Wiser Financial Advisor – Avoiding Financial Hangovers
Hi, Everyone. Welcome to the Wiser Financial Advisor with Josh Nelson, where we get real, we get honest, and we get clear about the financial world and your money. This is Josh Nelson, Certified Financial Planner and founder and CEO of Keystone Financial Services.
Let the financial fun begin! Today we are talking about avoiding financial hangovers.
This is a fun time of year. There are a lot of different traditions around the holidays with the gatherings and the Christmas music and Christmas movies and Thanksgiving stuff. A lot of us overdo it, right? That’s a common thing. On Thanksgiving, we eat way too much. All the food and the treats and things like that are so good that we just want a little bit more. So today, we’re gonna talk about how to avoid a financial hangover. It’s important because at this time of year a lot of people tend to overdo it with lots of stuff. Then in January people start to look at their bank statements or their credit card statements or whatever they’re looking at for their finances—and all that spending does not feel good. It might have been a lot of fun at the time but when those bills come in, not so much.
Early in my career, my first job as a financial representative was back at John Deere Community Credit Union. That credit union doesn’t even exist anymore. I think it’s gone through some mergers, some acquisitions, but it was my first financial job and it was a lot of fun. I started out as a bank teller and quickly got promoted to a financial representative helping people with opening accounts. I moved on to loans, car loans and mortgages, things like that. I really enjoyed that environment and learning about money. It planted a lot of the seeds for where I am today because I got to move on to the financial planning and investment world. Back then, the credit union had this product that was a type of account called the Christmas Club account.
Some of you may remember this. You had a separate account called Christmas Club account. It was a separate savings account and from every paycheck every month there was an automatic transfer from your checking account into that Christmas Club account. By the time Christmas rolled around, the credit union would transfer the balance of that account into your checking account. That would be your money to spend on Christmas. It worked quite well for people from a budgeting standpoint. It’s kind of funny that it’s a throwback, right? But really the whole point of that account was to help people avoid the financial hangover they might experience if they got to Christmas and realized, “Holy cow, I’m overspending; I wish I had enough money to be able to buy the stuff that I want to buy or have the experiences that I want to have.”
Worse, if they put it on credit cards, January rolls around and all of a sudden people are getting statement balances they can’t pay off. For those of you who have been on the podcast for a while, you know that carrying certain debts, especially your credit card debt, can be a financial burden that’s hard to get out of. That’s because the interest is so high on those things. It’s no wonder the banks have these big stadiums and buildings and beautiful things with their name on them—because they make a lot of money. They’re pretty good at this business. They know that there are a certain percentage of people that will carry a balance on their credit card and will not be able to pay it off right away. And then will be paying 20 something percent. That’s on average. People are paying 20% plus on their credit card balances. Then some people get stuck in this cycle where they continually carry credit card balances for months and months on end, which easily ends up eating up whatever miles or points or whatever it was that you thought you were doing it for.
Banks and credit unions are there for a reason. If we didn’t have a banking system, that would be really bad, but it’s certainly something that we can take too far and end up with a financial hangover. It ends up becoming an unhealthy thing from a financial standpoint. Now, with that in mind, you could be doing something like a Christmas Club account and planning ahead, knowing that there will be a certain time of year that will have higher expenses than during other parts of the year. Planning ahead really means being thoughtful about expenses and knowing that there’s a cadence that most people go through year after year.
Christmas comes along every year, right? And there are certain things that we tend to do. We tend to like to go out and buy gifts and shop and things like that. Or maybe for you, it’s travel. Maybe you’re trying to help the kids or grandkids get together for a family gathering. Bottom line is that it could be an expensive time of year, much more expensive than other times of the year. To plan ahead, there are some mechanisms you can put into place. Banks and credit unions are very good at this, so there are all kinds of tools and automatic transfers and things like that. You could certainly sit down with your bank representative or your credit union representative and say, “I’d really like to automatically have something pulled aside and saved up so when these large expenses come up we don’t have a big surprise.” A lot of our Keystone clients have done this. Sometimes people will have several types of savings accounts. They might have a travel account or a vehicle account to replace a vehicle. It could be several years accumulating enough payments to buy that next vehicle.
