What does a return look like in your stock portfolio?
6%?
10%?
20%?
Whatever your goal, whether it’s in your personal stock account, mutual funds, or your retirement account, you are in a speculative environment where you could make your desired percentage — or you could easily LOSE that much or more if you or your mutual fund company or your financial advisor are WRONG.
Meanwhile, if you have loans or credit card debt, you carry these hefty balances that you MUSTpay off. If you choose not to pay these things off, then your only other choice is bankruptcy. During the bankruptcy process, they will likely take away the things you bought in the first place (your house, car, or boat)!
What is the interest rate on your debts? Since these are interest rates AGAINST you (meaning money flowing out of your bank account and into someone else’s), these interest rates should be viewed as negative percentages. Let’s look at some real world rates for various debts below:
Mortgage = -5.25%
Car Loan = -4.25%
Credit Card (Low Int.) = -16.99%
Credit Card (High Int.) = -22.99%
HELOC (Home Equity Line of Credit) = -6.25%
Student Loans = -3.99%
So here is the problem: “do you really have as much money/net worth as you think you do?” You are the summation of your ASSETS (+) and your LIABILITIES (-). If you have more liabilities (like mortgages and car loans), then you do assets (cash in the bank, stock accounts, house value, car value), then you are worth NEGATIVE dollars. To equal zero, you literally have to go out and pay off ALL your liabilities and then save some more money to get back to positive.
There is a surefire way to increase your net worth, however. PAY OFF YOUR DEBTS! If you stop and look at your accounts, you can make MORE money by paying off your debts than by putting your money in the bank or the stock market. Here’s an example below:
-$5,000 stock account makes 6% this year
$5,000 * 6% / 12 months per year * 12 months of gains = +$300
-$3,500 credit card balance at 16.99%, you carried this balance for 7 months.
$3,500 * 16.99% / 12 months per year * 7 months with credit card balance = -$346.88
In this example you are actually LOSING money by carrying your credit card balance. You’re out $46.88 per year to be exact. Below is the SAME example, but instead using the stock account to pay off the credit card:
-$5,000 stock account
-$3,500 credit card, spend $3,500 from stock account to pay off balance
-$1,500 remaining stock account that makes 6% per year
$1,500 * 6% / 12 months per year * 12 months invested that year = +$90
So you went from LOSING $46.88 to GAINING $90. That’s a $136.88 swing in your favor! And you did NOTHING but move some money from one place to the other and redefined what a “return” means to you.
Consider all loans as “handcuff debt” (good debt) because you are forced to pay the monthly payment on these debts each month. At least you get to own a house, car, or boat because of them though!
Consider your credit cards to be “bummer debts” (bad debt) because you’ve been out spending your money wildly and they are a bummer when you go see your balance every month.
The formula for paying off debt is very simple, pay off the HIGHEST interest rate first NO MATTER WHAT. Even if you look and see that you have a higher balance elsewhere, reducing a debt by $5,000 only pays off on the $5,000, not on the remaining balance.
So reducing credit cards by $5,000 at a 22.99% rate vs. $5,000 on a 6% mortgage rate, you get a better return on your money by reducing the credit cards first. ***That was shocking to me the first time I did the math. It really is that simple, just pay off your highest interest rate first!***
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Now! All of those concepts were to get you to here: the 7-year mortgage — and I’ll get to it soon, but first I want to show you what you did by taking ALL your extra cash and putting it into your debts.
You took $5,000 that SPECULATIVELY makes you -50% to +10% per year, and immediately made yourself 22.99% by reducing a debt that you planned on carrying on your credit card for a full year. YOU MADE 22.99% ON $5,000!!!!
If you kept things the way the are, even in the best-case scenerio, you would have LOST! That’s because (if your credit card and stock account are equal) then the equation becomes this…
+10% – 22.99% = -12.99%
…as you put NOTHING towards your credit card balance. It sat there, and you paid interest on it likely without even knowing!
If you put all of it towards your credit card, you reduce your output of cash by 22.99%
***So, just to be clear, you are not going to SEE this return in your bank account immediately, but you will start paying less on your credit cards and watch as you leave an extra $95.79 per month ($5,000 * 22.99% / 12) in your bank account. So the return is seen and felt MONTHLYand over time, but not immediately.
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OKAY! On to the 7-year mortgage now that I’ve hit you with numerous topics and you understand everything. A good savings ratio at the end of every month would be something like 33% of your income after all taxes and expenses are taken into account. If you take 33% of your income and put it ALL into extra principal every month, you will see that your 30 year mortgage becomes a 7 year mortgage. Yep, it’s that easy. No tricks, no dramatic “systems” to buy into, no bullsh*t! It’s just that simple.
(ASK ME ABOUT MY ‘DEBT DESTROYER!‘ SPREADSHEET. IT CONTAINS DETAILED EXPLANATIONS ON WHY THIS WORKS!)
But how do you manage the big expenses if you get hit hard with financial burdens? How do I manage my monthly expenses? That’s up to your discretion. Leave enough room either in your bank account, on your available credit lines for each of your credit cards, or open a HELOC and leave enough credit available to cover your major expenses in cash when you need to. You set your own personal threshold for how much money you MAY need at any given time, and make sure that the threshold NEVER changes unless a major event occurs.
An example of a good finance mix using this technique may be to have $5,000 in your bank account (to cover mortgage and autopayments monthly), sending all your income into this bank account, pulling all extra principal payments from this account, and keeping a $15,000 credit balance on a HELOC to cover major expenses if any arise.
***As long as ALL the money moving in and out of your bank account for the month keeps your balance at $5,000, and your HELOC stays at $15,000 available to pull out for major expenses, YOU ARE DOING IT RIGHT! WATCH YOUR DEBT MELT AWAY!***
So let’s say that you get hit with a medical bill for $5,000 and you want to pay that off ASAP! Pay it out of your emergency HELOC funds, and skip a few of your extra principal payments to recover from the emergency. Let’s say you’re putting $2,000/month into extra principal. You’ll be back to making extra payments in 2 1/2 months. No big deal!
*** In this case, you would manually stop the extra principal payments to debt, and instead put that money towards bringing your HELOC back up to the desired threshold amount***
This requires discipline, and analyzing your finances to the fullest so you can understand just how much you need each month. From there, you can determine the amount of your extra payments and what your account thresholds should be!
This is how you use your money wisely! You are not wasting your time putting your money into a bank account that makes less than 0.5% per year, you’re not speculating to make 10% a year in your stock fund, and you’re not risking your lifestyle to make any of these extra payments because you have a threshold that allows you to over-spend every now and then at your own discretion. You’re simply putting your money to WORK the way it should be put to work.
And THAT is how you get to a 7-year mortgage.
$2,000 * 7 years * 12 payments per year = $168,000 in extra principal payments.
Add that to the principal you’ve gained through each monthly payment for the 7 year period (maybe an additional $97,000) and in 7 years you will have paid off a $255,000 mortgage!
If you read through all of this and still aren’t convinced, at least remember this. YOU are the only person that is looking out for your financial benefit. The bank will lend you money for a house, a credit card company will lend you money for personal expenses, and your financial advisor will help you invest your money — because they’re all being PAID TO DO THAT.
SAVING money in a bank account is PASSIVE.
Putting money into STOCK is SPECULATIVE.
Putting money towards paying off debt is WORKING your money.
“Make your money work for you” is a saying a lot of people say but don’t understand. Make sure you know what the right work is for your money!
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***This material may be really dense, so remember that I’m always happy to work with you on a custom finance plan of your own. Just shoot me an email at dchisholm@LIVSIR.com and set up a coffee/lunch date to get started!***
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