October 3, 2013

paul

How do you allocate resources to pay off debt? 

Dear Friends:

While I enjoyed a vacation with my wife and daughter, a young financial educator, Stacy Gary, did a great job substituting for me on my weekly podcasts, specifically addressing first-time investors. While those of you who are long-time investors may not need this information, there is likely a friend, relative or associate who can benefit from it. I hope you will join me in sharing this valuable information with them.

In response to Stacy’s podcasts, a 30-year-old posted the good question: How do I allocate resources between paying down school debt, investing for retirement, and a house down payment?” Here is his answer based on sound investing principles and the goal of real financial freedom.  

First, I saved 3 months of living expenses in a bank account as an “emergency fund”: money ONLY to be touched for an unforeseeable crisis. Then I saved in my Roth IRA (and later in a 401k when my employer matched funds) enough to start taking advantage of the miracle of compounding interest over time. I also worked diligently and aggressively on accelerating paying off my car, credit card, and student loans from my MBA program.

After my student loans were paid off I celebrated. It’s an amazing feeling to be debt-free and have a taste of what real financial freedom may feel like. Then I saved 6 months in my emergency fund, while also contributing to my “house down payment/closing costs fund”. For that fund, you can never have enough, and houses are more expensive than realtors and lenders will express.

In my first and fourth podcast episodes, I cite two studies showing that many people are retiring broke, or using debt at an alarming rate to cover expenses. Between 2009 and 2011, several million homes were foreclosed, and many more were short-sold. One lesson learned from the housing crisis/financial collapse is that debt can be catastrophic. The greater the total debt, the greater the risk of financial catastrophe.

In a study of America’s millionaires published in the booksThe Millionaire Next Door and its sequel The Millionaire Mind by Thomas Stanley, it was found that people who became wealthy got there in part by avoiding debt. In his work, The Bootstrapper’s Manifesto, Seth Godin also encourages people to spend only what they have, and make it work rather than leverage themselves with other people’s money (debt financing). While I understand that for most people a mortgage is necessary… at least when buying a first house, it can be very wise to start out debt free and keep one’s debt load as low as possible. If that’s what Americas’ millionaires do, then I figure it’s prudent of me to follow their example. -Stacy Gary

As always, we welcome your comments and questions at:info@paulmerriman.com

To Your Success,
Paul

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