None of these things should be a surprise, but sometimes they are. Sometimes Murphy’s Law has an effect. There are ways to avoid the unexpected disasters that could happen. Sometimes we end up having too much to pay just because it was unexpected. Most people don’t like the word budgeting, but budgeting means at least having a plan. It may not be perfect, may not be down to the dime as far as your expenses, but having some framework for how much we tend to spend on a monthly basis is helpful. Some things are very predictable, right? They come up every single month. Other things are predictable but they don’t come up every single month. It could be once a year or a couple of times a year, like a car insurance premium that you need to plan ahead for and at least know which month it will be taken out. That way we don’t have to go cash out investments or something like that just to cover normal expenses.
We don’t want to go in the hole over Christmas. We don’t want to go into debt. Some of this is just financial maturity. We’re going to talk about some strategies around this. I don’t mean that some of you are immature, but sometimes there is a need for financial maturity with having these things in place and being responsible enough to know what amounts are too much to spend. We could do the same thing with eating and drinking or just about anything in our lives, right? When there’s too much of one thing it can be unhealthy, and certainly overspending can be unhealthy if it results in going into debt.
There are strategies around this. There are a lot of patterns of success that we’ve seen. We know how our wealthy clients got there. Once in a while, somebody gets a big inheritance or some kind of a big windfall, but most of the time our wealthier clients started with very little. In most circumstances, people were poor when they started out. They got a good education to where they were able to open up a business or something. They worked really hard over years and years and years to build something up, whether it was a 401K or a business that they were able to sell. The bottom line is, they put money away over many years and that resulted in success. Most of it is not luck. Most of it is very purposeful, consistent investing and saving, putting money away, paying off debt.
If you find yourself in a position where you’re saying, “Well, what do I do first?” We’ve got ways to handle that. Before we dig into the specific steps, I want to point out that Murphy’s Law is a real thing. If something can go wrong, it will. That is paraphrasing Murphy’s Law. To say that if something can go wrong, it will, probably sounds really cynical, right? But those of you who have been around for a while—if you’ve had a car, if you’ve had a dog, if you’ve had a house, if you’ve had kids, if you’ve ever gotten sick or had something happen that you didn’t expect, you know that sooner or later—you may not know when and you may not know what it will be—but something will happen. That’s just part of being human and having a financial life.
You’ll have some responsibilities that come up that you couldn’t possibly have planned for. Statistically, if you have a house long enough, some things will break down. You’ll have a roof that gets destroyed by hail. You’ll have something that happens that you couldn’t have expected. We try to mitigate some of those things by having insurance for the things that are insurable: car insurance, health insurance, home insurance. As financial planners, we always recommend that you have a good insurance review and we do that for our clients along with your insurance agent. We want you to have enough protection. But not everything can be insured against. Let’s say your dog gets sick. That could be a couple thousand dollars easily from a vet bill. You could buy pet insurance, but there are other things that you just can’t predict and can’t really protect against, so you need to budget for that stuff by setting some money aside.
We like the Baby Steps, borrowing from Dave Ramsey. We think that he has come up with a pretty darn good framework. If you’ve talked to us very long, you know that we use the Baby Steps a lot simply because they’re anybody can follow them, even on a very small income. So if you’re just starting out, maybe you just got out of college and into your first career and you’re making some money and trying to figure out what you need to do to have some money that’s extra each month, check out the Baby Steps.
