Your financial security is not real; take action now

Do you feel financially stable? Many of us feel confident about our finances, and even though a little extra money would always be helpful. You likely have a job, and maybe a car and a house, making financial troubles seem distant. But no matter how secure you feel now, financial instability could be closer than you realize. Imagine suddenly losing your job. Would you manage to pay your bills? Probably not. Financial stability often appears more secure than it is. Consider the author’s client Sarah, for instance. After getting married, she and her husband calculated their combined annual income to be over $75,000, with few debts between them. Feeling comfortable with their earnings and debt levels, they decided to take out a substantial mortgage on their home.

Sarah suddenly lost her job which paid $45,000 annually. This led to a potential foreclosure of their home. When unexpected financial crises hit, they can quickly become overwhelming. What can we do in such situations? Taking action early can prevent unpleasant surprises. It’s common to ignore signs of trouble and assume everything will be fine until it isn't. However, this approach is risky. Financial problems can sneak up on you, leaving you in a tough spot before you realize it. Imagine a frog in a pot of water on a stove. As the water slowly heats up, the frog doesn't notice it's getting hotter. It might not realize it's in danger until it's too late. Similarly, your financial stability could be quietly crumbling around you, without you even knowing. It's time to take action and make a change.

Debt is common but risky; we must acknowledge its limits

In today's world, we're constantly urged to buy things like houses, cars, and big TVs. But how do we pay for all these must-haves? Mostly with credit. Debt has become such a normal part of our lives that imagining life without it is difficult. Chances are, you have your share of debt, whether it's from student loans, a mortgage, credit cards, or car payments. Debt is so deeply rooted in our culture that one of the author's clients was fine with having $72,000 in debt on a rental property and $35,000 on credit cards and student loans. Debt is commonly seen as a constant in our lives, but it doesn't lead to financial happiness. Instead, it often leads to financial problems.

Consider credit cards, a popular form of debt. They give us the ability to spend money we don't have, which can feel like a benefit. However, in the long run, they can weaken our financial stability. Surprisingly, many people who file for bankruptcy—69 percent, according to the American Bankruptcy Institute—cite credit card debt as the cause. Interestingly, while some use debt to appear wealthy, truly wealthy individuals tend to avoid it altogether. Three-quarters of people on the Forbes 400 list believe the key to wealth is staying clear of debt. Some of the most successful companies, like Walgreens, Cisco, and Harley-Davidson, operate entirely without debt. If these companies and individuals can achieve success without debt, then why can't we?

An emergency starter fund is the first step to financial fitness

We've already discussed one ineffective way to achieve financial security: attempting to use credit to buy success. So what's the solution? Begin by developing a step-by-step plan that outlines how to achieve financial health. Recognize that changing your financial habits requires patience—you can't overhaul everything all at once. Instead, take it slowly, one small step at a time, to set yourself up for success. Consider this: if you had to eat an elephant, you wouldn’t try to do it all at once. You might start with a foot each day, then move on to the trunk and eventually the body, eating bit by bit.

Similarly, approach your finances in small steps. Trying to tackle everything at once—like your mortgage, credit card, and 401k—will spread your efforts thin and likely lead to failure. Take it slow and focus on one area at a time. But where should you begin? The first step in your Total Money Makeover is to build a starter emergency fund of $1,000. This fund serves as a buffer for unexpected expenses. Money Magazine reports that 78 percent of people will face a significant unexpected event, like a sudden pregnancy or car trouble, within a decade. It's important to be prepared for these situations. While $1,000 may not cover all emergencies, it's a good starting point and reduces the need to go into debt. Remember, this fund is strictly for emergencies. If you have to use it, make sure to replenish it as soon as you can.

Repay debts one by one, then build your emergency savings

Once you've set up your initial emergency fund, the next step is to address your debts. Step two of the Total Money Makeover involves creating a debt snowball. Everyone knows that rolling a small snowball downhill quickly turns it into a large snow boulder. The same principle applies to paying off debts. Here's how it works: First, list all your debts from smallest to largest. Then, focus on paying off the smallest debt aggressively. As you eliminate these smaller debts, you'll gain momentum and motivation to tackle larger debts.

The third step aims to increase your emergency savings to cover your expenses for three to six months. Everyone's spending needs differ, so this amount varies. Typically, it ranges from $5,000 to $25,000. For example, if your family earns $3,000 monthly, aim to save at least $10,000 or more. Once you've achieved this goal and have a larger emergency fund, you'll gain the confidence to pursue financial independence. If you need to dip into your savings or retirement funds while paying off debts, having an emergency fund covering half a year's expenses ensures you can move forward securely and confidently in life.

