Most people approach financial freedom by responding rather than planning. Planning your finances, rather than responding to alternatives presented to you, is a far more secure path to achieving your long-term financial needs. Below is a sequential strategy that revolves around achieving a positive cash flow margin and then making decisions regarding the use of this margin.
Step 1: Pay off all your high interest debts first, like credit cards and hire purchase. Repay your mortgage as fast as you can, and you’ll end up paying thousands of dollars less overall. Not having to pay that interest is, in effect, the same as achieving the same rate of return on any monies invested by you.
Step 2: Save for an emergency fund. Save a ‘cash cushion’ of 2-3 month’s income (this is worth doing even if you’re paying off a mortgage, but not if you’ve got high interest credit card debt). This will help cover you if the car breaks down, or if you lose your job, or any unexpected major expense. This becomes, in effect, your own bank. Once the money is “borrowed”, it should of course by replaced as soon as possible.
Step 3: Draw up a budget and stick to it. You should spend less than you earn, so cut costs and/or find ways to increase your income, rather than borrowing to pay bills or to pay for consumer items. Borrow only what you need, and know the true cost of your debts. The true cost of your debt can be significantly higher, eg. interest payments can greatly increase the total cost of a purchase.
Step 4: Once you’ve paid off your high interest debts, start regular saving for the short term. Short term savings include savings for a deposit, a holiday or a lump sum to invest. Set aside about 6 months’ living expenses in a interest-bearing money market fund account.
Step 5: Know your net worth. Your net worth is the difference between what you own and what you owe. Set goals to increase it. Protect your assets. Buy the right amount of insurance, make a will, and see if a trust is right for you.
Step 6: Set long term goals, especially a financial plan for your retirement. Aim for financial independence, save for your children’s college education, and plan to increase your cash-flow margin.
Step 7: Consider investing to make your money work for you. By this time, you should have met all your financial goals. Many people simply jump to this step without taking steps prior to this, and live with the high risk of losing it all.
Today’s Bottom Line
Ultimately, it all boils down to 3 simple rules in financial planning: First, spend less than you earn. Second, avoid the use of debt. And lastly, save up for your financial freedom. Download the Small Groups kit here.