By: Rachel Richards, author of “Money Honey: A Simple 7-Step Guide for Getting Your Financial $hit Together.”
You. Yes, YOU. With the credit card debt. Whether a few hundred dollars or several thousand, that debt is putting a weight on your shoulders that you may not even realize you carry.
Owing money to anyone makes you dependent on and obligated to them. You are not free. As long as you owe money to someone else, any money you might make or have on hand does not belong to you.
That’s true whether you owe money on a mortgage, a car, or the drinks that your friend paid for last night. Credit card debt, though? That’s its own beast. Minimum payments just don’t cut it when the 20% interest rate keeps you from paying down the balance, or worse, keeps your balance climbing ever-higher. Becoming trapped in credit card debt is a lot easier than most people think. Just take a look at how easy it is to justify a credit card purchase in this excerpt from my book, “Money Honey: A Simple 7-Step Guide for Getting Your Financial $hit Together:”
Here’s how credit cards make money from you. You go to the store and see a classy AF $250 trench coat that you must have. But then you cry a little on the inside because you have $11.85 in your checking account. Then you remember that you have a credit card, which means you can buy it right now even though you don’t have $250. So, you do. Then, you make minimum payments of $15 per month until it’s all paid off. Ah, the beauty of credit, amirite? Isn’t $15 per month way better than $250 up front?
NOPE. Let’s say that your credit card charges you 20% interest, which is pretty common. Guess what, Sherlock? It will take you 19 months to pay that bad boy off, and when all is said and done, you will have paid almost $50 in interest, making the total cost of that trench coat $295.37. Are you still happy with your decision? If you answered yes, go and stand in a corner and think about what you did.
Maybe you’ve recently realized how scary and overwhelming your CC debt has become. Maybe you’ve been in denial. Either way, fear has paralyzed you. Where do you begin? You don’t even want to look at the balance anymore. You’re afraid of it, you feel lost, and you feel defeated.
Never fear, my friend. If you’re reading this, it’s because you’ve realized most of what I just stated rings true, and you need help getting out of CC debt, ASAP. Let’s dig in.
Getting out of credit card debt, while not easy, can be summed up in five simple steps.
1. Pay only the minimums on all other debt
First, take a look at any other debts you have and make sure you are only paying the minimums. When a friend did this, she was surprised to find she was paying $100 more towards her mortgage each month than was necessary. She had set up her payments that way a long time ago so that she could pay down her principal faster, which is a smart move. For this exercise, however, I recommended that she temporarily take a break from doing that to free up as much extra money as possible.
So this will be a quick step; just login to your accounts and ensure you are paying only the minimums on any debts you have.
When it comes to any retirement contribution you may be making, I want you to stop doing that, with one exception. If your employer offers a match or contribution of any kind, make sure you are contributing at least enough money to take full advantage of that company match. If you are not offered an employer match or contribution, then temporarily stop contributing to your retirement accounts altogether.
2. Grow your Golden Number
In my book “Money Honey,” I talk about your “Golden Number” which is simply the amount of money you save each month. Your Golden Number equals your monthly after-tax income minus your monthly expenses. The bigger this number is, the more you can put towards saving and/or paying down debt each month.
There are two ways to grow your Golden Number:
Brainstorm a list of as many ideas as possible in each category. Think about renting out a room on AirBNB, starting a side hustle, walking dogs, babysitting, getting a part time job, and anything else that can bring in some extra income. On the expense side, what bills can you call and negotiate down? What subscriptions can you temporarily give up in the name of financial freedom? Where else can you cut back or sacrifice?
Once you have a huge list, focus on the top 2-3 easiest things in each category and implement them right away. This should increase your savings rate instantly so that you can save and pay down debt even faster.
3. Save $1,000
This might sound counter-intuitive, but you must set aside at least $1,000 in a savings account BEFORE tackling the CC. Why? Because you need some money set aside for emergencies and unexpected expenses.
Exhibit A: Jane Doe is killing it. She’s paid off $1,300 in CC debt in just under one month. She’s cut her expenses in every way possible, she’s been scrimping to get by, and every extra dollar she gets goes straight to her CC debt. UNTIL…
Inevitably, one day, Jane’s car breaks down, or her son has to go to the ER, or her dog ate her medication and had to be taken to the vet. And since Jane Doe doesn’t have anything in savings, she has to put that unexpected expense on her CC, wiping out all the progress she’s made.
