helplient Case Study:  Savings vs. Debt

When is adding more to savings not the best advice?  When you are earning roughly 1% on savings beyond your emergency fund and paying 20+% on a credit card.  

My client Sam was doing a lot of things right.  He had a good job making good money and was living in an apartment that was well within his means.  He also didn't have a car payment, and he had a huge savings account.  However, he had several credit cards that he was juggling for points or other incentives, and because there were so many of them, he really wasn't able to mentally keep track of what he'd spent from his checking account and across all the cards and so would overspend and roll a balance.

This is the exact scenario banks hope for when they issue credit cards with incentives and other promotions.  Add up everything you pay in interest, and you may be surprised to learn it exceeds the cost of the flight or cash back you received.  While some people do game the system, the credit card company only needs you to get busy and drop the ball once or twice for them to win.  Otherwise they wouldn't offer these types of promotions!  I'm not 100% anti-credit card, but having worked for a credit card processor (and having helped the banks implement programs to make money from their clients), I can tell you they are very savvy at it, so you need to be very careful when playing chess with them.

The client and I worked together to determine what amount of his savings account was his emergency fund, settling on six months worth of his spending since he was single.  He then decided to pay off the credit cards with a portion of the remaining savings.

The remainder of the savings he'd earmarked for the down payment on a house.  He was planning to move to California to be with his girlfriend, work there for 5 years, and then move to a lower cost of living area and buy a house valued at roughly $500,000.  He'd heard that 20% was required as a down payment and so believed he needed $100,000 in the bank to purchase his first home.

While it is correct that buyers usually get the best interest rate when they have 20% to put down, we talked about the fact that there are many first time home buyers programs available that require a much smaller down payment.  While the market and the regulatory environment could change between now and 5 years from now, I explained that we had bought and sold multiple houses, and only now, on our 4th house, had we chosen to put 20% down.  That made him feel more comfortable with paying off his credit cards, since he knew there would likely be options down the road even if he did not have $100,000 in savings.

To make tracking simpler, he decided to carry only his debit card and the one credit card with the best incentives, so he could better mentally track how much he was spending in a month.  We also talked about the importance of tracking expenses with an application and not just in his head, either using Quicken (which he uses now, but only once ever few months) or You Need A Budget, which I use, to give visibility as the month is progressing how your money is flowing.

Are you interested in getting control over your money?  Interested in getting on track to buy your first home?  Contact me to learn more about my coaching programs so you can get support in your financial life. 

*Client name and some details have been changed to protect privacy.

In a world of endless financial information, how do we gain some knowledge that is useful in getting our money on track?  I recommend tracking your spending as a first step.

 It's hard to know where to begin in taking control of your money.  There's a ton of financial information available – the stock ticker crawl along the bottom of the TV screen, endless internet articles, boring books with terms that put you to sleep as soon as you get into them.  Where should you begin?

The first step is to gain some awareness as to where your money is going now.  I like (and currently use) You Need a Budget, and I was a Quicken user for many years prior to switching to YNAB last year.  But there's really no special program required.  You should be able to log in to your bank and download past spending into a spreadsheet.  You'll then want to sort those expenses into categories so you can get an idea of where your money goes today.

If you aren't a computer person, you can buy a notepad and write your spending down as you are out and about running errands or at home paying bills.  The main idea is to get a handle on what you are spending so you can do some analysis as to whether or not that's really how you want to be spending.

Why is tracking where your money goes so important?  If you don't pay attention, it can be easy for all your paycheck to flow through your fingers without doing anything toward building your wealth.  Seeing what you've been spending on will help you understand where you can easily make changes.

You probably know what you spend on the big fixed expenses – your mortgage or rent, your car payment, and other similar items.  But there are always variable bills, like that shocker of an August power bill that covers your air conditioning during the hottest month of the year.  There are also non-monthly bills that can turn into nasty surprises if they sneak up on you.  If you can look back over your past year's spending, you'll have a much better idea of what is coming your way this year.

So if you don't make any other moves this week, at least start out by tracking your spending and gaining an understanding of where your money has been going.  That data will form the basis for your spending plan going forward, and will help you identify areas where you want to make changes.

They say knowledge is power, so get to know where your money has been going to gain more power over how your money is flowing out of your account.  That's how you'll start to keep some of that money for your future self so it can build and grow over time.

We think the way to build wealth is to earn first, spend what we “need” to, and then save what's left.  In a world where wages have been stagnant in real terms since the '70s and conspicuous consumption is the norm, that generally means saving nothing at all.

 In fact, for most of us limiting ourselves to just spending everything we make would be progress.  Many Americans spend what we make plus what we have access to with credit.  There's always more to want, despite the fact that science proves past a certain point increasing spending and stuff doesn't bring lasting happiness.  It just keeps you on the hedonic treadmill and in your cubicle.

