Personal finance, depending on who you ask, is made up of several different pillars. Think of these pillars as the structural beams in which you create the financial home of your dreams or nightmares, depending on the choices you make. In order to have a solid financial foundation and home, you MUST take into account ALL of the pillars in order for your crib not to fall apart! I personally think, that an individual’s finances consist of four pillars:
Even though each pillar is unique and plays a critical part in getting your financial house in order, they must be focused on collectively. For example, it’s counterproductive to be consumed with saving for retirement while completely neglecting the mountain of debt that is growing in your backyard.
That’s why I believe, when it comes to your finances, all of the pillars constantly need to be inspected in order to gauge the integrity of your financial home. If you don’t want your home to crumble right before your very eyes, (yes -I know I’m being dramatic) then paying attention to the bigger picture while seeing the finer details, is critical.
Pillar #1 – Debt
Debt, to me, is the outcast of the entire group. You may be asking, “what the hell does looking at my debt have to do with helping me build a solid foundation?” Trust me, I know that debt is awful, as I’ve mentioned before, I started my debt free journey in 2016 (click here to read), but if you don’t take your debt into consideration, you can kiss your sweet financial crib goodbye.
You’d be better off building your house on quicksand from the start because that is exactly what debt is, quicksand. Quicksand, according to dictionary.com, is “loose wet sand that yields easily to pressure and sucks in anything resting on or falling into it.” Debt, if not managed properly, can quickly turn into quicksand that you may find yourself relying on (resting on) or can turn into a trap/pit that you “fell” into. Now don’t get me wrong, debt isn’t always evil but if you don’t manage your debt correctly, you can quickly find yourself drowning in it. You may be thinking “ok wait, based on what I just read, debt sounds like the devil, how is it not evil?” Well one example of good debt is a mortgage.
A mortgage, as many of you may be aware, is a form of debt. It’s considered debt because when you have a mortgage, you don’t own your home out right.You have to make payments to the mortgage holder (also known as) the lender until the mortgage is fully paid/satisfied. A mortgage is essentially an example of how debt, when used correctly and responsibly as leverage, can help you purchase something that would otherwise have taken decades to be able to afford upfront.
When it comes to managing your debt, the best snapshot or quickest way to gauge the amount of debt you have relative to what you are bringing in is your Debt to Income ratio (“DTI”). It’s a snapshot, at any given moment, of how much debt you can afford to take on or how much debt you’re currently managing. According to consumerfinance.gov, “your debt-to-income ratio is all your monthly debt payments divided by your gross monthly income”. This is one of the measures lenders look at to evaluate your ability to make payments on various debts/money you’ve borrowed.
For example, take Jake Doe from the post I wrote a while back on interest (click here to read more). Let’s say Jake brings home $2,500 each month (the actual amount of money that gets deposited into his account) and all his debts add up to about $1,500 (rent, student loan, credit card, car) each month.
$1,500 (debt) / $2,500 (take home) = .60 or 60% DTI
What exactly does that mean? Think of it this way, for every dollar you bring in the door, 60% of it is going towards someone else’s pocket (bills). While a debt to income ratio of 20% is considered good/low, a debt to income ratio of 40% or higher is, what the Federal Reserve likes to consider, a sign that your pillar may be on the verge of busting or is stressed. In the above example, Jake might be fine on paper but struggling a little bit to keep up will all the other requirements of life like water, healthcare, gas, food, etc.
Your DTI is one of the many aspects of the debt pillar you should look at when inspecting your financial home. The lower your DTI, the better! Periodically taking inventory of your DTI ratio is a great way to keep yourself in check.
Here are some other questions to ask yourself when inspecting your own debt pillar:
How much debt do you currently have?
What types of debt do you have?
What is your debt to income ratio?
What is your game plan to paying it all back?
How do you plan on not taking anymore debt on?
How can you lower your current expenses?
Are you paying your bills on time? If not, have you called and talked to the lender to see what arrangements you can workout?
Pillar #2 – Savings
Personally, I think that the “savings” pillar doesn’t get enough love in our society today. According to a survey conducted in 2017 by gobankingrates.com that included over 8,000 participants, 57 percent of respondents said they have less than $1,000 in a savings account. I get it, the act of saving money isn’t as glamorous as the act of spending it. I know for one thing, I would much rather be popping bottles of champagne, on a yacht, while eating artisanal croissants off the Almafi coast than save money! However, as painstakingly boring as saving money can be, it does give you something money can’t buy, peace of mind.
