Debt Guide – Step 6 – Goal Setting


Prerequisites

Before working on this step you should be able to check off all of the following.

  • I have begun paying off my debts using the debt snowball.
    • Start this step before you’ve paid off all of your debts, but only after you’ve begun making the Snowball payments.
  • I have automatic payments set up for all my services and my mortgage payment.
  • I have at least 3 months of expenses saved in an emergency fund (and more if necessary).

Congrats

Wow. You’re in a pretty good place right now. Congratulations! You’re on your way to being better off than most Americans and about in-line with or slightly ahead of most Western Europeans as far as debt is concerned. Now that you have a system in place and you’re staying focused during your debt snowball, you may have the feeling that your possibilities are endless. And they are! It’s time to set some goals and decide how to invest your extra money once all of your debts are paid off.

Once your debt is all paid off, use the money that was going towards your debt payments every month towards investing in one or all of your goals. This assures your success.

Stay Out of Debt

CAUTION! Don’t think that because you paid off your debt you can forget about what you’ve learned and implemented up to now. Doing so would be a grave mistake and you may wind up back where you started, with lots of debt. Budgeting, spending mindfully, and making sure your automatic payments keep up with your bills are crucial.

Goals

As we’ve learned from using the Debt Snowball technique, great things are possible when we concentrate our efforts (and our money) on one opportunity at a time. Don’t worry though, you’ve made a good start, so even if you split up your investments you’ll still be doing well.

At this point you’ll need some specific goals. If you don’t have anything particular in mind, here are a few to choose from.

  • Buy a house
  • Pay off your house
  • Invest for retirement
  • Save for a college fund

Yes, all of this and more can be yours! Just stick to the plan and then use your debt pay-off money towards the goal of your choosing!

What you decide to invest in is a largely personal thing. So here I’ll note some advantages and disadvantages of choosing any of the goals above.

Buying a House

Ah, home ownership. The American dream. What could be better?

Advantages

Home ownership has a few advantages, some of them financial.

  • You get a place that you get to say is “yours.”
  • You enroll in a forced savings plan.
  • Your mortgage payments will stay the same as rents increase.
  • The value of your home might increase over time.
  • Over the long term buying can cost less than renting.

I call home ownership a “forced savings plan” because every month you pay down the principle just a little bit (saving). If you ever miss a payment, or worse – get evicted, the consequences are dire. So most people do everything they can to keep up with payments. If you have trouble investing the extra money that you have, at least you know some of it is being put away for a future date in the form of equity in your house.

After a certain number of years your mortgage will have stayed the same while rents continue to rise. At some point it will end up being cheaper owning a house than renting.

Disadvantages

Despite popular belief, home ownership isn’t actually an investment. Investments are things that create an income. So the only way your home is an investment is if you rent it out for a profit over the mortgage payments.

  • Buying a home to live in is not an investment – the ROI (return on investment) is less than 0% for years and years.
  • That place you call “yours” is really “theirs” until you pay it off.
  • Owning a home can be more expensive than renting because of maintenance, utilities, insurance, taxes, and repairs.
  • Moving is costly when you own a home.
  • The down payment you’ll need could be invested elsewhere.

The cost of moving when you own a home is significant. Imagine if you wanted to (or had to) change jobs. When it’s time to sell, a real estate agent will take 5% off the top of whatever the sales price is. You may be forced to sell during a market downturn, while buying into a more expensive area wherever your new job is. In an apartment what can you do if you don’t get along with your neighbor? Well, in a house there are few people to complain to and moving is very expensive.

Maintenance is nothing to be laughed at either. It’s not only keeping things painted you know, roofs need replacing, water heaters too, and there are property taxes. Then there’s yard work and insurance of course. Someone has to mow the lawn, and if you don’t do it yourself then finding a reliable person to do it is sometimes not trivial. Please realize that just because you live in an apartment that costs $1,000 per month, that does not mean you can afford $1,000 per month mortgage payments. There are still taxes, utilities, insurance, maintenance, and repairs to pay for as well.

Advice

You should buy a house only if you’re planning on staying in the same place for a long time (like 5 to 10 years).

Buying a home is actually not an investment and thus is not the best thing you can do with your money, even though most people assume it is. Because home values may increase, decrease, or increase only enough to keep up with inflation, the most likely financial gain you get from buying a home is the “forced savings plan.” If you have self-control issues and feel like home ownership would help, I would have to ask why you haven’t set up automatic transfers into a 401K, IRA, or other investment strategy. When the money is transferred automatically into your investment plan you don’t even see it and the ROI is much greater than the “savings plan” of home ownership.

Rental property can be a good investment however, if you do a lot of research ahead of time and decide you’d like to be a landlord. Please read at least a few books on the subject before diving in though. :) I wouldn’t want anyone to just dive into a mortgage on a whim.

Don’t discount the option of renting out a room or a floor in your brand new house to offset the mortgage costs.