I would propose the way a lot of people are attempting to save is exactly backwards.  If you save the “extra” money, only the natural savers will have anything to show for their labor.  I view natural savers as interesting little aliens, and I'd love to find some research as to why they do what they do.  But it's not the way I'm wired.  I like travel and experiences and yes, stuff, to a degree.  I'm not a natural saver.

So what's the best way to save if it doesn't come easily to you?  Take your savings right off the top.

For those of you who have access to a work retirement plan, this is exactly what those plans do.  Remember these plans were designed by wealthy people to help people who think the way they do get wealthy.  This is also why they are so awful for most of us, as we were never taught to think that way.  Much easier to ignore the problems of funds and investing and living within your means and just go to Target.  We need some new throw pillows anyway.

If you can fight your spendy nature, though, take advantage of that work retirement plan.  At bare minimum do what you need to do to get the free match.  It's literally like money laying on the floor of your office that you aren't bothering to bend over and pick up.  PICK UP THE FREE MONEY, SARAH.  IT'S FREE.

 Once you've recovered from that adjustment to your paycheck, the next step is to do the same thing with your take home pay.  You need to skim some off the top and hide it from yourself.  Check with HR while you are setting yourself up for the payroll deductions for your retirement plan and see if they can split your check between a savings account and a checking account.  If not, once the money hits your account do a transfer – preferably automatic.

How to start?  Paula Pant recommends starting with 1%, and I think that's great advice.  Instead of earn – spend = save, for natural spenders the formula needs to be earn – save = spend.  It's the only way you'll have money set aside for emergencies and the only way you'll be able to build wealth. 

By the way, having money set aside for emergencies is the only way you'll get out of credit card debt.  Also keep in mind that the next recession is right around the corner.  So no matter how tight things are now, it's likely to get tighter at some point in the future.  If that happens, you will look back on the spending you are doing now and wonder where it all went and why you didn't set any of it aside.  Future you needs current you more than Target needs you.  So set aside some of your money right off the top.  Future you says thanks!

Melt down those balances….

The Debt Snowball is famous in personal finance circles – probably primarily for being Dave Ramsey's preferred way of getting people out of debt.  For those who like to play games with numbers, the Debt Avalanche is preferred.  But allow me to introduce the newest contender for the way to pay down your debt – the Debt Meltdown.

First a definition of terms for those who are new.  The Debt Snowball means paying off all of your debts, from smallest to largest, and it works because it allows you to get some quick wins and some momentum.  You make minimum payments on everything and throw and extra money at the smallest one.  As soon as that smallest debt is paid off, you take the extra money, the minimum on that smallest debt that is now paid off, plus the minimum payment on the next to the smallest one and roll all of that money into one payment on the second smallest of your original debts. 

The Debt Avalanche is for those who point out that, all things being equal, you should actually pay less in total dollars if you start with the debt that has the highest interest rate and pay that off first.  If you are a spreadsheet/math/super disciplined person, then this may be the approach for you.  It's definitely the correct approach mathematically, but if you are going to get discouraged and quit while paying off the credit card from he!!, then don't bother.  In either scenario you will pay less in interest than if you just give up and ignore the problem.

II'd like to propose a third way – in which you pick either approach outlined above and add a separate step.  If you are anything like me, as you create a list of all your debts, the minimum balances, the interest rate, and the total due, your system is going to go bananas.  For many people, this could cause them to quit or to push the emotions down and keep going.  I'm going to encourage you to view this as an opportunity to do a bit of research.

Most of what messes us up the most about money is all the nasty limiting beliefs and toxic money scripts we have.  In order to address and get rid of those beliefs (important if we want to stop them from getting in our way), we have to find a way to bring them from the subconscious mind where they have been like apps running in the background up to the conscious mind where we can look at them and deal with them.  As you take inventory of all the debts you have and how much you owe, your thoughts and feelings will start to go wild.

You may hear yourself thinking, “ugh, this is a disaster.  I'll never pay off these debts.  I'm just bad with money.”  You may feel anxiety.  This is actually really valuable information, as this mental chatter is harder to get rid of than the debt itself.  Take the opportunity to capture all of that.

For the thoughts, sometimes just bringing awareness to them is enough to dissolve them.  When my husband and I got married, I just completely abdicated the bill paying to him.  The problem was that he had a very different standard of what was ok.  My standard was to get the bills paid before the due date – his was to get the bill paid before they turn off your lights.  Yikes.

I had been paying my own bills for years.  Why, when we got married, did I suddenly decide I was done with money?  I had a subconscious belief that money is the man's department.  As I remember it (which may not be actually how it happened), my dad earned the money, managed the budget, and paid the bills. 

Now consciously I did not believe this.  I was a career woman.  I had no interest in having kids, being a stay at home mom, babysitting, or otherwise being a traditional wife.  But deep in my brain, the belief lurked, completely without me knowing about it.

For other beliefs, you may need to go from negative, “I'm bad at money” to more neutral, “I can learn any skill.  I can learn about handling money,” to positive, “I am great with handling my finances”.  But move the needle over time so you can improve what you tell yourself about yourself.