How discouraging is that? Here’s the thing: there’s nothing wrong with having those unexpected expenses. Things come up; that’s life. But you can and should be prepared for them. You must expect the unexpected. You must have some money set aside so that WHEN, not IF, those emergencies come up, you can pay for them out of your savings instead of putting them on your CC.
Not setting aside money for the unexpected is the most common mistake people make. They start to aggressively pay down their CC, and then five weeks later, an emergency expense comes up and they have no way to pay for it, so it gets charged to the CC. And normally it’s so discouraging that they give up altogether.
Don’t be that person. Use your newly inflated Golden Number to get $1,000 saved as fast as humanly possible.
4. Set your timeline
Now you can get started. Everything is in place and you are ready to go. I recommend doing one last thing, which is taking a look at how long it will take you to pay this bad boy down. Simply take the total balance on the credit card, and divide it by your Golden Number, to calculate the approximate number of months it will take to pay off. (It’s approximate because interest will keep accruing so it will likely be a tiny bit longer.)
For example, let’s say your CC balance is $9,000, and your Golden Number is $500. It will take you $9,000 / $500 = 18 months to pay off.
“18 months?!” you might say, shocked at how long this will take. If that’s how you feel right now, you have exactly one lever you can adjust that will get you there faster: your Golden Number. Feel free to revisit Step 2 and see how else you can increase your income or decrease your expenses. (Most people take another look at that step once they do this calculation).
YOU have the power to speed this journey up. It’s all about how much YOU are willing to sacrifice. You’ll likely have to sacrifice time to increase your income, and quality of life to decrease your expenses. You can be as aggressive as you want to be.
In the example above, if you double your Golden Number to $1,000, then it will only take you 9 months to pay off your CC. Now you know how long you will have to commit in order to achieve this goal and you can mentally prepare. You can even set up milestones along the way or make a fun calendar or countdown to put on your fridge.
Get at it! Take it one day at a time. Feel free to share this exciting journey with your friends or family. Trust me: most of them probably have credit card debt too, and you never know who you could positively impact by sharing your goals. Paying off your CC debt is not something to be ashamed of; it’s something to be proud of. Plus, sharing your goals has two benefits: encouragement and accountability from your peers.
You will hit roadblocks, but don’t let that discourage you. We are all human. We are flawed. There’s no sense in beating yourself up if you get off track one day. Just forgive yourself, get back on track, and vow to be better. I promise you that it will be SO worth it in the end.
Remember your Golden Number? This next point will encourage you: think about what you will do with that money after you get your CC paid off. Maybe you’ll take a month off and splurge on yourself! Maybe you’ll immediately put that towards your student loans or other debt. Maybe you can use it for that trip you’ve always wanted to take. The possibilities are endless!
You can do this. Go get ‘em!
An excerpt taken from Rachel Richards's book Money Honey: A Simple 7-Step Guide for Getting Your Financial $hit Together.
Copyright © 2017 Rachel Richards
Have you noticed that there hasn't been a Financial Adult Dish in awhile? This is why. We are so excited to announce that over the next three weeks, we will be doing a Money Honey three-part series with author, financial guru, and friend Rachel Richards. Rachel's book Money Honey: A Simple 7-Step Guide for Getting Your Financial $hit Together has over 300 five-star reviews on Amazon and has helped change lives (both young and old) for the better. The book is a quick, easy read that helps make financial concepts understandable for everybody. Below is an excerpt from her chapter on savings, here is a link to her book. Trust us, you don't want to miss a thing.
Americans suck at saving money, it turns out. 19% of Americans have NOTHING set aside to cover an emergency. Uh, no wonder everyone is in debt! ValuePenguin reports that if you are under 35 years old, you only have $1,580 saved on average! Did your jaw just drop? It should have! Oh, and also, one-third of Americans have zero saved for retirement. SMH.
Ladies and gents, you have two financial goals. They are:
That’s all you need to know. Do I even need to write the rest of this article? Fine, I’ll keep going.
