Week 4: Debt and the power of compounding
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Debt, Debt, Debt. It pulled Alan's family apart and the Donegans are on a mission to stop it doing the same to other people. This week we discuss how companies put you into debt, how they market it and use it to profit and how you can avoid it. Katie also goes through the mathematically best way to get rid of debt!
Even if you don't have debt, this week will be useful to help others, protect your family and avoid future problems. Let's get out of debt and start taking control of our own finances! |
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Debt
This is a big topic! We think about this in two parts....
- How we get into debt
- How we get out of debt
How do we get into debt?
It's so easy to get into debt
There are three main ways we go into debt......
There are three main ways we go into debt......
- Life happens. Unemployment, redundancy, reduction in income, illness, worldwide pandemics...
- Companies want you to go into debt and have all sorts of tactics for getting you to borrow money from them. They don't call it "debt" they have far sexier terms like "here's some credit" or "why don't you put it on finance". These are all code terms for DEBT! We want you to be wise to it.
- We do things to ourselves. We accept high interest rates, we have unhelpful spending strategies and the way we play the game of the credit card companies (and lose)
How can we protect ourselves?
We can protect ourselves from this by building an emergency fund in the good times, changing our spending strategies and learning how companies sell us debt.
8 ways to stop debt happening to us again. it is SO IMPORTANT we have a good defence against debt happening to us again. if we don't cure the problem then it is something that is bound to repeat again! A good defence starts with a strong emergency fund
- Have an emergency fund - This protects you against so many things. if you loose your job, the car breakfast down or you fall ill the emergency fund protects you and stops you going back into debt. This is SO important to build
- Sell off big liabilities - If you own big liabilities like cars, motorbikes, bike houses then these not only lock away money you could use but COST you money in maintenance and insurance each month. SELL off the big liabilities in your life and use the money to stock your emergency fund.
- Buy small liabilities - if you are going to buy a liability like a car then buy a small one that doesn't cost too much to run. This way less money is drained away from you each month.
- Create a huge gap - do everything you can to create a huge gap between your expenditure and income. The bigger the gap the easier you will find it to ride problems and avoid going back into debt
- Change your spending strategy - we talked a lot about spending strategies. instead of 1 click purchasing on amazing put it in your basket, set a reminder for a week and ask if you really need it a week later before buying it. Instead of just buying things now ask; can I afford this from positive balance not credit? can I get the same value for less money? and could I buy my freedom instead?
- Cut up your cards - as you saw Jason do on the call cut up the cards. If you can't resist the temptation then cut them up and get rid of them all!
- Monthly finance meetings - we will be going into how to run these in week 5. What get's measured get's improved so track your progress each month and discuss what has happened!
- Teach your family sales - the more you understand sales the more you will be able to defend yourself form the sales techniques companies use against you. Learn sales and teach your family. Maybe start with Influence by Robert Chaldini.
How to get out of debt:
The debt attack strategy
This is how we think about debt. As always, don't take our word for it! Do your own homework and research and think about whether this is right for your circumstances. That being said, here's the strategy! We've put some ideas under each step - do all of the steps but you don't have to do ALL of the additional ideas. Don't get overwhelmed, just pick a couple to start with and get some momentum.
1. Get crystal clear on what your debts are
For each of your debts (car loans, store cards, credit cards, personal loans...), find the paperwork and get clear on:
Include 0% cards, this is a temporary situation. It won't always be 0%. You have to pay these off too. You can't just keep shifting it to 0% cards forever. Your calendar is your friend. Set a reminder a month or so before the deal ends so you can work out what you want to do with that debt and so you won't be surprised when they start charging you interest!
1. Get crystal clear on what your debts are
For each of your debts (car loans, store cards, credit cards, personal loans...), find the paperwork and get clear on:
- Balance (how much you owe)
- Interest rate
- Minimum payment
- If the deal changes after a certain time (e.g. pay nothing for a year), find out what the payments will be, what the interest rate will be and when it changes. Put a reminder in your calendar of when the deal is going to end so you can reassess
Include 0% cards, this is a temporary situation. It won't always be 0%. You have to pay these off too. You can't just keep shifting it to 0% cards forever. Your calendar is your friend. Set a reminder a month or so before the deal ends so you can work out what you want to do with that debt and so you won't be surprised when they start charging you interest!
2.Can you pay off any of the debt immediately
There are some ways you might be able to raise some cash straight away...
We’re not telling you that you have to give it up forever. Store it on gumtree/craigslist until you can afford it. What we mean by this is sell it on these platforms (or something else like Facebook Marketplace). You can always buy it back (or one very similar) when you're in a better financial position.
