April is National Financial Literacy Month. In proclaiming National Financial Literacy Month, President Barack Obama wrote, “I call upon all Americans to observe this month with programs and activities to improve their understanding of financial principles and practices.” The Financial Planning Association and other organizations are supporting events and activities across the country to enhance financial education.
Many different programs and resources exist to enhance financial education. As I work to improve my financial situation or help others learn the skills needed to improve their situation, I have found four elements that lead to success.
- Expand your time horizon. When you are thinking about how you will get this paycheck to last until your next paycheck your focus is not on those things that will build long-term wealth. Try to expand your horizon from this pay period to the next six months. Then expand to the next two years, then expand it again, and again, and again. It is by expanding your horizon that you plan for your semi-annual insurance premium. That is how you plan for your vacation. That is how you prepare yourself for your next promotion. That is how you achieve financial independence.
- Keep your fixed expenses down. As a banker in the 1990s, my clients needed 25% of their gross monthly income to cover their mortgage payments. By 2007, 50% of gross income had become the standard.If you make $4,000 per month and allocate $2,000 for your mortgage, you might have $800 in taxes, perhaps $400 for car payments and utilities. That leaves $800 for groceries, clothing, entertainment, vacations and savings. You might be okay until you have a car repair for $1,000 added to your grocery bill.
Think how much better off you would be if you only had $1,000 in mortgage payments and had $1,800 for groceries, etc. That $1,000 car repair might be easy to absorb in a month or two. Perhaps some people would consider having even lower fixed payments so they have more room to absorb unplanned expenses and take advantage of unplanned opportunities.
- Understand your foibles. All of us have quirks although not all the quirks are related to money. Some of us cannot go to the mall without spending money. Some of us cannot resist the latest cool toy whether we can afford it or not. Some of us succumb to temptation for impulse buying or “wants” that we cannot afford. Some, like me early in my career, find it difficult to save in an accessible account. Find a way to avoid those expenses you will later regret, those expenses that will keep you from achieving your goals.Your way to avoid the expense may be to leave your credit card at home unless you plan to use it. It may be to put a picture of your most passionate goal in your wallet near your money so you are reminded of your goal before you spend the money. It may be to go to the mall only when you need something. It may be to move your savings account somewhere that takes planning and forethought to make a withdrawal. Whatever approach you take, find something that works for you.
At the same time, working toward your goals is not the same thing as depriving yourself today. If it is important to you to drink an expensive latte every day, go for it. Just realize that 200 days of $5 lattes is another $1,000 toward that boat you want, that vacation you dream to take, that day of financial independence. You can still have the boat, you just get it six months later. You decide which of your goals is more important to you, the latte or the boat.
- Know the time value of money. Everybody knows a dollar you receive today is worth more than a dollar you receive in ten years. If you can earn 7% interest and you start saving for a goal ten years before you want to achieve the goal, you only have to contribute 70% of your goal and interest contributes the rest. However, if you have 40 years until the goal, you only have to contribute 19% of the goal and interest contributes the rest. That means that for a $10,000 goal, you have to contribute $6,933 in equal monthly installments over ten years or you could contribute $1,828 in equal monthly installments over 40 years. Alternatively, you could borrow the money for the goal over five years at 7% so you can reach the goal sooner. In this case, it will cost you 119% of your goal or $11,881 for a $10,000 goal. You reach your goals more quickly but you can accomplish fewer goals.
I don’t know about you, but I am kind of excited about all the things I can have if they just cost me 20 cents on the dollar. Unfortunately, I do not have as many 40 year time frames as a recent college graduate. I may have to stick with paying 70 cents on the dollar.
What are the most important goals in your life? Do you have the patience to save for them over time? If you do, perhaps you will find more financial success and security. Perhaps you will be able to afford more goals.
Share your goals and your strategies for attaining them with a loved one during National Financial Literacy Month.
John Comer, CFP®
Comer Consulting, LLC