Think of the savings pillar as the cornerstone of your entire home. The cornerstone, back in the day, was generally the first foundation stone to be placed. Like the bricks of a building when it comes to the cornerstone, all of the other pillars rely heavily on the savings pillar. Some of the best ways that you can support this pillar is by automating your savings, getting on a written budget (click here to read more), living below your means, and by building up an emergency fund.
Free Budget Sheet
Make Real Cents Free Budget Sheet- Download as many times as you want!
Automate Your Monthly Savings- Set it and forget it. Ever hear of the term “Pay yourself first?” Most people look at it the other way around, they usually pay the bills first then pay themselves with whatever is left. Always pay yourself first (click here to read more). Whether it be $1 to $1 million dollars, each month as soon as you get your paycheck you should be putting money into your savings before doing or paying anything else.
Written Budget – Getting on a written budget and sticking with a plan each and every month for your money, will help you identify areas in your life where you can save even more. Budgeting (click here to read more) helps you maintain an active role in your money situation and should help reduce wasteful spending which can ultimately be put towards better use (money towards debt or savings).
Live Below Your Means – Spend less than what you make! Stop buying stuff you don’t need to impress people you don’t like. Sacrificing a little today will go a long way tomorrow!
Emergency Fund- Fully stockpiling your emergency treasure chest (saving 3- 6 months of living expenses) will help you combat the “oh shit, how am I going to pay for this” moments in life. Whether it be losing your job, having to get a new car because the wheels fell off your old one, paying an unexpected hospital bill, you name it, things happen and they happen fast. You never know when you need a big bucket of cash to help crush an even bigger problem.
Pillar #3 – Retirement/ Asset Management
Retirement in and of itself, is worthy of a few posts, a short section on it won’t give it the justice it deserves, but I’m going to give you a brief summary.The sooner you start saving towards retirement the better, time always seems to have the investor’s best interest at heart. The longer you save, the more money there will be to continuously compound, and the more you’ll have time you have to recover any losses should anything happen.
Here is a quick example of the power of time and the miracle of compound interest:
As you can see, the 23 year old that started early and only invested for 10 years then stopped, will actually have more money at retirement than the 36 year old that started late. This graph only goes up to 50 years old but you get the picture. The 36 year old will inevitability have to continue to invest money up until retirement and still not have nearly as much as the kid that started early. The decisions you make today will have a resounding effect on your tomorrow. The average life expectancy for a healthy adult, according to a report on 2016 data published by the National Center for Health Statistics, is 78.6 years old/years of age. That means if you plan to retire at 65, you will need AT LEAST enough money to out last you 13+ years. That is a LOT of money to save, so the sooner the better.
Another part of this pillar is asset management. Your ability to manage your money efficiently at retirement, is critical in order to not blow it all in one shot. Planning for things like property tax, the proper amount of drawdown from your retirement account(s), managing rental properties, ensuring your invested assets are still growing at a good rate, etc.
Pillar #4 – Life Planning
The life planning pillar is just that, the pillar that supports all of the other aspects of life. Aspects that affect your financial home such as, purchasing life insurance, funding your child’s college education or grandkids education, selecting the right health insurance to meet your needs, putting a will in place, creating a trust fund, filing your taxes, and all that jazz! Life is what happens when everything else is going on. These are important pieces of the financial structure, that need to be checked off at the appropriate time(s).
For example, as I get older, I want to make sure my partner is all set should anything happen to me, so I’ve been looking into various life insurance providers. I’ve also been looking into what type of life insurance will be best for me, term vs whole. Maybe you’re past that point and would like to fund your child’s education, so they don’t take out student loans. Take it a step further and maybe you have elderly parents that haven’t been very trusting of banks but have a lot of assets. What will happen when they pass? How will their estate be taken care of?
Life planning is such an important pillar because all you really can do is plan and hope for the best. Without a plan, like the old saying goes, “ when you fail to plan, you are planning to fail”.
The biggest takeaway from all the pillars is that consistency is key. Consistently checking in on all four of these areas of your finances, will set you up to only have to make minor adjustments now rather than major adjustments later. Building a solid financial home that incorporates all of these aspects, will help keep your dream home (personal finances) in tack! Can your current financial home support your dreams and ambitions for the future? If not, it’s time to start building these four pillars in your life today!
4 financial pillars to consider when getting your financial home in order:
1. ) Debt (mortgage, student loans, credit cards) – Managing your debt and knowing what your debt to income ratio is.
2.) Savings- Pay yourself first, get on a written budget, live below your means, build up an emergency fund.
3.) Retirement /Asset Management – Starting early is key! The more you can set aside for your future today, the better off you will be tomorrow.
4.) Life planning – All the other nitty gritty details of finances that will need attention like purchasing life insurance, funding your child’s education, etc.
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