This has a double whammy because you'll get the money from selling the liabilities AND you'll stop paying for them each month.
- Can you sell any liabilities?
- Holiday home
- Car that’s barely used
- Motorbike
- Pleasure boat
We’re not telling you that you have to give it up forever. Store it on gumtree/craigslist until you can afford it. What we mean by this is sell it on these platforms (or something else like Facebook Marketplace). You can always buy it back (or one very similar) when you're in a better financial position.
This has a double whammy because you'll get the money from selling the liabilities AND you'll stop paying for them each month.
- Can you sell any belongings you don’t use? Are you using that treadmill you bought as a very expensive clothes horse? Sell the stuff you have in the house and the garage. In the UK you can use Ziffit or Amazon to sell second hand books and DVDs.
- Do you have a storage unit full of forgotten belongings? Sell that stuff AND stop paying the storage fees
- What savings do you have? Banks make money by lending at a higher rate than they'll give you on your savings. KEEP EMERGENCY FUND of £1,000. Use any other savings to pay off your debt.
3.Can you increase monthly repayments?
You need to prioritise paying off your debt and stop going on expensive holidays, stop eating out, stop getting takeways and stop buying the latest iPhone. Stop investing in the stock market (for now), until you've paid off your expensive debt. If you're doing this, you are essentially borrowing money to invest in the stock market and this is NEVER a good idea.
How much a month can you put towards paying off the debt? How might you reduce your spending elsewhere or increase your income? Widen the gap between income and expenses as much as you can! Trim the fat like we showed you in week 2!
How to increase income
How to reduce spending
These are some ideas to reduce spending.... some are more extreme than others! Pick the one(s) that work for you
How much a month can you put towards paying off the debt? How might you reduce your spending elsewhere or increase your income? Widen the gap between income and expenses as much as you can! Trim the fat like we showed you in week 2!
How to increase income
- Read Alan's 10 ways to increase your income article and pick one idea to implement
- How might you change your living situation to increase your gap? e.g. Get a room mate/lodger. In the UK the rent a room scheme allows you to earn £7,500 a year (£625 a month) TAX FREE by renting out part of the home you live in
- Start a side hustle. Check out Alan's Rebel Entrepreneur podcast which is all about how to start a business without going into debt. Start with the episode 5 ways to start a business with no debt
- Use the gig economy (Deliveroo, Uber, Flex etc.)
- If you have a partner, first of all tell them about the debt. Secondnly they might be willing to help and put some of their income towards the debt
How to reduce spending
These are some ideas to reduce spending.... some are more extreme than others! Pick the one(s) that work for you
- Go through your spending category by category. Where can you reduce spending? We use moneydashboard to track our spending (see week 2 for more details)
- Streaming platforms. You can only watch one at once! Cycle through them rather than having them all at the same time. e.g. have Netflix for a month or two to watch the shows on there, then switch to Amazon Prime and so on.
- Transport. Could you downsize your car? Have you optimised your car to spend less? Do you even need a car? Multiple cars?
- Utilities. Compare to the average in your area. Use comparison sites to check you have the best deal.
- Insulate your home. In some areas/countries there are government schemes to help you do this. Check if there's one in your area
- Don't have any kids or dependents? Rready to go extreme with your living situation? Check out Property Guardians in the UK
- Food shopping.
- You *think* you're an Aldi shopper and just get a few bits and bobs in Waitrose but are you really? Track it for a month and find out.
- Make a list before you go to the supermarket and only buy what's on the list
- Other spending
- What subscriptions could you cancel and put towards the debt instead. We coached someone who had an £18.99 gym subscription they weren't using. When they put that towards their credit card debt it saved them £514 in interest and they paid if off 10 months quicker.
- Stop expensive hobbies (at least for now). Be creative with ways to have fun for free or for much cheaper
4.Reduce interest rates
Can you negotiate lower interest rates with your credit card company or get a 0% balance transfer?
Could you get a cheap(er) personal loan?
BEWARE commercial debt management companies. They are there to make money out of you
The best way to do this is to call them on the phone and talk to them. Tell them you can't afford the repayments. Tell them the debt is crippling you. Tell them you are doing to need to move else where to get on top of it Ask for a reduction in interest rates and then go silent. SILENCE is so powerful when negotiating.
5.List all your debts in descending order of interest rate (highest first)
NOT in order of balance. This way you will pay the least amount of interest. If you have multiple 0% cards, put the deal that ends soonest first.
6.Put as much as you can towards paying off the first one on the list
Pay the minimum payments on all debts AND put any and all additional cash towards paying off the first debt on the list. The key is to attack the debt with the highest interest rate with all your resources. Tackle that sucker!
