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Heard on the Street Blog

3 Steps to Financial Freedom

Whatever your financial goals are, there are some things that will be universal truths in helping you succeed. Whether your goal is to be a millionaire or to help put your kids through college, I have compiled a list of 3 Steps that will help you discover financial freedom.


1. DEBT -

Get rid of (most of) your debt. Debt can be the Achilles heel to your financial security, but not all debt is bad. Some debt, like a mortgage, is collateralized debt, meaning that the interest rate is lower because if you don’t pay your loan the bank takes your house. This is an okay form of debt because most people don’t have hundreds of thousands of dollars of cash to purchase a house outright. But think of that house as an asset, each month that you pay your mortgage, you are building up more equity (ownership) of your house. Eventually, once you’re wealthy you shouldn’t ever have to buy things on credit but until that time a little debt here and there is okay. There are some forms of debt that you should pay off before others. For instance, I always tell people to STAY AWAY from credit card debt, it will eat you alive. Credit cards are a form of uncollateralized debt, meaning if you go bankrupt, the Credit card companies are the last people with a claim to your assets (and they usually get nothing). So, credit card companies let you spend a certain amount and pay it off in a month or over years. If you use a credit card to buy things you don’t have money for you’re actually borrowing from your future self because if you spend more now, you will have less to spend in the future because you’ll have to pay back your creditors (with interest). Credit card companies offer those sweet deals like “Get $200 when you spend $2,000 in 6 months” or they will give you “3% cash back on such and such category” and they can offer those deals because those same credit card companies are charging you up to 29.99% interest. The longer you keep that balance on your card, the larger your balance becomes. Picture this, you have a credit card balance of $10,000, you decide you will never spend money on that credit card again, your interest rate is a fixed 25% APR and your minimum payment is $15 or 3% of your balance (whichever is greater). So you decide you’re only going to make the minimum payment on that card, it would take you 32 YEARS to pay off that debt and you would be charged $22,000 in interest during that time. Assuming you didn’t incur any more credit card debt during that 32 year period, you would have paid $32,000 for that $10,000 you spent so many years ago. That is why getting rid of your debts is so important, and why you need to start by tackling the highest interest debt first, and tackle it aggressively. Ideally, you should ALWAYS pay off the balance of your credit card at the end of the month because then those credit card rewards and cash back is essentially free money. I used to work for a credit card company- (I quit because I saw how much they hurt people), but in the credit card industry, they hate the people that pay off their balance every month, they are called transactional creditors, that is, they have the money to pay off their balance every month and they just use the credit card for the rewards and because it is easier to use than carrying lots of cash on you. They actually lose money on those customers. However, there is another group that they love and that is the revolving creditors, that is, the people who may not have the money to pay off their full bill every month and therefore carry their balance to the next month. They love revolving creditors because that is who keeps the credit card companies in business. Bottom line: you can’t have financial freedom if you’re drowning in credit card debt, it is easy to fall into that hole but make sure you only spend within your means so you can pay off your bill every month. Also, I don’t have time to talk about every sort of predatory credit lending but stay away from high interest loans, if you can, opt for a collateralized debt, yes you are putting up collateral (ie your house, car, etc) but as long as you plan on paying it back then you’ll be fine and the interest rate will be much lower. Also always stay away from payday loans- just stay away from them at all costs.

2. Investing-

This is arguably the most important step to financial freedom and it is so incredibly important to start investing as early as you can because of the power of compound interest. Compound interest is essentially the “interest on interest” or another way to explain it is the interest earned from reinvesting your interest. And the powerful thing about this is that while it starts gradually, it grows exponentially not linearly. One of my favorite quotes is from the great Albert Einstein who said “Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.” He then goes on to say “Compound interest is the most powerful force in the Universe. Compound interest is the greatest mathematical discovery of all time.” Yes, that’s right, the smartest man of the 20th century, the same one who also formulated the theory of relativity could not emphasize enough just how powerful a force compound interest is. So if you don’t take my word for it, at least take Albert Einstein’s. This is why it is so important to invest early, so you can let the power of compound interest take effect. There is a simple rule in finance called the Rule of 72 which is an easy (fairly accurate) way to estimate how long it will take for your money to double in size. So, let’s say you have $10,000 and you are earning the market’s historical average rate of 10%. I don’t have enough time to show you all the calculations that prove the Rule of 72 works but take my word for it, to calculate how long it will take you take 72 and divide it by your percent rate of return which is 10. That means it would take 7.2 years for your $10,000 to turn into $20,000. Now this is where you start to see the magic of compound interest because applying that same equation, in 7.2 more years you now have $40,000, then 7.2 years after that you have $80,000 and then 7.2 years after that you have $160,000 and then another 7.2 years after that you’ve got a whopping $320,000 and so on. That is ONLY if you just invested that original $10,000 and didn’t invest any more money during all those years. Now imagine if you had to continued to invest $10,000 a year, every year, for those 36 years you would have 3.6 million dollars. So if you started investing when you were 20 -years-old, forty three years after your initial investment, when you are comfortable retired at 63, you would have 7.25 million dollars. This is why it is so important to start investing as early as you can because the greatest force to drive compound interest is time. Let’s say you started investing when you turned 27 instead of 20, when you retired at 63, you wouldn’t have that 7.25 million you would have $3.6 million, which is the difference between being able to retire comfortably and being able to retire and never worry about money again. The best time to start investing was yesterday, the second best time is today. A great rule of thumb is to invest 10% of your money and live off the other 90%.

3. Diversify your Sources of Income-

Have you ever heard the saying “Don’t put all your eggs in one basket”? Well, the same thing applies to your sources of income. Along with your day job (the one that pays the bills), you should try to have at least two other sources of income (but the more sources, the better). This is arguably the hardest of the 3 to do but it is very important. Along with your day job and your investment income (which you shouldn’t be touching yet) you should add a third form of passive income. That is, income you earn that requires little to no additional work on your part. An example of this would be something like investing in real estate and owning a rental property. Basically you buy it and rent it out; the rent payment covers the mortgage plus a little extra money for you. Each month, you are building equity in the property and earning income without doing any physical work. Despite the real estate crisis in the 2000’s, real estate is actually still a fairly safe investment as long as you pay a fair price for it. However, there are plenty of other examples of ways to receive passive income such as stock dividends, bond or treasury note coupon payments, money market accounts, etc. There are really two ways to diversify your sources of income and that is to 1. Invest Money or 2. Invest Time and Effort. Due to my personal laziness and the amount that I cherish my time, I personally prefer to invest money and let my money work FOR me. That is the last part of this step is that you can either work for your money or you can have your money work FOR YOU. If you have your money work for you, then you can have the ability to devote your time and effort to other passions without having to worry about money.