Back at the start of 2016 I set about sorting my personal finances out, inspired by Soft Skills. The book makes a point to consider passive income as a viable solution to wealth building. The reason for this is simple, software developers tend to get paid well if working professionally. Like most professionals though, during school or university you won't be guided on how to handle money until you are thrown into the deep end.
Assets and Liabilities
At the start of February we listed all our assets versus liabilities and were rather shocked. Our net worth (assets minus liabilities) was negative. Not only was it negative, it was negative by a rather large number. This scary realisation forced us down the path of personal finance. Most of this knowledge came from a handful of books and took no more than a few months to really get to grips with the basics. For the small cost of a few books and your time the return on this investment is huge. In summary you want to maximize assets (things that give you income) and reduce or eliminate liabilities (things that take your money away) as much as possible.
Despite knowing nothing than the basics of the stock market and investing, investing in stock (sometimes known as equities) is one of the ways to maximise assets. Again a few simple introductory books and some online research was all that was required. Having explored individual stocks, we settled on low cost index funds as our main investment solution. Before we could invest though we had to attack our debt. Without eliminating the debt we were unable to maximize our investments. Paying off debt is also considered a guaranteed return, something you cannot get with investments, hence it should be your first target.
Attacking debt took up the whole of 2016. Thankfully there was an easy system to follow. The difficult part is sticking the course, though you will quickly start to see benefits. The best solution we found is the debt snowball, which is part of Dave Ramsey's Baby Steps. Steps 1-3 must be completed in order, sequentially. While steps 4, 5 and 6 can be completed in parallel.
- Save £1,000 in an emergency fund.
- Pay debts down from smallest to largest using the debt snowball method.
- Save 3-6 months of living expenses for a fully-funded emergency fund.
- Invest 15% of income into retirement.
- Start funding higher education for children.
- Pay off the mortgage early!
- Build wealth and give!
You Need a Budget
I was actually advised to create a stick to a budget by a friend while in university, however I ignored her wise advice. A budget is a crucial tool to paying off debt and in turn staying out of debt. The best budget to use with the baby steps is a zero based budget. In this case you run your personal finances like you would a company such as a bank. At the end of each month (or whenever you receive income) your balance should be fully allocated to equal zero pounds available. All of your money is either paying of debt or working hard in investments, while the rest is allocated to expenses.
A written monthly budget is single handedly the best piece of personal finance I can recommend to others. Once you tell your money where to go, and have a audit trail of where you are spending you have control. How we lived prior to a monthly budget is a mystery, though it does explain the shocking net worth we amassed. To be blunt, get and use a budget. You need to.
Previously I thought of retirement as something you do when you're old. Think of your parents or grandparents. However this is not the case. Retirement is simply being able to do what you want to do, whether or not this includes work. Being able to wake up each day and do what you want is a powerful thing.
Another shock discovery was the fact that becoming financially independent in order to retire can be done in ten years, instead of the traditional thirty of forty year window. A whole community exists that prove this is the case - FIRE (Financially Independent - Retire Early). To summarise this process, instead of doing what the norm do and investing 10% of your income, invest 50%-90% and you can shorten the process dramatically. FIRE is a long term goal that requires minimized expenses and a strict budget, but the pay off will be more than worth it.
Our personal goals for 2017 include completing our six month emergency fund, followed by aggressively paying off our mortgage, with the goal to complete this within two and half years versus the remaining twenty year window. Without the basic concepts above this would have not been possible.
- Eliminate all debt, and stay out of debt.
- Create and use a monthly budget.
- Use the baby steps to get out of debt and build wealth.
- Low cost index funds are a recommended way of simple investing.
- Retirement isn't a thirty or forty year process.
- No one will teach you personal finance, it's up to yourself to get to grips with it.