Personal Finance Archives - The Broke Professional

Pay Off Debt With a Strategy

Debt is a way of life in America.  It’s easy to acquire and everyone has got it.  The vast majority of people buy homes and cars with debt.  It’s almost impossible to go to college with no student loan debt, especially for any type of graduate or professional school.

People are comfortable with debt, even high interest credit card debt.  And that is a problem.  But that’s for another post.

The problem I want to discuss in this post is how people pay off debt.  And the big problem is that many people, even high income professionals, have no debt payoff strategy.  They usually pay the minimum and then maybe (or maybe not) throw some extra money once in a while at the debt.

This is very inefficient since there are certain types of debt that should be paid off first and there are certain debts that are actually okay to have around.  Some debts should take priority in being paid off over others.

Having a clear debt payoff strategy will allow you to get out of debt faster and, most importantly, minimize the stress associated with having debt.  A debt payoff strategy will allow you to know how much you will end up paying in interest payments and how long you will be paying the debt off.

Here are three debt strategies to consider:

Strategy #1:  Pay the minimum and pray

This seems to be the strategy favored by most Americans.  Safe to say I don’t recommend it.

It can be soul crushing to just get by paying the minimum payment while knowing there are decades of debt in your future.  Probably why most people just try to forget their debt even though it’s eroding their wealth.

Let’s just move on to the next method.

Strategy#2:  Snowball method

The snowball method was popularized by Dave Ramsey and is perpetuated by his rabid followers.  I don’t agree with a lot of things Dave says (such as not having credit cards), but the snowball method is one of the good things he’s put forward.

(Quick tangent:  I’m not a big fan of these finance “icons” or “gurus” like Dave Ramsey or Suze Orman.  The reason is that they are not genuine.  They did not get wealthy by doing what they tell their followers.  Things like “save up a $1,000 emergency fund” and “get your 401k match!” is good advice, but it’s not how Dave Ramsey got rich.

He got rich by putting all of his energy into growing his business.  He got rich by selling products and building his empire, not by creating an emergency fund.  And I’m pretty certain he laughs at the idea of an emergency fund.  Same goes for Suze and any other larger than life finance guru.

They’re business people and they got wealthy by focusing on that.  I would respect these guys a lot more if they were sincere in helping people.  But all they do is create books and courses for the “working man” that have the same old advice in a shiny new package.  Rant over.)

I’m on to you Dave…

The snowball method is simply making a list of your debts by balance, and focusing on paying off the one with the lowest balance.  Obviously, you make the minimum payment on the rest of the loans to keep them current and avoid late fees.

But then you throw everything you can at the loan with the lowest balance.  When that is paid off, you roll (like a snowball!) the minimum payment of the paid off loan into the loan with the next lowest balance.  And proceed to obliterate it with all you have.

I used to dismiss the snowball method because technically it’s not the mathematically best way to get out of debt.  But money is so much about psychology that having a system like this that propels you forward is much better than being discouraged by debt and not having a strategy at all.

Seeing those low balance debts disappear does have a positive effect on your psyche and will keep you in the fight.  For debt payoff novices especially, I would recommend the snowball method.  Just put your head down and plug away at the lowest balance debt and move on to the next.

Strategy#3:  Avalanche method

The absolute mathematically quickest way to get out of debt is the Avalanche method.  It’s the method I use and it has saved me tons in interest.  I’m not sure who coined the term, but I like the idea of an avalanche destroying my debt as opposed to a snowball.

With the Avalanche method, you list your debts in order from highest interest rate to lowest.  Every month you would pay the minimum on all your debts, and focus on eliminating the debt with the highest interest rate.  Then you turn that minimum payment around into the debt with the next highest interest rate.

This is the quickest way to get out of debt.  There’s no argument about that.  But it does require some more upfront work with no apparent payoff in the form of more money.  But once you eliminate the first few higher interest debts, the rest will be engulfed in the avalanche in no time.

The best method

Too many people are in denial about their debt.  I see this a lot regarding student loans.  Doctors and lawyers usually have very high student loan debt.  We’re talking six figures easily.  This kind of debt can seem crushing and it would be easy to turn a blind eye and just make the minimum payment month after month.

That’s a surefire way to pay the most interest possible over your lifetime.  Having a debt payoff plan at all would be great progress for a lot of people.  So using either the snowball or avalanche method is fine by me.  But I think the best way to pay off the debt would be a hybrid version of the two.