Baby Step #1 has two parts. One is to have a budget. You can be detailed about it or general about it, but having a plan is better than having no plan. I highly recommend that you use a technology tool to help you with this. You don’t have to do manual entry or spend hours and hours. This is not something that should take a lot of time. There is a lot you can do to connect accounts and arrange things so that stuff is feeding into the software or the app automatically. We do like a couple pieces of software that we’ve tried personally. We don’t have any dog in the fight financially; it doesn’t matter to us which one you choose. One of those is Every Dollar, which is a Ramsey product. If you go to Dave Ramsey’s website, that one is an online software and I think there’s an app that ties into your phone. Very easy to use. We provide that to our Keystone employees free of charge as an employee benefit. We’re certainly happy to visit with you about that product. Another one of those is called Mint. A lot of people use Mint. There are several others that are popular. Take a look at some of the technology tools. Some are free, or they’re cheap. Use them to shave off some of the time having to become a master budgeter. They’ve already done a lot of the work for you
The other part of Baby Step #1 is having a baby emergency fund of $1000, just $1000 in a separate savings account at a bank or credit union. Don’t put it in stocks or bonds or anything like that. This is just cash in your checking or savings account for minor emergencies. A thousand bucks will not cover every emergency but it will cover some minor things; it’s something standing between you and Mr. Murphy, right? With Murphy’s Law, you know there will always be minor emergencies or unexpected expenses that come up, so that’s a good place to start.
Baby Step #2 is the debt snowball. Sometimes people have a lot of debts stacked up. You might have credit card balances, student loans, car loans. I certainly did earlier in my life. I started out poor in college, living in a crappy apartment and driving a crappy car and trying to figure out how to pay the bills each month. And thankfully, I’m not out there anymore. I’m further down the path, but I know some people are trying to figure out, “How do I get out of this? I have all these different debts accumulated.” It doesn’t matter why at this point; it’s just the reality that you may have some debts stacked up.
The mortgage is a completely different kind of debt. For right now, we’re just talking about everything else, which includes credit cards, student loans, car loans, boat loans, any personal loan, even from a family member. It’s any money you owe.
We’ve done a whole episode on the debt snowball method. You can go back and listen if you care to know the details. Basically, the debt snowball method says that you take a piece of paper or a spreadsheet to list out your debts from smallest to largest. List them by the balance owed, not the interest rate. We’re not talking about monthly payment, we’re talking about balance. So if we use a simple example, let’s say you had a $500 debt on a store credit card, maybe from Home Depot. And then you’ve got a $1000 Master Card balance and a $5000 student loan. It doesn’t matter what the interest rates are. You might want to argue with me on this one, right? Because you say, “Well, no wait, Home Depot said they’re not gonna charge me any interest for the first year.” You still want to pay off the smallest debt first because doing so will eliminate an entire debt, an entire payment. And Home Depot is not stupid—or the bank that is providing that loan. They know that when it comes time that the interest is going to start coming due or accumulating, there will be a certain percentage of people who have something happen in their life. Murphy’s Law. You could have some emergency right about the time you were gonna pay that thing off. Now you’ve got a $2000 debt because the dog got sick and had to have some surgery. So now you can’t pay off the Home Depot debt and it’s charging 20% plus interest. This stuff happens. That’s reality. It’s just life. So we need to plan ahead for it.
If you eliminate the smallest debts first, that is going to free up the extra money for whatever amount was required on that Home Depot payment. Now it’s gone, which frees up more cash flow. Now you can tackle the credit card and after that student loans and after that car loans or whatever other debts you have. Studies have shown that this is the most effective way for the average person to eliminate debt as soon as possible and get to a place of financial freedom. There is more information on the debt snowball in Dave Ramsey’s book Total Money Makeover.
Baby Step #3 is going back to that baby emergency fund, that baby savings account from Step 1 and turning it into a bigger emergency fund. Because as you know, many emergencies are much more expensive than $1000. A lot of things could cost more than that these days, especially with inflation. Anyway, you want to build up three to six months’ worth of living expenses for your emergency fund.
I want to step back for a second because you might wonder how much that should be. If you did your budget in Baby Step #1, you have an idea of what on average you spend per month for your needs. We’re not talking about adding in vacations and all that stuff; we’re talking about required living expenses, the things that come up every month. The groceries, gas in the car, utilities, things that you can’t avoid to be able to live a basic life, not going on a nice trip to Tahiti or something like that. That would be cool, but we certainly wouldn’t include that in the calculation to accumulate an emergency fund. You’re going to go with three to six months’ worth of living expenses. In my experience as a financial planner for 23 years, that amount covers most people for most emergencies.
