Traveling back from North Carolina after dropping my younger son at sleep-away camp, led to some heavy thoughts about debt.
Part of my decision to drive back from Hendersonville, North Carolina (about 30 minutes out of Ashville) back to Palm Beach Gardens, Florida in 1 day, was to make it home in time for a work day.
Another purpose was to save money, something I continuously encourage my clients to do.
On the drive home, I spoke (hands free) to one of my new clients. He is moving to Florida and he is worried about qualifying for a new mortgage. He has roughly $450,000 in his 401(k) plan and not much in personal savings. My firm is currently managing his 401(k) plan and we are doing great. He is all in individual, dividend paying stocks.
He has about $30,000 in credit card debt. After doing the math, he should have 3 to 6 months of after tax dollars saved as an emergency fund. In theory, he needs $60,000 of after-tax dollars to live on for the year, and thus he needs $30,000 in his savings accounts. He currently has about $3,000 and he asked me a question many people often worry about; “How do I save and pay off my debt?”
He attended a Dave Ramsey class and he has seen Suze Orman on television many times. He has tried several binge programs, including cutting up credit cards, consolidating debt, paying off one or the other card, only to suddenly find himself with even more debt in 6 months.
We are encouraged…almost forced by the big banks…to amass debt. How many teaser rates of interest have you had? Start at 0% or 4.9% and the next 6 months it goes up to 17 or 18% interest! If you do the math and only pay the monthly minimum, you are doubling your debt every 2 ½ years!
So how does one get off the nauseating Ferris wheel of debt?
The First Secret to Successfully Paying off Debt.
If your goal is to save 6 months of money in an emergency fund, look to see the amount of credit card debt you have. How close is it to that number? Pretty close, right.
You need to make a chart where you have 2 buckets. The first bucket has the word Savings under it. Write the amount of current savings in that bucket. Then above the bucket right the desired amount of savings. So, if you have $3,000 saved, that number will be in the bucket. If your goal is to have 6 months of living expenses and that is $30,000, write that number above the bucket.
In the second bucket to the right of the first, write the word Debt (or Credit Card Debt) under it. Write the amount of current debt in that bucket. Above the bucket, write the number $0.00, this is your desired amount of debt.
Now figure out how much money (extra) you have this upcoming month to apply to the debt. For example if you have $5,000 of income (after tax) per month, and you have an extra $1,000 of that after your monthly expenses, use that amount to apply to your debt.
Now you might think, great let me use the $1,000 to pay down the debt and then you know in 30 months, I will be debt free? Right? NO…actually wrong! Not all things in the world are logical.
How tired are you? You have driving 7 hours and you have 5 more to go. Are you making the right choices, or are you falling to the same old bad habits?
Yes, the thought of just paying off the debt is very alluring. However, somewhere in the back of your head you must remember that you still need to save money…and only have $3,000 in savings. And trust me, you will feel guilty about paying off debt. There is no natural enjoyment in paying off debt.
Alternatively, you could just start building up your savings account. Unfortunately, in 9 months, you might have been able to save, but you will still have the credit card debt…or even worse, you may even have more debt than you started with.
Okay, here is the secret. Split the baby down the middle. It worked for King Solomon, it will work for you. If you have $1,000 extra to pay down debt this month, take $500 and place it into your savings and pay down the debt with the other $500.
You cannot permanently change a behavior unless you understand the “why”.
The more you save, and once you have all of your ‘emergency fund’ saved, anything extra you should continue to split 50/50. The first 50% should go into to a new investment fund (maybe a Roth IRA) and the other 50% should pay off the rest of the debt.
Try it. Think about it. And change your life. Look out for my next article where I discuss the second secret to successfully paying off debt.
Remember, plan today… protect tomorrow.
Until Next Time,
Peter Blatt is the president at Blatt Financial Group. He has more than 17 years’ experience in the financial industry. He received a bachelor’s degree in accounting from Boston University, a law degree and a post doctorate degree in tax from the University of Miami School of Law. He is an active member of the Florida Bar Association, the Palm Beach County Bar Association and the former secretary of the Tax Section of the Florida Bar. He has been published or quoted in numerous periodicals including The Wall Street Journal, Yahoo Finance, SUCCESS Magazine and on Fox Business News.