How to Avoid Debt is . . .
a forgotten concept in modern America. Here in the United States debt is a way of life. I know very few people who are legitimately concerned about how to avoid debt (even those who owe most of their paychecks to someone else — they just keep digging a deeper hole)!
Two Things We Love to Buy
We love to buy coffee and cable (TV that is).
Following are a few scenarios (ignoring inflation for simplicity).
You spend $5 each morning on a Starbucks latte. That’s $25 per week (excluding weekends), $100 per month, $1,200 per year, $12,000 over 10 years, and $48,000 over 40 years.
How about cable? The average cable bill is about $100 per month according to this article on fortune.com. That’s the same amount I calculated for coffee.
I say cut the cable and say “no” to Starbucks and throw the savings in a bank account, and in one year you’d save $2,400, plus interest. In 40 years you’d save $96,000. With interest and inflation accounted for, that number would be much higher.
More Things We Like to Buy
It wouldn’t be realistic to say the average American only blows cash on cable and lattes.
How about going out to dinner? $50 per month seems quite the low estimate (that’s about one dinner at Red Robin for a family of four) but let’s underestimate. $50 per month for one year would equal $600 per year, $6,000 for 10 years and $24,000 over 40 years.
Let’s talk about car payments. The typical American car payment is over $400 per month but let’s just say it’s only $300. That would be $300 per month for maybe 6 years. Let’s just ignore (again for simplicity) the interest. Over one year you’d spend $3,600 and after six years you’d be minus $21,600 (plus the down payment).
So quit eating out, consume more fresh vegetables, be healthier and save a bunch of money. Sell your car, buy something used and save that $300 per month (and earn interest in the process). In just one year you’d save $4,200 if you quit eating out and abolished your car payment.
If you said “no” to Starbucks, cable, dinners and your car payment, you’d save $6,000 in just one year. In 40 years you’d save $240,000! That’s about a quarter-million dollars.
Again, that’s ignoring the interest you’d pay for any borrowing and the interest you’d earn from putting your money in a savings account (or in stocks or bonds).
Managing Your Money Effectively
So how can we manage our money effectively? Here are some tips that have worked well for us.
Avoid Debt At All Costs
In over 18 years of marriage, we’ve paid no interest on anything but our mortgage. We live within our means. We use credit cards, sure, but we manage them; they don’t manage us. We pay them off in full each month. So we reap the rewards of utilizing a credit card (convenience, monetary rewards, airline miles, etc.) but we don’t pay the price for using them–and that price is interest.
It’s fine to have some short-term credit card debt, but live within your means and pay off your bill each month before you have to start paying interest.
The problem most people have is that they spend more than they have. Then, when the bill comes, they don’t have the cash to fully pay the debt. Now the credit card company is making profit, and they (the borrower) are throwing away their earnings.
You want to buy a car. My advice? Pay cash and avoid the hefty car payment and associated interest fees.
But I don’t have the funds to purchase a car with cash!
Neither did we. So here’s what we did. When we got married, we bought a very cheap car for about $2,000. Most people can afford that because that’s about five car payments. Cheap.
We drove that clunker for a few years while putting our “car payments” in an interest-bearing checking (or savings) account.
We upgraded a couple years later and bought a Ford Escort with about 20,000 miles on it. Almost new! An Escort is by no means a luxury car, but we paid cash for it. It was ours. And we kept faithfully putting our “car payment” in an interest-bearing account.
A few years later, we bought a brand-new Pontiac Vibe for about $17,000. A Vibe is still no Rolls Royce, but it’s a reliable car with good gas mileage. We’re still driving that car. And we’re still putting our “car payments” in an account that we don’t touch. When the time comes, we’ll have money to buy our next car with cash.
This method takes a lot of patience. You can’t get the car you want right now because you simply don’t have the cash for it. Sure, you can get an expensive loan and put a financial burden on yourself and your family so you can roll in a luxury sedan, but is your financial freedom really worth it?
Avoid debt at all costs.
Be Organized, Planful and Patient
Being organized, planful and patient is how you avoid debt. It keeps you ahead of the game. Here are some ideas.
We’re credit union members. We can append numbers to our main account number to create multiple sub-accounts. So, we have a -1 account, a -2 account, a -3 account, etc. Each account has a specific purpose.
For each bill we have, we have a separate account. For example, we have a car insurance account. We put money into that account as soon as my paycheck comes as if we’re paying a bill. Once it’s in the account, we can’t touch it. It is gone. It is spent. When the quarterly bill comes due, all the necessary money is already in the account. We pay the bill and it doesn’t hurt at all.