Once you have that three to six months’ worth of living expenses in a savings account, you dip into that to pay for unexpected expenses instead of borrowing the money. That will save you a lot of heartache and a lot of interest that you would otherwise have had to pay. Now you might say, “Well, but once I dip into it, I don’t have the three to six months’ worth of living expenses.” Now you need to reaccumulate, right? Resave, build that back up.
If it was a major emergency you might think you need to use a home equity loan. Or you might want to buy a new car and get a car loan. We could debate about that, right? We might ask, “Do you really need that expensive of a car?” This isn’t about judging you, it’s just about reality.
I’ve made plenty of financial mistakes in my life. I certainly was financially immature in my younger years. And once in a while I still do something stupid, so it’s not to say that any of us is perfect, but you want to be careful and keep a mindset that you don’t want to be in debt once you’re out of debt. Don’t get back into debt. Make a decision to permanently have cash going forward, and to have things built up and planned for in advance so you don’t have to go out and take on debt again. If you’re not doing that; if you’re just perpetually in Baby Step #2 and never paying off debt, the banks love you. You’re probably their favorite customer. If you don’t have any debt at the bank, they probably don’t like you very much. You’re just not very profitable, right? Because that’s how they make money; it’s based off of loans—especially really high interest loans.
Eventually in Baby Step #3 you’ve accumulated enough cash for that emergency fund. Then Baby Steps 4,5,6,7 get into the fun stuff. That’s after you’ve gotten into a really stable financial position, so you can avoid the financial hangover. If you’re following these steps, you won’t have a financial hangover. You won’t overspend, or at least, your spending will not be unplanned. That’s not to say you couldn’t spend a bunch of money on Christmas presents if you planned ahead. There’s no problem with that, right?
There are other episodes where we go into copious detail on the Baby Steps. But to give you a quick teaser, Baby Step #4 is saving for the future. Many people say the retirement years. It’s expensive to retire if you want to retire at a reasonable age. It’s going to require a good chunk of money, especially if you’re younger, because you’re probably not relying on a pension or Social Security in your planning. So saving for the future should start as early as possible. That’s why we want to get out of debt, get the cash, and so. Then we can move on to retirement planning.
Baby Step #5 is accumulating money for college education expenses. There are a million different ideas out there on how much you want to be able to fund or help with kids and grandkids. Bottom line is, get something set aside and have a plan to at least pay for a portion of that, probably through some type of a tax advantaged college education plan.
Baby Step #6 is paying off that mortgage early. Ideally you pay off your mortgage in 15 years or less. To follow Dave Ramsey’s teachings you would take out a 15 year fixed mortgage and pay it off in 15 and become completely debt free.
Baby Step #7 is when you really go nuts as far as accumulating wealth. You’re completely debt free and you’ve got lots of cash in the bank. You’ve got a budget, you’ve got a lot of discretionary money that can now be put into investments. It could be that you’re accumulating rental houses. You could be investing in stocks. There are many possibilities, so I’m not recommending anything in particular when I say you’re investing in something you expect a return from either now or in the future. Then you can give generously to charities of your choice.
I hope this was helpful for you, and I know there are a lot of people listening. Our downloads keep going up and up and up, and we are now in the top 25% of all podcasts. There are a lot of podcasts out there, but we have some very loyal listeners. I definitely enjoy that and thank you for being here and sharing the episodes, letting other people know what we’re doing. We certainly want to be here as a resource and a support. As Certified Financial Planners, that’s our job—to help people make good, informed financial decisions. You are the CEO of your own finances. You are the CEO of your own wealth, just like I am, and everybody else is. We’ve got to take responsibility, because nobody else will do that for us.
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This episode has been prepared for informational purposes only and is not intended to provide and should not be relied upon for tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors. Investment advisory services offered through Keystone Financial Services, an SEC registered investment advisor.