Financial Freedom

Every so often you run into something that you’d like to share with those you care about. I read an article on personal finance that does a great job of summarizing a lot of collective wisdom on the topic. I highly recommend reading it, as everyone I know that practices such wisdom has achieved, or is on the path to achieving financial independence.

Just for fun, I’d like to present two scenarios, the first is of Average American. Average’s family income is about $60,000, the 2003 average (IRS) for married filing jointly. Each month the Average family pays $300 each on two car payments and $900 for their home. They have 2.3 kids and after living expenses, they have just enough left to make the minimum payment on their $2,000 of consumer (credit card) debt. They seem to be doing well.

Every so often calamity strikes (car wreck, illness) but they mange to make ends meet. One day a tidal wave comes ashore and the Averages find themselves awash in bills they haven’t the means to pay. This could be either of the Averages losing their job or unexpected expenses. In America, the two most common causes for personal bankruptcy are divorce and medical bills. Since the Averages have no financial margin, their only choice is to assume debt they can scarcely afford, or declare bankruptcy. Their boat is still floating, but the paddles have washed out to sea.

What did the Average family do wrong? A little math will illustrate. Each of their cars cost $300 per month. Over the course of twenty years, they will pay $144,000 in car payments. If they had instead spent half that money ($72k) and purchased two used cars every 5 years at $4,500 each and invested the other half at 10%, in 20 years they would have $228,000. That money would provide a substantial cash cushion for cleaning up after the waves of life rock the boat. They could also use the surplus to pay off their mortgage early and be completely debt free.

If left unused, that cash cushion would generate almost $2,000 per month in interest for the rest of their lives. That is the difference between getting by on Social Security and having enough extra to enjoy their golden years. As Dave Ramsey says, “live like nobody else, so that you can live like nobody else.” The Averages enjoyed having new cars to drive but neglected to plan for the future. Let us now consider a less average couple.

The Frugal family brings home the median income of $44,389. They also have 2 children. However, early in their lives they worked hard and lived on rice and Ramen for a few years while paying off their debt (house, car, student loans, etc). Now they give the first 10% of their income to charity and the next 10% to savings. By doing so they help their neighbors and are taxed less. Further, they have additional savings towards the purchase of their next car.

The rest of their income more than covers their cost of living. Their cash cushion needs only to be a few thousand dollars whereas the Average family needs closer to twelve thousand to cover six months living expenses. The Frugals track their spending on a computer and periodically review their spending together. Unlike the Averages (the #1 cause cited for divorces is finances), the Frugal family seldom argues about money. The Frugals developed their budget together and have ample margin.

Which family are you? Which family would you prefer to be?

Jen and I favor the latter. We share a commitment to fiscal prudence and we have a large degree of financial freedom. Because we have no debt, we are able to make choices about how to use our money. In the last year we made trips to Alaska, Costa Rica, and St. John V.I.. This year we moved and we’re paying for my tuition. I’m working much less but we still have enough.

I recommend this degree of freedom to everyone. Read the article. Don’t buy the books! If you need the advise, save money by checking them out at the library.