Occam's Razor

This is the second in an indeterminate series of entries that provides my “real world” lessons to young adults. It is my conviction that these lessons are rarely taught either at home or in the schools. For those who did not get them growing up you can get them from me for free. This is part of my way of giving back to the universe on the occasion of my 50th birthday. It is my hope that at least some of you reading this will benefit from my experience and save yourself a lot of unnecessary anguish.

When I was growing up managing money was straightforward. If you were just starting out it was almost impossible to get a credit card. Consequently, you lived within your means, no matter how modest they were.

Now managing money is much more complicated. Unfortunately, it is a good bet that you graduated high school without a money management class. Credit card companies spend millions trolling for financial fools willing to get themselves deeply in debt. They especially target young people, and try to make your indebtedness to them a lifelong habit. It appears that many Americans and young people in particular now see money as wholly abstract. As long as your ATM card works or your credit card is not over its spending limit, you assume your head is above water. Personal debt has become as abstract as the National Debt.

If this is what you think, you are sadly mistaken. Debt matters and the kind of debt you carry matters even more. Carrying debt costs you dearly and limits what you can do with our own money. Your goal should be not to be one of the millions of Americans with a negative net worth. Your goal should be to get out of debt entirely and start accumulating both a reserve of cash and a supply of assets that exceeds your debts. What you will get are financial resiliency and peace of mind. You want to be one of the financial winners in life, not one of the many losers out there always struggling under a crushing load of debt. If a real financial crisis hits, like a banking crisis or the need for an expensive operation not covered by insurance, these people will end up as financial road kill. You should not aspire to be one of the unfortunate.

Having no debt is ideal, but impractical. Credit card debt, like any debt that is unsecured is bad debt. Any debt that does not help you work yourself up the food chain is also bad debt. Consequently, student loans are probably good debt, providing you use the money to study earnestly in a program that will provide you with a good and steady income in future years.

All your expenses can be placed into three categories based on decreasing priority: things you need, things that will enhance your long-term financial solvency, and things you want. You need food, housing and a way to get to and from work. You may aspire to be a college graduate or a truck driver. Money spent here is your second priority because it enhances your long-term solvency. The latest Xbox game station may be something you think you need for your happiness. Do not delude yourself. It is something you want. You can live without it. If after satisfying the first two priorities there is money left over, go and buy something off your want list, providing you can pay for it without going into further debt.

You might say, “But I need high speed internet so I can respond to emails for job searches.” Sorry. It is convenient to you to have high-speed internet, but it is not a need. You can go to most public libraries and use their internet service for free. Similarly, you do not need a car. You can walk, bike, join a carpool or take public transportation. You might even be able to work from home. If you live in the middle of nowhere you can move to some place closer in. People survive without cars all the time and so can you. I used public transportation for years until I could afford a car. Similarly, you may think you need your own apartment. However, you could also find a roommate, take a room in a group house or even live in your parents’ spare bedroom if they will let you.

Granted this sort of life will not necessarily be fun. However painful what you are doing is in the short term, always keep in mind that it is a sound long-term strategy that has been proven effective over millennium. It means that you are living within your means. It means that you are positioning yourself for your long-term prosperity.

After seeing where your money goes, the next step is to make sure money goes where it needs to go first. This involves the prosaic but vital exercise of making and sticking to a budget. If you have more expenses than income, you either need to cut expenses, increase income or do both. Creating a budget is not rocket science. If need be you can do it with a pen and paper, as most generations until now have done it. Any spreadsheet can be used to create a budget. If you cannot afford Microsoft Excel, download the free OpenOffice suite, or use Google’s free spreadsheet tool.

For years, I would end up going “ouch” whenever that big bill arrived. I did not necessarily have all the cash on hand when, for example, the auto insurance bill arrived. Eventually I figured out that if I escrowed equal parts of the money I needed every month I would have all the money on hand when I needed it and I would not be so anxious. You can use the same strategy. My criteria is that any bill paid less often than monthly and which will be for more than $250 when it arrives I will escrow for in advance. I divided up one of my bank accounts into a number of imaginary accounts, one for each of these major expenses. For example, I pay $765.18 a year for homeowner’s insurance. That is $63.77 a month. Therefore, every month I put $63.77 into that account. I expect the bill in 4 months, so I have paid 8 months into the account so far and have accumulated $510.16 in it. When the bill comes due, I have the money to pay it in full. In addition to known bills, I also escrow for anticipated major expenses. For example, I put $250 a month into a car savings account. It is there to act as a down payment for future car purchases, as well as to pay for any major car repair bills that come up. I have a similar account for major repairs. This generally means that I do not need to touch savings when I have to install a new roof or put in a new air conditioner.

To use an escrow system you first need a pile of cash that you can subdivide this way. If you have no pile of cash because you are making payments on your credit card instead, work to get its balance down to a zero balance as fast as possible. You can use a debt calculator to figure out how much money to pay every month to get rid of a credit card balance. For example if you have $8000 in credit card debt and are being charged 15% interest and want to pay it off in 2 years, you can use an online debt calculator like this one. Pay $383.10 a month over two years and you will pay off the debt.

I suspect you will find that when you pay off a debt that you will feel like a weight has been lifted off your shoulders. While you are paying off the debt, you will have the satisfaction of seeing your finance charges and outstanding balance drop lower every month. When finally paid off, there will be no more finance charges ever. You can use the money on other priorities. $383.10 a month can buy a lot of Xboxes.

I plan to offer more financial guidance for you to ponder will be coming up in future entries.