So that we are all on the same page, allow me to define assets and liabilities for you. Assets are items that add to your net worth: cash, savings accounts, 401(K)s, the value of your house, money that someone else owes you, and so forth. Liabilities are items that subtract from your net worth: loans, credit card debt, the mortgage on your house, money that you owe someone else, and so forth. Here’s how it all works together:
Assets - Liabilities = Net Worth
Therefore, to grow your net worth, you must increase your assets and/or decrease your liabilities.
I urge you to track your net worth via a balance sheet each month. This exercise can be eye-opening and FUN! (I’m serious!) You can download a balance sheet template to use for free at http://eepurl.com/c1ro7H, courtesy of yours truly.
Magic exists. It exists in the form of continuously compounded interest. This beautiful mathematical concept explains how you can put $10,000 in savings today, do nothing for 30 years, and then – BAM – have $44,816.89 (assuming 5% continuously compounded interest.) I’m not making this $hit up. Fill up your wine glass and take a seat so I can explain this to you.
You earn interest by putting your money in a savings vehicle that offers to pay you interest. It’s like a bank saying, “Pick me, choose me, love me; I’ll even pay you!” The money paid is calculated based on the interest rate they’re offering.
Allow me to break down the term continuously compounded interest, starting with compounded. Compounded means that the interest you are earning is added to the principal amount of a deposit. In other words, you are earning interest on your interest.
Let’s throwback to Algebra II for a second. You deposit $100 in your savings account, which earns 10% interest per year or $10. So after one year, you have $110. What happens in year two? In year two, you get 10% interest again, but this time it’s based on the $110 amount, so you earn $11. After year 2, you have $121. See how that works? Your interest is added to the total amount so that every year, you will earn more and more dollars in interest! This is why Albert Einstein is said to have called compound interest the greatest mathematical discovery of all time.
#MathingOver. What does continuously compounded mean? Interest can be compounded in any time period. In the example above, interest was compounded annually. It can also be compounded semi-annually, monthly, daily, or even continuously. The more frequently the interest is compounded, the more you will earn overall. I could bore you with the details and formulas, but how about not. Just know that a bank account offering 1% interest compounded daily is more attractive than a bank account offering 1% interest compounded annually. Below are a few banks I would recommend for savings based on personal use, but you can also do a quick Google search of “best high yield online savings accounts.”
A quick word on Annual Percentage Yield (APY.) APY is a standardized representation of an interest rate, based on a compounding period of one year. Let’s say you’re trying to compare several interest rates from several banks. However these interest rates are compounded, whether monthly or daily or continuously, the APY converts them into a per year rate so you can compare them evenly. Higher is better. Bottom line: when you are comparing interest rates offered by different banks, you always want to compare the APY since it accounts for differing compounding schedules.
Understanding how interest works (and why it’s so important) is vital to setting up your various savings accounts so you can achieve your goals. Also, knowing that there are banks offering over 1% APY versus your checking account which offers 0.01% APY will help you put your money to work. #KnowledgeIsPower. Next, let’s take a look at your savings strategy.
Let’s talk about growing your assets; specifically, your cash or checking accounts, savings accounts, investment accounts, and retirement accounts.
Your cash on hand or checking account will always be fluid, which means immediately available to spend. If you have just received a paycheck, you might have lots of available cash. Or, if you are a college student, you might have $3.81 to your name in which case, I raise my glass to you in remembrance of times gone by.
Savings is a whole different ball game. That’s because sometimes you are saving for an urgent car repair, sometimes you are saving for your wedding that’s a year away, sometimes you are saving for retirement when you turn 60, and sometimes you are saving so you can go get a few martinis after work (been there, girlfriend.) Since we all have different, and often multiple, savings goals, please humor me and envision four buckets. Bucket #1 is Emergency Savings. Bucket #2 is Medium-Term Savings: one year or less. Bucket #3 is Long-Term Savings: greater than one year but before retirement. Bucket #4 is Retirement Savings.
Remember your Golden Number? That’s what you’ll use to fill up the four buckets. Bucket #1 for Emergency Savings should hold at least $1,000. This will cover any unknown expenses that come up suddenly, such as the heating system in your house malfunctioning in the middle of winter. Bucket #1 covers expenses for which you were not prepared but that must be remedied right away, AKA Unforeseeable And Urgent Expenses. These funds should always be easily accessible, meaning you should be able to withdraw them instantaneously. You can keep this money in your checking account, in a savings account that you can access immediately, or even in your sock drawer. Don’t worry about what interest rate you earn; this money’s only job is to be available when needed. Also, friendly reminder: those amazing heels that you saw at the mall are not an emergency, sadly.