How this would work is focus on paying off the first couple of low balance debts to get some progress under your belt.  Once you do that, shift your focus to your highest interest debt to really attack that total balance.  So start with the snowball and switch to the avalanche.  It’ll feel much better to be out of debt in a few years rather than a few decades!

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Plan Out Your Paycheck

The key to getting ahead financially is to spend less than you earn.  There is literally no other way to achieve financial freedom.  This applies to billionaires and regular old working people.

But it’s not easy.  We hear about the athletes and actors who are in debt because of overspending despite making millions of dollars over their careers. If you make $10 million but spend $11 million, you are not in good shape.

However, this is a problem for people of all income levels.  Things like credit cards, mortgages and other personal loans have made it super easy to spend more than you earn.  Easy access to credit makes people more greedy for things like fancy cars and big houses which can create more debt.

A big reason why Americans find it difficult to save our hard earned, and highly taxed (federal tax, state tax AND sales tax!) money is that very little planning is done when receiving that bi-weekly paycheck.  Everyone looks forward to Friday payday but for most people the money hits their checking account with no thought to where it’s going next.

And this is where the trouble begins.  Most of the time that money just gets spent on various bills.  And nothing is left over for savings.  Rinse lather and repeat every 2 weeks.

Now it’s easy to see why lack of planning is a big reason people have a hard time saving.  So what’s the solution?

Checking is the Central Hub

I like to think of my checking account as the control center of my finances.  Money goes in and is then distributed to where it needs to go.  It’s not a place where I like to park money since I like to have my money either invested or paying off debt.

This requires a mindset shift since most people, including my past self, just park their money in checking and paid bills as they came in and tried to save if possible.  Not a real financial strategy since most of the time you’re just trying to keep your head above water.

I consider this a very REACTIVE way to handle your paycheck.  You just kind of pay bills as they show up and have no real savings strategy.  Worse, any extra money that happens to be sitting in checking usually just gets spent.

A more PROACTIVE way to handle your paycheck is to have multiple destinations set up before the money arrives.  That way you can be sure money gets where it needs to be according to your financial goals.

Pay Yourself First Every time

Most people have heard the financial cliche “pay yourself first”.  It’s another core financial concept just like “spend less than you earn”.  While both of these sayings sound fun and useful, they can be difficult to implement.  While most people WANT to save, it just doesn’t end up happening (evidenced by the fact that the average American saves less than 5% of their income).

So if you can’t will your way to save, the next best thing is to get out of your own way and let robots do the work.  This is done through automatic saving and investment plans which are very easy to set up.

Want to save $500 a month in your emergency savings plan?  Set up an automatic monthly deposit.  Finally want to max out your Roth IRA?  Just start a monthly transfer from your brokers website for a $458.33 monthly transfer from your checking account (That’s the $5,500 IRA max divided by 12 months).

You can also set up automatic payments for your credit cards.  This way you’ll never have a late payment and you can use the full grace period the card issuer gives.

It might take a few months to get all of your major goals and bills set up but once you do, money will be moving in and out like clockwork.  You’ll be able to meet your financial goals with a minimal amount of maintenance needed.

And that’s the best way to pay yourself first.  Set up automatic transfers into all of the different accounts you want to save into.  Those transactions should shape how much you spend.  Unfortunately, most people just save whatever they can AFTER they have spent to their heart’s content.

There’s usually not much left for savings after that.

Conclusion

“Spend less than you earn” and “pay yourself first” are two common personal finance phrases that are difficult to put into action.  But these are the two things you have to do in order to meet your financial goals.

The best way I’ve found to do both of these things is to have a plan for any money that hits your checking account.  With technology today it takes a few clicks or smartphone taps to set up automatic transfers from your checking account into your savings account of choice (emergency savings, IRA, brokerage account, student loan accounts to name a few).

Once you get all of these transfers set up, managing your money becomes a breeze.  And you can meet your financial goals with minimal ongoing effort.

Treating your checking account like your money managing robot will make sure your spending less than you earn and paying yourself first month after month.

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Disability Insurance: Yes, You Need It

Insurance is one thing that everyone needs but very few want to sign up for.  And people who sell insurance aren’t exactly the most beloved people on the planet.  But the fact remains, we all need insurance.

There are many different types of insurance.  Everyone is familiar with car insurance and health insurance.  Life insurance is another important one.  (I previously wrote about my life insurance experience here.  Hopefully we’ll never have to use it but I’m glad it’s there.)