We have a car account, a car insurance account, a Christmas account, a vacation account, an Eric spending money account . . . you get the idea. As I said before, as soon as the paycheck comes in the mail, we put the necessary money into the necessary accounts and it’s gone. It doesn’t exist for us anymore. It’s already spent.
The benefits are substantial.
If the car breaks down and we receive a $600 repair bill, it doesn’t hurt. We pay the bill and take the money from the car account. Our bottom line doesn’t suffer. That money was already there, just waiting to be spent on such a circumstance.
When Christmas rolls around, we go out and we buy our Christmas gifts. It doesn’t hurt and our bottom line isn’t affected. The money was already there, just waiting to be spent on Christmas gifts.
When Eric (me) wants a new tripod that costs $500, he goes out and buys it. The wife doesn’t say a word about it. Why? It’s my money. I can use it for whatever I want. And, importantly, it doesn’t affect our finances in any way.
This is a dramatic shift in thinking from the typical American mindset which is, buy now, pay later.
Here’s a different, more lucrative mindset — save now, buy later.
Let’s look at a hypothetical car account. Joe pays $300 per month, every month, into an interest-bearing savings account. In five years, that account has $18,000 (plus some interest, minus any unforeseen car repairs). At that time, Joe can simply buy a new car for cash. Obviously he can’t buy a brand new Toyota Landcruiser or a Dodge Ram 3500, but he can buy a nice car like the 2007 Pontiac Vibe that we bought brand new a few years back (for cash).
Does Joe have to wait a while for his new car? Yes. Does he have to drive a beater around for a few years because he can’t afford anything better at the time? Yes. So does this method take a bit of patience? Yes!
If you’re not able to see past “the now,” this system won’t work for you. If you want a $50,000 vehicle right now and you don’t have the cash, well, you’re going to have to get a loan and then you’ll always be in debt, never getting ahead. And that’s exactly where most Americans are. In debt. Always trying to catch up but never getting there. But at least they’re driving around that Lexus and putting up a nice front.
Patience is key. If you want to build wealth and don’t have a lot of income rolling in (like me), you must be patient. Even now, I’m not driving the vehicle I want to drive. I have an old beat-up Nissan pickup I’ve been driving since 1998 and I have a 2007 Pontiac Vibe. I don’t exactly feel like a high roller when I park my rusty old pickup next to a brand new Tundra at work.
But it’s OK. People without debt have something most people don’t have. Peace of mind. And cash reserves on hand. Save now. Buy later.
Recap! Why Are Americans Broke?
- We buy things we don’t need.
- We live in a constant state of debt.
- We buy now (because we don’t have the money) and pay later.
- We pay interest instead of earning interest.
- We spend freely and aren’t organized.
- We don’t plan our spending.
- We aren’t patient. We want something so we buy it now.
Keys to Breaking the Debt Cycle and Building Wealth
- Don’t buy things you don’t need.
- Avoid debt (especially credit card debt) at all costs.
- Save now, buy later.
- Earn interest, don’t pay it!
- Be organized.
- Plan your spending carefully.
- Have patience!
How to Get Started Immediately
- Make a plan now. Tonight (or this morning–whatever it is). Don’t wait.
- Believe that you can get out of debt. You can.
- Sell your fancy vehicle and buy something cheap.
- Buy a vehicle that gets good gas mileage.
- Stop buying needless luxury items (do you really need that new TV?)
- Eat at home more often (it’s healthier too).
- Cut your cell phone bill (there are almost always cheaper options than what you have–shop around a bit).
- Say goodbye to cable TV (it’s especially easy if you live in an urban area; rabbit ears on your roof will give you an uncompressed signal–a better signal than that provided by your cable company).
- Stop buying Starbucks every day. Make coffee at home for just a few cents per cup.
- Evaluate all your monthly bills and try to minimize them.
- Shop at second-hand stores (we just did that today).
- Buy in bulk.
- Pay off those credit cards!
- Cut up those credit cards!
- Have a garage sale and simplify your life a bit.
- Open a savings account today.
- Create relevant sub-accounts today.
- Set goals. Decide what you want to buy and start saving.
- Donate unneeded items. Track your giving and reduce your taxable income.
Any other ideas? Post them in the comments!
How to Avoid Debt–The Most Important Things
If you don’t remember anything else, remember these two things:
- Don’t spend more money than you have (don’t buy on credit). Save your money, earn interest and buy what you want when you have the money to buy it.
- Avoid ongoing monthly fees on luxury items (cable, coffee, eating out, car payments).
It’s not the American way, but it’s the smart way. It can be difficult to get started, but once you’ve built up cash reserves, you will be well on your way to peace of mind and financial freedom.
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