Bucket #2 for Medium-Term Savings is first and foremost a secondary emergency bucket. It must contain enough money to hold you over for three to six months should you lose your job. Calculate how much money it takes you to survive for one month, multiply that by 4.5, and make sure you have at least that amount in Bucket #2. I hope you don’t have to thank me later. Bucket #2 is also used for whatever you are saving for within the next 12 months. This might include buying a car, going on a vacation, completing a house project, or buying an engagement ring. You don’t need both components: you need whichever is greater. If your 4.5 months’ worth of expenses is $30,000, and you are saving for $20,000 worth of stuff within the next 12 months, then Bucket #2 should hold $30,000.
Since Bucket #2 will be accessed within the year, I would recommend keeping this in a high-yield savings account rather than investing this money in the stock market. If you invest money in the stock market and pull it out in less than a year, you have to pay this unfortunate thing called short-term capital gains taxes. To avoid this tax, I recommend only investing money in the stock market that can stay there for more than a year. So put Bucket #2 in a high-yield savings account where you can withdraw money in a few business days if needed, but where you will still earn more interest than in a checking account.
Bucket #3 for Long-Term Savings will hold whatever you are saving for that is more than a year away but prior to retirement. If you’re 12 years of age, you’ll want to use this bucket to start saving for your wedding since those cost $40,000 these days. #WishIWasKidding. In all seriousness, future weddings and honeymoons would fall in Bucket #3 for most people. Saving up money to buy a house is another great example for this bucket. I recommend investing Bucket #3 in the stock market, where it will likely grow a lot more than in a savings account.
Finally, you have Bucket #4 for retirement savings. If you’re around my age, this is pretty far off, and you won’t need to access this money for several decades. This money should be kept in an IRA, 401(K), or other retirement account. Please, do yourself a favor and envision your retirement account like a jail cell for your cash. You cannot access this money until you retire. Okay, okay, I won’t lie to you: In reality, you can access this money whenever you want, but depending on the type of account, you normally will be required to pay taxes and a hefty penalty fee if you withdraw it before you reach retirement age. So, for our purposes, do not contribute to Bucket #4 unless you know without a doubt that you will not need that money until you retire. Because trust me, if you do have to withdraw money early, it hurts. Since Bucket #4 will ultimately require a lot more cash than the other buckets, you’ll be contributing to this regularly for the rest of your life. Welcome to Adulting.
If you can’t already tell, the four buckets are divided based on ease of accessing the money, which is called liquidity. These buckets exist because sometimes you need to access your money right away for emergencies, but sometimes you won’t touch it for 40 years and therefore can lock it up in a retirement account. You may feel that $1,000 is not enough for emergency savings, or that Bucket #3 doesn’t apply to you because you have no savings goals that fit in that category, or that you’d rather not invest your long-term savings in the stock market at all, and that’s your prerogative. But this structure will work wonders for you, and you can customize it based on your own needs.
I will be strict on this: you must fill up Bucket #1 first! You need some sort of emergency savings before you start saving for anything else. This ensures that when, not if, you have an emergency, you will be adequately prepared.
Let me stop you right here. This is an opportune moment for some more brainstorming so you can set this system up for yourself. Get your cherry-spiced rum, pen, and paper. Go on, I’ll wait.
On your paper draw four big buckets and number them 1 through 4. Obviously, when I’m talking about buckets, I’m envisioning champagne buckets.
For Bucket #1, write $1,000.
Next: remember the monthly expenses that you estimated earlier? Multiply your total monthly expenses by 4.5 and write down that number in Bucket #2. The reason for this calculation is that you need to have three to six months’ worth of living expenses in Bucket #2 in case your a$$ gets fired. Bucket #2 ensures you have enough to live off of if you are ever out of a job for an extended period of time.
Now, for Buckets #2 and #3, brainstorm all the items or experiences you want to save for within the next year (write those for Bucket #2) and that are more than a year away (Bucket #3.) Here’s a list to jog your memory: buy a house, buy a car, buy a boat, go on a trip, plan a wedding, buy an engagement ring, complete a house project or renovation, enroll in college, have a baby, and so forth. Once you have finished brainstorming, jot down dollar estimates next to each item and add them all up.
