You are here for a purpose. I believe that is true of everyone. But every great purpose requires funding. And I have found that most people face the same obstacle when trying to fund their purpose. That obstacle is personal debt. Carrying too much debt can be a heavy, scary beast on your shoulders. Fortunately, that weight begins to change the moment you decide you’ve had enough. You immediately feel better on the day you look that beast in the eyes, and say, “I’m coming for you.”
Of course, debt has its uses. My personal wealth was built primarily on real estate, the greatest leverageable asset on the planet. But, as Robert Kiyosaki says, there is a big difference between good debt and bad debt. Bad debt makes you poorer, costing you money every month. Think car loans, credit cards, and personal loans. Whereas good debt makes you richer, earning money every month. Think mortgages on income-producing rental properties.
And the first step is to start digging yourself out of bad debt.
Step #1: Create an Automated Budget
We all begin with great intentions. But most great intentions fail. This is because people rely on willpower, leaving it up to themselves to “do the right thing” and not overspend.
The key to succeeding with your budget is to remove failure as an option. Eliminate your ability to overspend.
Begin by calculating your monthly debt payments. Then commit to an additional amount that’s a bit of a stretch but not unbearable. Add the two together. This is your first step toward paying off your debts… and investing in your future.
Then have that money go directly from your paycheck to a savings account. If your employer’s payroll can split your direct deposit, great. If not, set up recurring transfers from your checking account to your savings account on the same day you get paid.
Next, take your credit card out of your wallet and leave it in a drawer at home. You may not spend more than what’s in your checking account. Period.
Step #2: Prioritize Higher-Interest Debts
You now have money arriving safely in your savings account every pay period. Awesome! Now what?
List out all your debts, highest to lowest, based on the interest rate they charge. For most people, that will be credit card debt. Take the additional money you’ve set aside in step #1 and apply all of it toward that one debt with the highest interest charge. Don’t worry about your other debts yet. Just make the minimum payment on them. Focus all your energy (and money) on that single debt with the highest interest rate.
These payments should be automatic and scheduled to recur on the same day you get paid. Therefore, in the beginning, no money will accumulate in your savings account. Keep only the bare minimum required to keep the account active. The money should go out the moment it comes in, paying off that high-interest debt. Don’t worry about having no money in the account. That’s okay for now.
The important thing is you’re now putting a serious dent in your debt, every pay period.
Step #3: Snowball Your Payments
Congratulations! You’ve now paid off your credit card! What’s next? Stay the course.
With that card paid off, your monthly debt payments are much lower. Now turn to your next highest-interest debt. You can now pay that one off much faster because with lower debt you have more money to pay towards the second debt every pay period.
Once that second debt is paid off, repeat the same process, funneling even more money toward the next debt.
Remember: You are simply maintaining. Your personal budget (created in Step 1) remains the same. And the portion of your paycheck going toward your debt remains the same. But, as you pay off debts, you are concentrating more and more money toward each remaining debt.
But remember: All debt is not created equal. Some debt may be worth keeping. Where do you stop?
Step #4: Decide When to Stop Paying Off Debts & Start Investing
All credit card debts should be paid off, as well as any other high-interest debt. I recommend eliminating all debt over 8% interest. Then, when you get down to debts below 8%, suddenly it becomes a judgment call: You need to ask yourself, “Can I reliably earn more from an investment than I’m paying for this debt?”
Historically, the stock market yields a 7-10% return on investment. Real estate can earn substantially higher returns. But investment returns are not guaranteed. They are simply projections. Real estate investing, although more stable than many other investments, is not very liquid. Paying off your high-interest debts provides a guaranteed return on investment.
If you doubt your ability to get higher returns than the interest rate on your debt, then pay off that debt. For example, I know I can earn higher returns than the low interest I pay for my home mortgage. Therefore, I only pay the minimum monthly payment on that mortgage and invest my savings elsewhere.
The most important part is to continue redirecting money from your paycheck to areas that are working for you, whether it is paying off debt or investing. Even after you’ve paid off your high-interest debts, don’t cut your savings rate. Simply shift that money to investing rather than paying debts!
Acquisition Versus Defensive Cycles
Even good debt has its downsides. Borrowing money to buy a rental property may help you acquire it in the first place, but from that day forward, it eats into your cash flow.
Always remember that leverage (borrowing money) is a means to acquisition. And paying off that debt multiplies your passive income. When buying appreciating assets, it does make sense to borrow to acquire. But that debt will eventually need to be paid off. Always have that plan in place as well.
Personally, I don’t spend much time trying to time the market. That is speculation, and I’m an investor, not a gambler. The key is to first eliminate your bad debt, and intelligently manage your good debt. Once done, you are now in control. When you are feeling good about the market, keep acquiring (building wealth). If not, pay down the mortgages on your existing properties (building cash flow).
The important point is that you have committed to a savings plan and a disciplined lifestyle of financial independence. And this is the path to finding your life worth living and your purpose worth pursuing.