So why debt meltdown? Well, if being honest about your debt leads to a meltdown, best to take advantage of all the thoughts and feelings that are going to come up during that meltdown.  Plus, I believe if you can combine internal finance with external finance, you'll get better results faster, melting down that mountain of debt and reducing the chances of it coming back.

of Approach finance from both sides for the best results.

Most of us are familiar with the exterior world of finances – tax returns,statements, retirement planning and such.  But there is an interior world of finance as well that is just as important.

The model of exterior finance and interior finance I have pulled from the book Facilitating Financial Health by Klontz, Kahler, and Klontz.  This model has given me a great way to explain what I do. 

Exterior finance is the “real world” of money – the world of tax returns, bank statements, and retirement accounts.  You can split the world of exterior finance into thirds – past, present, and future.

Exterior finance in the past is the domain of the CPA.  An accountant's primary concern is getting everything reconciled and reported to the IRS so that you can pay your taxes and be a good, upstanding citizen.  While your accountant may have some thoughts about how you are handling your money, she will likely keep those to herself and focus on getting your taxes filed.  While accountants may stray into other areas of finance, such as the exterior future if you come back later in the year for a tax planning meeting, primarily the exterior past is the accountant's arena.

The exterior future is the realm of financial advisors and especially financial planners.  A planner's main job is to capture the vision you have for your financial future and to advocate for your future self to your present self when your present self starts to mess things up for your future self.  Long term goals like retirement and paying for kids college often are a risk of being traded for pleasure in the present – vacations and toys and such.  If you have enough money to do it all, fantastic.  If not, it is your planner's job to remind you of what you said you wanted.

That doesn't mean a planner won't venture into the exterior present.  Keeping track of your progress toward your goals helps them update and modify plans as life circumstances change.  And a financial planner may be able to earn her fee back to you by letting you know about a great tax credit or other strategy in the short term.

Financial planners may move into the interior world as well.  The degree to which they do so is often a product of their training, their personality, and their level of comfort with behavioral finance and emotions.  But even the most spreadsheety of planners will often start their engagement in the interior future by asking about your dreams for the future.

The interior world has more to do with what's going on inside your head – stuff that you may not even be consciously aware of.  It's easy to say that what is happening in your head doesn't matter or shouldn't matter,  but I truly believe Brooke Castillo has it exactly right.  Your thoughts create your feelings.  Your feelings drive your actions.  Your actions lead to your results.  If you don't have your thoughts right, you'll get in your own way over and over again.

The interior past is the primary world of the financial therapist.  By exploring what you learned about money as a kid, you'll uncover hidden beliefs and stories you'd forgotten that related to how and what you were taught about money.  While I'm not a therapist and don't feel qualified to spend all my time in the interior past (and definitely refer out if childhood trauma is uncovered), I think exploring the interior past is one of the most important things we can do to improve our relationships to money.  While you can certainly do this work yourself through journaling, it can be helpful to have a facilitator to draw the information out of you and to help you see how those beliefs may have created patterns in your life.  That's exactly what I do in my Money Mindset session. 

 As you begin to uncover and shift the limiting beliefs and negative money scripts from your childhood you'll begin to live life with more clarity and awareness.  You'll start to be able to make choices based on who you are now and what you believe now rather than what you picked up as a kid and lived by subconsciously.  This is the world of the interior present. Both financial coaches and financial therapists spend time in the interior present with clients.

One of the biggest things you can do to be more present in the present (see what I did there?) is to meditate.  Meditation is just the act of being here now.  Not using our minds to relive the past or to imagine the future, but just being still and aware and moving more into observer mode.  I have yet to develop a consistent meditation practice so I am not an expert here, but I can tell you that meditation is nothing to be freaked out by.  It is basically exercise for your brain. The practice of focusing and being present has been shown to have huge benefits for your brain.  I can tell you from personal experience that even though I'm not super consistent, even the little bit of meditation I have done makes a positive difference. 

Some financial coaches start with clients in the interior future.  “Tell me what buying a house would do for you?  What would it do for your family?”  By having a good idea of the clients dreams and desires, they can help use that emotion to energize clients toward their goals.  While you might talk to both a financial planner and a financial coach about your dream of retirement, the planner will more typically respond with what it will take from a numbers side to get you there, and the financial coach is more likely to help you really paint the picture for yourself and feel the emotion of that dream to help you stay motivated.

What I've given you are rough outlines – what is more typical.  Certainly each of these professionals may draw from different techniques and disciplines to work with clients, and each has their own preferred style.  So while there are no hard boundaries, hopefully you now have a better understanding of where to start.  Are you looking for more interior work – help in sticking to your plans?  Or are you needing more the hard numbers side of exterior work?

 Regardless of where you are today, I hope you will talk more about your finances, even if it's just with a friend or a significant other.  If we can normalize the money conversation it will be easier for us to get the information and support we need to demystify this area of life.