7.Keep momentum
When you pay off a loan or card, roll that payment into the next one on the list. Never lower overall repayment amounts. Keep rolling each one you pay off into the next one. This build momentum and helps you tackle the debts quicker and quicker.
8.Keep going until you are (expensive) debt free
Celebrate your freedom! Maybe have a picnic or do a little jig in the kitchen.
9. How are you going to make sure this never happens again?
Do you trust yourself with credit cards... if not, cut them up! Make sure you have an emergency fund. Sell any big liabilities if you can. Change your spending strategy. Have a monthly finance meeting.
Thank you so much to Jason for being our debt case study on the call and being so open about his circumstances, helping us all to learn. This is the tool Katie used to work out what order Jason should pay off his debts and how long it will take: https://www.vertex42.com/Calculators/debt-reduction-calculator.html
When it asks you to choose which strategy you want go with "Avalanche". This puts the debts in descending order of interest rate.
Can you negotiate lower interest rates with your credit card company or get a 0% balance transfer?
Could you get a cheap(er) personal loan?
BEWARE commercial debt management companies. They are there to make money out of you
The best way to do this is to call them on the phone and talk to them. Tell them you can't afford the repayments. Tell them the debt is crippling you. Tell them you are doing to need to move else where to get on top of it Ask for a reduction in interest rates and then go silent. SILENCE is so powerful when negotiating.
5.List all your debts in descending order of interest rate (highest first)
NOT in order of balance. This way you will pay the least amount of interest. If you have multiple 0% cards, put the deal that ends soonest first.
6.Put as much as you can towards paying off the first one on the list
Pay the minimum payments on all debts AND put any and all additional cash towards paying off the first debt on the list. The key is to attack the debt with the highest interest rate with all your resources. Tackle that sucker!
7.Keep momentum
When you pay off a loan or card, roll that payment into the next one on the list. Never lower overall repayment amounts. Keep rolling each one you pay off into the next one. This build momentum and helps you tackle the debts quicker and quicker.
8.Keep going until you are (expensive) debt free
Celebrate your freedom! Maybe have a picnic or do a little jig in the kitchen.
9. How are you going to make sure this never happens again?
Do you trust yourself with credit cards... if not, cut them up! Make sure you have an emergency fund. Sell any big liabilities if you can. Change your spending strategy. Have a monthly finance meeting.
Thank you so much to Jason for being our debt case study on the call and being so open about his circumstances, helping us all to learn. This is the tool Katie used to work out what order Jason should pay off his debts and how long it will take: https://www.vertex42.com/Calculators/debt-reduction-calculator.html
When it asks you to choose which strategy you want go with "Avalanche". This puts the debts in descending order of interest rate.
Student loans
Student loans - UK
Many of you asked whether you should pay off your student loan before you start investing. This is a complicated question! The interest rate you pay depends on when you took the loan out and, for people who went to university in more recent years, what tax bracket you are in. Money Saving Expert has some excellent articles on this: https://www.moneysavingexpert.com/students/student-loans-repay/
And here's the official government website: https://www.gov.uk/repaying-your-student-loan/what-you-pay
People often ask us about ways to make their earnings look lower so that they don't have to pay off their student debts. (In the UK, repayments are based on how much you earn and are wiped out after 30 years.) To me, this feels like cutting your nose off to spite your face. Playing a game to try and minimise your earnings is the wrong thing to focus on if you're aiming to get to Financial Independence (FI) or Partial FI. Focus on maximising your earnings and paying your debts off so that once those are gone you can quickly accumulate wealth.
You are NEVER worse off earning more. The more you earnt he quicker you can get onto more exciting thigns after getting rid of the debts.
As ever, this is NOT binary. If you have some savings that are earning less than the interest that's building up on the student loan, consider paying off at least some of the loan. For example, if you are not yet earning enough to have to pay anything back but you are earning some money and have a reasonable gap between your earnings and expenses, consider paying down the interest that's building up so at least it's not compounding against you.
CAVEAT: this depends on age and amount of debt. If you're 25 with £30k of student debt, just get on with it. If you're 50 with £300k of student debt we need to think through the options. Of course this is after more expensive, higher interest rate debt like credit cards.
Don't take our word for it, read the Money Saving Expert articles and watch his videos and see what you think.
