out to your creditors and work out a long term payment plan. That’s extremely unfortunate, but most medical emergency situations can be worked out over long periods of time.
You cannot use the excuse of emergencies to avoid the need to stop accumulating debt. Cut up your credit cards immediately. In the next chapter, we’ll start talking about your emergency fund, which is cash in a separate checking account needed to cover short term emergencies. For right now, know that you need to save some cash, equivalent to at least 1% of your salary, right now as a first step to getting out of debt.
Wait, I need to save money in order to get out of debt? How does that work? The primary thing that will get you off paying down the debt train is emergencies. Your car goes out, and you pay for the repairs with your emergency fund, not credit cards. It’s a crucial first step to avoid getting thrown off by life emergencies that will definitely happen from time to time.
So, you need to open a separate checking account at a local bank, and you need to allocate as much cash as you possibly can right now to start filling it. The thing is, when you start working to get out of debt, even trying to save 1% of your salary will feel like a stretch. It’s ok to start there and work up over time. Again, open a separate checking account, automatically transfer 1% of your salary there. Do it this week. Then next month, increase that to 2%. Over the course of a year, you’ll be saving 12% of your income. Over 2 years, you could be up to 24%. The fact that you’re increasing your savings a little at a time will make it very easy to digest, but you’ll quickly amass a pool of funds to pay down debt and eventually build wealth. But the first step is to save 1% of your income.
At this point, you may be throwing up your hands by looking at something I wrote in the last paragraph. 24% of my check is going to pay down debt? Are you crazy? That’s too much! I won’t be able to live! Let me provide some perspective. First of all, by working up to that amount, over a 2-year period, you’ll find that it won’t be as much of a struggle as you think. In addition, once you’re out of debt, that 24% is going to be a powerful force that will allow you to grow wealth, and more important security, for you and your family. You’ll be able to use that 24% to save up for a down payment on a house. You’ll be able to use it to invest in your 401K and real estate. You’ll be able to give 10% to church like you should. What you’ll be doing over this 2-year period is changing your way of looking at money little by little. You’ll end up spending your money like a wealthy person, instead of a broke person. What you’ll likely find out is (a) you’ll want to get to that 24% rate in a faster time frame than 2 years and (b) you’ll want to keep going past 24%, especially as you earn a higher income. If you can, try to push your amount to 40% or 50% of your paycheck, and get there as quickly as possible, especially if you’re heavily in debt. The faster you pay off that debt, the faster you can have that money working for you in the form of investments and other items that actually build wealth.
Another question people often ask is why do I recommend a separate checking account?
Why not just send what’s left over at the end of your paycheck to pay down debts from your regular old checking account?
Waiting for funds at the end of your paycheck will never happen if it stays in your regular checking account, you’ll always run out of money because people always find reasons to spend their entire paycheck if it’s there. I’m the same way. But by sending my money allocated to wealth building to a separate account, at the start of the pay cycle, I’m using that account strictly for wealth building. If I’m allocating 24% of my paycheck to wealth building, then when I see that cash in my wealth building account, I know that when I spend it, it needs to be on my future, and not on the present. If you’re in debt, in your case, you’re going to need to spend those funds on fixing the past for a season in your life, and then eventually you’ll transition this account to wealth building, once your debts are paid in full.
I want you to have a separate checking account to instill a system of “paying yourself first”, as Robert Kiyosaki is famous for saying in his “Rich Dad, Poor Dad” book. I believe it also appeared in the famous “Richest Man in Babylon” book as well. The concept is the first thing that needs to happen, whenever you get money, is to pay yourself for your future. I feel the separate checking account concept fits perfectly into this idea, because it happens automatically. You can set it up so at each paycheck, without lifting a finger, money will appear in your wealth building account, ready for you to spend on building your future, and legacy.
In addition to beginning to allocate money from your paycheck, you need to go over every inch of your house and find things to sell in order to get that 1% savings amount. Old clothes, sports equipment, furniture, books, etc. Have a garage sale, get it on craigslist, Facebook, eBay, etc. Just get the stuff sold and get to your 1% savings mark. Most people have enough crap in their house that this figure should be pretty easy to achieve quickly.
Once you get to that 1% savings mark, you need to take a look at all of your debts. Dave Ramsey says to list them out smallest to largest, and start with the smallest and pay it off, while paying minimum payments on all the others. Once that smallest bill is paid off, move on to the next bill, and the next one, and the next one. This creates what he calls a “snowball effect”, which will make you feel like you’re really achieving something as you pay down your debts. I can’t think of a better method, and I’m going to endorse that one whole heartedly.
Now, let me warn you about something that’s going to happen while you’re paying down debt. Emergencies are going to happen that will throw you off course. You’re going to have a car break down. You’re going to have a huge medical bill. Life’s not going to stand still for you just because you want to get out of debt. If anything, the enemy is going to throw curveballs at you in an effort to drive you down to mediocrity like most Americans.
Be aware of this, and don’t let it get you down. When emergencies happen, you need to adjust and adapt. The first thing is to pay them with cash from your 1% emergency fund. You need to limit yourself to this amount. If your car breaks down, and the repairs are more than your emergency fund, you need to tell the mechanic, “I’ve only got $1,000 (or whatever your emergency fund is), can you get me back on the road for that?”. You need to call the hospital and say, “I can pay $1,000 right now, can I put the rest on a payment plan?” What you don’t need when an emergency happens is to grab a credit card. Resist the urge! You’ll be amazed at the ingenuity you’ll find when you limit yourself to your emergency fund, and don’t consider alternatives that involve more debt and interest.
When an emergency happens, the first thing you need to do is replenish your 1% emergency fund. Shut down debt payments (besides your minimum payment) until this is done. Usually, you’ll be able to make another round through the house for things to sell in order to raise the cash. Get back up to that level as soon as possible, and get back to paying off your debts.
Any big chunks of money you get, like bonuses, inheritances, tax returns, etc., should go to paying off debt. Don’t even think about taking a vacation or buying some new toy, just get out of debt. As you increase your percentage of salary towards paying off debt, and as you pay debt down with any windfalls you get, you’ll quickly see the end in sight. You can even calculate the approximate month when you’ll be out of debt. Imagine the feeling when this happens!
There will come a point when you’ll reach the end. All your debts will be paid off and the weight of the world will be off your shoulders. What then? Well, now you have a large amount of your salary that you can transition into wealth building. For those of you who can’t imagine, that you’ll ever be able to afford a house, put your kids through college, save enough for retirement, etc., the secret is positioning your paycheck in a way that helps you get on a path to wealth and legacy building. You’ll still be spending money on food, bills, and stuff, but through the paydown of debt you’ll have trained yourself to allocate a growing portion towards wealth creation. When you reach the point of being out of debt, it’s time to flip that switch and start building wealth for you and your family!