The thing with insurance is that we only need it when we need it.  But those times of need can be highly stressful on your family and finances.  Just think of the last time you or your family member got into a car accident.  Insurance was the last thing on your mind, but if you had good coverage, it really gave you piece of mind when the dust settled.

Which is why I highly advocate that everyone, especially high income professionals, get disability insurance.  Not only does it insure against the main engine of your life (your income), but the chances of becoming disabled are much higher than most people think.

Don’t Take A Chance

I’m an optometrist.  Anyone who has been to the optometrist knows that optometrists don’t have one of the more dangerous occupations out there.  It’s a pretty safe environment to practice.  I also am currently devoid of any major health problems such as high blood pressure and diabetes.  And I don’t do skydiving.  So it would seem my chances of a disability are pretty low.

But according to the calculator from the Council of Disability Awareness, I have a 13% chance of being disabled for 3 months or longer at some point in my life.  And the average length of a long term disability for someone with my profile is 78 months.

That’s 6 and a half years of no money being made.  I don’t think there are many families out there that could live off of savings for that amount of time.  This is why disability insurance is so important.  Not having it is putting you and your family at a very great and very real risk.

Like most insurances, disability insurance is a complex product with a lot of moving parts.  Most people would do well to talk to an independent agent and get as much information as they can.  There are also many online providers out there that will help you sign up for disability insurance.  I signed up with Quotacy, who I also used for life insurance.  The process was easy and the agent was very helpful every step of the way.

But two very important aspects of disability insurance, especially for high income earners, is knowing how much insurance you need and making sure you have a policy which gives you the most specific definition of being disabled, namely an “Own Occupation” policy.

How Much Should You Buy

Once you decide to sign up for any type of insurance, the next big question is to decide how much insurance you need.  Disability insurance is no different.

If you’re deemed disabled by the insurance company, they will pay out a monthly amount for the amount of time you remain disabled.  The question to answer is exactly how much of a benefit to sign up for.

Most people would assume that you should apply for a monthly amount similar to what you get paid while working.  This is not a good idea for a number of reasons.  One, insurance companies usually won’t even let you sign up for a monthly amount that meets 100% of your income.  They may come close, but that would make your monthly premiums very high.  Most insurers will limit you to 70 or 80% of your income.

Secondly, you probably won’t be spending as much money when you’re disabled as you do when you’re uh, abled.  Things like eating out and traveling probably won’t be on the top of your list as a disabled person.

Instead, you should focus on what you spend.  Tally up your fixed and necessary expenses like rent, food, electricity etc.  Add some for retirement savings if you would like as well.  This is how you should find an appropriate amount of insurance to sign up for.  Being overinsured will just lead to much higher monthly premiums and more money than you could possibly need while disabled.

Own Occupation FTW

Finally, a key aspect of disability insurance is the specific definition of disability by the insurance company.  The worst case scenario is that you become unable to do your job for some reason and the insurance company doesn’t pay out any benefits because you don’t meet their definition of a disability.

The way to avoid this is to look for an Own Occupation plan.  This is especially important for high income professionals like doctors and lawyers.  While they can come in slightly different flavors, an Own Occupation plan in general states that you are disabled if you can’t perform the duties of your specific occupation.  It is a strict definition and this is what you want in a disability plan.

For example, if a doctor and is disabled and can’t perform his duties, an own occupation policy would consider this a full disability and start making monthly payments.  But if the doctor didn’t have a specific Own Occupation policy, the insurance company could contend that he could do another job like a grocery store cashier or a suit salesman, and would refuse to make the monthly payments.  That sounds like a bad situation.

So it’s in your best interest to get a policy that has a definition of disability that is specific for your profession.  Specialists like surgeons should look for even more specific Specialty Own Occupation policies.

Conclusion

Disability insurance is a vital part to any working professionals insurance portfolio.  Becoming disabled is actually more common than people think.  Something as simple as a fall can cause a total disability.  It is essentially income protection in case the unthinkable happens and you aren’t able to work for an extended period of time.

Pay attention to your expenses when deciding how much insurance you’ll need.  You probably won’t be spending as much money while disabled.  Also, it’s important to sign up for an Own Occupation policy to ensure you will get the proper payout.

Finding disability insurance isn’t as easy as car or life insurance.  But it’s not that hard.  I used Quotacy and it was pretty easy to do it online.  You can also look for an independent agent that will shop policies for you as well.  A good policy isn’t as cheap as life insurance, but it is not too expensive and is definitely worth it for peace of mind for you and your family.

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