Student loans - USA
Choose FI is a financial independence podcast whose co-host Jonathan had a LOT of student loan from studying to become a pharmacist. This article talks you through the things to think about when you're considering paying off your student loan: https://www.choosefi.com/paying-off-student-loans-vs-investing/
Many of you asked whether you should pay off your student loan before you start investing. This is a complicated question! The interest rate you pay depends on when you took the loan out and, for people who went to university in more recent years, what tax bracket you are in. Money Saving Expert has some excellent articles on this: https://www.moneysavingexpert.com/students/student-loans-repay/
And here's the official government website: https://www.gov.uk/repaying-your-student-loan/what-you-pay
People often ask us about ways to make their earnings look lower so that they don't have to pay off their student debts. (In the UK, repayments are based on how much you earn and are wiped out after 30 years.) To me, this feels like cutting your nose off to spite your face. Playing a game to try and minimise your earnings is the wrong thing to focus on if you're aiming to get to Financial Independence (FI) or Partial FI. Focus on maximising your earnings and paying your debts off so that once those are gone you can quickly accumulate wealth.
You are NEVER worse off earning more. The more you earnt he quicker you can get onto more exciting thigns after getting rid of the debts.
As ever, this is NOT binary. If you have some savings that are earning less than the interest that's building up on the student loan, consider paying off at least some of the loan. For example, if you are not yet earning enough to have to pay anything back but you are earning some money and have a reasonable gap between your earnings and expenses, consider paying down the interest that's building up so at least it's not compounding against you.
CAVEAT: this depends on age and amount of debt. If you're 25 with £30k of student debt, just get on with it. If you're 50 with £300k of student debt we need to think through the options. Of course this is after more expensive, higher interest rate debt like credit cards.
Don't take our word for it, read the Money Saving Expert articles and watch his videos and see what you think.
Student loans - USA
Choose FI is a financial independence podcast whose co-host Jonathan had a LOT of student loan from studying to become a pharmacist. This article talks you through the things to think about when you're considering paying off your student loan: https://www.choosefi.com/paying-off-student-loans-vs-investing/
Further help on debt
This article from Money Saving Expert has some additional tips and ideas for how to pay off debt as quickly as possible: https://www.moneysavingexpert.com/loans/debt-help-plan/
Compounding
Albert Einstein is reputed to have said "Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it." MIKE DROP
We met Early Ellie and Late Larry and saw the power of compounding over time. The earlier in your life that you start investing the better. The lesson here is NOT "I'm too old I've missed the boat", it's "GET ON WITH IT"! You're on this course so you're in the right place and you're sorting out your finances so stick with it. You'll be way better off than Never Bothered Ned who never got his finances in order and ended up with no savings whatsoever for retirement.
Debt warning
For a recap of the key concepts about debt and a warning about avoiding it please read this blog post and share with your friends
Homework
To get the most out of this course you must do the homework! Here is the homework for week 4...
1. Make a plan of ATTACK for your debt
2. If you have kids or any other younger people in your lives, think about how to help them avoid debt.
3. Have you done the homework from the first 3 weeks?
If not go back now and do it! Consider doing some of the optional exercises you might not have got round to yet. Continue journalling about money and notice if any thoughts, beliefs or values have shifted. You can find all homework for previous weeks here:
Week 1. Week 2. Week 3.
4. Come up with ways to increase the gap between your income and your expenses. On the expenses side, one way of doing this is to go through each of your spending categories and see if there's anything you could cut. Remember, this is not about deprivation this is about conscious expenditure.
1. Make a plan of ATTACK for your debt
2. If you have kids or any other younger people in your lives, think about how to help them avoid debt.
3. Have you done the homework from the first 3 weeks?
If not go back now and do it! Consider doing some of the optional exercises you might not have got round to yet. Continue journalling about money and notice if any thoughts, beliefs or values have shifted. You can find all homework for previous weeks here:
Week 1. Week 2. Week 3.
4. Come up with ways to increase the gap between your income and your expenses. On the expenses side, one way of doing this is to go through each of your spending categories and see if there's anything you could cut. Remember, this is not about deprivation this is about conscious expenditure.
Discussion questions
So that you have them all in one place, here are the questions we discussed during week 4.
Company strategies for putting you in debt
Our strategies for putting ourselves into debt
Debt recap
Ask for help
Remember to reach out in the Facebook group with any questions you have or if you get stuck. Don't let confusion be an excuse for not progressing with this stuff. We are here to support you!
Company strategies for putting you in debt
- How have you fallen for these in the past?
- What have you learned?
- How aware are you of these tactics?
- How aware are your family of these tactics?
Our strategies for putting ourselves into debt
- What are your spending strategies?
- What do you say to yourself before or as you are spending money?
- How do you use credit cards? Or are they using you?
- How are you going to change your spending strategies starting today?
Debt recap
- What have you learnt about debt?
- How will you share this with the next generation?
- What’s your biggest take away from the debt attack strategy?
Ask for help
Remember to reach out in the Facebook group with any questions you have or if you get stuck. Don't let confusion be an excuse for not progressing with this stuff. We are here to support you!