Pause. Look at what you brainstormed for things you want to save for within the next year in Bucket #2: Is the total amount greater than your 4.5 months’ worth of expenses figure? If so, circle the former number. Or is your one-year savings goal number less than your 4.5 months’ worth of expenses figure? Circle the salary figure instead.
Now you should have a total dollar amount for Bucket #2 and #3. So far, your paper should look something like this:
(Jealous of my pretty picture? Download the excel version for free at http://eepurl.com/c1ro7H.)
Yeah, yeah, we didn’t do Bucket #4. I hate to break it to ya, but if your retirement is more than 20 years out, neither you nor I have any idea how much money you will need for retirement. You can estimate it, yes, but there are so many unknown variables between now and then that even the best estimate is nothing but a guess. The exception is if you are nearing retirement, which in that case, put your best estimate down.
I could write an entire book about retirement (sequel?), but I won’t; so I will let you research all that goodness for yourself. I could also give you a goal (save 15% of each paycheck!), but that is meaningless without knowing your particular circumstances. The bottom line is, retiring requires a LOT of money―we’re talking six zeroes―so you need to save as much as you can. You can put a big ole question mark for now in Bucket #4. We will discuss your retirement plan in more detail later on.
Let’s talk strategy. How do you fill up these buckets? I will prioritize for you. Bucket #1 is first. Even if you have to stop contributing to your retirement account for a couple months so you can fill up Bucket #1, DO SO. There is nothing more important than having at least $1,000 in emergency savings tucked away. If you don’t have an emergency fund, you’ll be thrown off your savings game later on when an emergency happens, which will discourage you. Once you check that off, we can talk about how to distribute your money between Buckets #2, #3, and #4.
Bucket #1 is the most important. Next most important? Bucket #4. Yes, retirement is far off, and you want to save for the things you know you’ll need within the next year, but if you do not start saving for retirement right now, you won’t ever retire. Let me repeat that since you’ve had a couple alcoholic beverages: if you do not start saving for retirement right now, you won’t ever retire.
So once Bucket #1 is full and happy (like you are right now), you will contribute regularly to Bucket #4. I would personally contribute as much as possible while also hitting my most important savings goals for Buckets #2 and #3, but even $50 per month is better than nothing! And you could always follow the 10% to 15% per paycheck rule, but like I said earlier, that’s pretty meaningless since you don’t know how much you’ll need for retirement. More on this to come.
After Buckets #1 and #4, Bucket #2 is next in priority because it is where you’ll pull money from if you ever lose your job. This bucket should hold at least three to six months of living expenses or whatever savings goals you’ve outlined for the next year, whichever is larger. So after filling up Bucket #1, and contributing regularly to Bucket #4, I would put the rest of your Golden Number in Bucket #2 until that’s full. Then, naturally, once Bucket #2 is full, fill up Bucket #3. Ya dig?
You might be frustrated with me since this seems so abstract. This exercise will differ for every individual. There is no hard and fast rule. Put your big girl panties on and use your brain to determine what makes the most sense for you and your circumstances. If you’ve made it this far and you understand that you’ll eventually fill up your first three buckets while contributing to Bucket #4 regularly, you’re in great shape.
“Wait a second Rachel! My Golden Number is barely big enough to split between all these buckets!” Yes, there are a lot of buckets. But you can never have too many buckets. Also, I never said that this would happen overnight. It could take several paychecks to fill up Bucket #1. Depending on your savings goals, it could even take an entire year to fill up Bucket #1 and Bucket #2. That’s okay! Progress is progress, and as long as you do it in the order I’ve outlined, you’ll be dandy. I would not expect you to have $50,000 in savings overnight.
Hopefully you can now see why your Golden Number is so important, and why you should increase your income and decrease your expenses. Growing your Golden Number means hitting your savings goals faster, which means growing your assets and therefore your net worth. Do your best, educate yourself, and believe in yourself.
But wait, there's more! This was only an excerpt from Rachel Richards's book Money Honey: A Simple 7-Step Guide for Getting Your Financial $hit Together. Click here to get the full book, here to go to the Money Honey Facebook page, and here to visit the Money Honey Instagram page. Otherwise, stay tuned for next week's post on getting out of credit card debt!