Invest 15% of your income in mutual funds for retirement savings

Many people worry about their financial situation after they retire. They wonder if they will have enough money to live comfortably during their golden years. To alleviate these concerns, we look to step four of the Total Money Makeover: saving 15 percent of your income for retirement. While this might seem like a large amount, there are several good reasons to set aside this money. Firstly, relying on others for financial support during old age wouldn't be enjoyable. This is especially true if you're depending solely on government pension plans. As retirement approaches, the likelihood of government support providing a dignified life diminishes significantly.

It might seem tempting to save less for retirement to focus on things like your children's college fund or paying off your mortgage quickly. However, your kids' education won't support you in retirement, and many retirees own their homes outright but lack extra money. Once you've committed to saving 15 percent of your income, where should you invest it? Historically, the stock market has averaged just under a 12 percent return. Mutual funds capitalize on this trend, making them a great choice for long-term investing. A key tip is to choose funds with a strong track record of success over five to ten years. Diversify your investments across different funds to maximize profitability. Another good strategy is to allocate 25 percent to growth and income (or blue chip) funds, 25 percent to growth (or equity) funds, 25 percent to international funds, and the remaining 25 percent to aggressive funds, which carry higher risks but can yield higher returns.

Plan for your kid to attend college without debt

Many parents dream of sending their children to college and are willing to take on debt to make it happen. But as discussed earlier, debt should be avoided at all costs. Using loans to pay for college isn't a good idea. Taking out a college loan can burden your child for a very long time. The current generation of students is often called "generation debt" because they graduate with an average of $25,000 to $27,000 in debt, which can linger for years. So, how should you cover college expenses? One option is to win a scholarship or save enough cash to pay for education expenses. Another approach is to use an Education Savings Account (ESA) and invest in a growth-stock mutual fund. For instance, if you contribute $2,000 annually to a prepaid tuition plan from your child's birth until they turn eighteen, you would accumulate $72,000 for tuition. 

Alternatively, using an ESA invested in mutual funds averaging a 12% return, you could accrue $126,000 for education and living costs. Using this account to pay for educational expenses means the money isn't taxed. However, you should still question whether investing in a college degree is the right choice for your child. In his book "Emotional Intelligence," Daniel Goleman discusses successful individuals, noting that only 15 percent of their success can be attributed to education and training. The remaining 85 percent comes from qualities like attitude, perseverance, diligence, and vision. These qualities often lead to greater success in life than simply having a degree. So, does your child need to attend college? If doing so means taking on debt, then perhaps not.

Pay off your mortgage to become debt-free

How long have you been paying off your mortgage? Often, it takes decades to finally pay it off.  Step six of the Total Money Makeover is about paying it off as soon as possible. For most people, this is the final hurdle on their path to financial fitness. Paying it off will make them completely debt-free. However, many pitfalls can prevent you from finishing your mortgage. It’s your job to avoid them. For example, some might suggest borrowing money from your home to take advantage of low interest rates and invest in the stock market.

Imagine if you borrowed $100,000 against your home at an 8% interest rate and invested it in stocks returning 12%. You could potentially earn $12,000 in profit. After paying $8,000 in mortgage interest, you might have $4,000 left, which seems promising. However, this calculation doesn't include taxes and fees associated with stock market investments. In reality, after all deductions, you might only end up with about $1,000, making the risk less worthwhile.

Another common belief is that you can take out a 30-year mortgage and pay it off in 15 years. Unexpected expenses like high heating bills or medical costs for pets or children can derail this plan. Additionally, few people manage to consistently make extra payments required to shorten their loan terms unless required by law. It's often more financially beneficial to opt for a shorter mortgage term. For instance, compared to a 30-year mortgage at 7%, a 15-year mortgage could save you $150,000 over the loan's duration. Just think about the possibilities with that kind of money.

Follow your plan: spend and give away your money if available

When you're almost at financial stability, you're nearing the end of your journey, just one step away. Once you're free of debt and have started saving for the future, it's time to begin growing your wealth. Surround yourself with experts like tax advisors, accountants, and estate-planning attorneys who can give you solid advice on managing your money. Stick to your financial plan no matter what. As you get older, you might feel tempted to react to small market changes, especially if you're worried about a downturn. Remember, these fluctuations are minor compared to the market's overall long-term growth trend. Lastly, know that being financially fit doesn't mean being overly frugal. Enjoy your money responsibly whenever you can.

It's essential to have fun in your financial journey, but responsibly. Can someone wear a $30,000 watch, drive a $50,000 car, or live in a $700,000 home? If they can afford it. Learn to spend within your means and forget about what you can't afford. When the opportunity arises, be ready to give your money away wisely. Giving money can be as fulfilling as spending it, sometimes even more so. It feels great to be generous, but first, you must have enough to give. Finally achieving financial freedom means enjoying comfort, happiness, and security in your life.