If I haven’t talked you out of home ownership and you still want to “settle down,” then please remember this. The loan amount that you are approved for is probably either one of two things: 1) way too little for you to afford the house you want, or 2) way more than you need for the house you need. Do not buy a home based on the loan amount you are approved for – buy only as much house as you need. Housing is the most expensive part of most people’s budget and minimizing that expense in any way possible is a great idea. If you get approved for $300,000 and want to buy a $200,000 house, your bank and your real estate agent will probably not understand. Your bank will make more money off of you if the loan is bigger, so they want you to spend as much money as possible. Your real estate agent takes a percentage of the sale price and makes more money when you buy a home that costs more. The only person looking out for you is you. At the same time, if you have multiple kids that will soon want separate bedrooms, don’t forget to consider that.

To see whether renting or buying is best for you, use this handy calculator. http://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html

Paying Off Your House

Well look at you, a happy homeowner. Now let’s get you out of this mess, shall we?

Advantages

What’s awesome about paying off your house is that it’s like extra insurance because even if you lose your job you won’t be evicted. Besides that, imagine what it would feel like to have no debts whatsoever? None! That would be something.

  • Financial freedom will knock at your door.
  • Having low, or no payments means becoming a landlord will be easier.
  • There is a guaranteed return on your investment because you won’t pay as much interest overall.

Disadvantages

  • Once you pay down the principle, that money is hard to get back (the only way to get it back is by taking out a loan or selling the house).
  • Depending on the interest rate of your loan, you may get a better deal investing your extra cash.

Advice

Paying off your mortgage is a fine idea. Just make sure you have some more liquid (accessible) funds invested elsewhere in case something comes up where you want a large chunk of cash.

Investing For Retirement

Investing for retirement comes in many different forms; 401Ks, IRAs, rental properties. There are so many different options that it’s impossible to cover them all here.

Advantages

  • Security, options, comfort, focus, a greater chance at happiness.

I had to throw in a greater chance at happiness because I believe investing and spending less in general causes people to focus on what’s important in their lives. In other words, it forces people to focus on what’s more important than owning things. Thus, (in my opinion) a greater chance at happiness follows inevitably.

401Ks and IRAs are accounts made to let people avoid paying some taxes. Only the most common types of retirement accounts are covered here. Always do your own research before deciding which to invest in.

  • 401Ks and IRAs are great because you can often use the funds to pay for college without having it affect your student loan eligibility.
  • 401Ks are awesome because some employers have a “match” program where the employer matches your contributions (they give you free money).
  • 401Ks and IRAs allow you to avoid paying some taxes if you leave the money in there until you’re 59 1/2 years old.

Disadvantages

  • 401Ks and IRAs are annoying because you can only take the money out without penalty if you’re 59 1/2 years old, or for certain exceptions.
  • If you’re planning on retiring early then these retirement funds can be a pain because you may pay more taxes when withdrawing funds.

Advice

No matter what your personal goals may be, you should be investing in something.

If your employer offers any kind of 401K match then you should take advantage of that to the fullest extent possible. Even with all of the fees, simply getting the match is probably the best investment return you’ll ever get.

If you’re planning on retiring at the normal age of 59 1/2 or later, then maximizing your contributions to both a 401K and an IRA is the best way to go.

If you’ll be retiring early by spending less and by investing 50% of your income or more, then you still may want to max out your contributions to a 401K or IRA. Refer to this post from the Mad Fientist to see the various ways you can withdraw from your retirement fund before age 59 1/2 and minimize the penalties.

Saving For A College Fund

Saving for college doesn’t have to be for a child or grandchild, it can be for you! Because learning is fun. Anyway, usually when people think of saving for college they’re thinking of a 529 college fund.

Advantages

  • You are not taxed on contributions or withdrawals used for college and some related expenses.
  • 529s are not included as an asset if you file for bankruptcy and the deposits were done at least 2 years earlier.

Disadvantages

  • The money in a 529 is only partly yours. You must specify a beneficiary and if you take the money out for a non-college related reason then you pay income taxes and a 10% penalty (on the earnings, not on the initial amount invested).
  • The laws governing 529s are a mess because they vary from state to state.

Advice

Sure, I would say go right ahead if it makes you feel good. Personally I’m not convinced though. There are too many unknowns to decide whether it’s a good idea or not. Will the beneficiary actually go to college? How much help will they need? If you put too much in then you’re almost guaranteeing yourself an extra tax penalty on the earnings. Ugh!

There are a lot of different options to allow students to make their way through college with or without help from a parent. From scholarships or working at the college for a huge discount, to going to college in a country where a decent education doesn’t cost a ridiculous amount of money. Did you know you can get a college education in Germany for about $300 per year (in 2016)? Get yourself a job over there while you’re studying and you’ve just gotten a good education, a broader mind, and little to no debt.

If you want to stay in the States because the world is a big scary place, okay. There are still lots of ways to get an education in the US on the cheap. If you want your child to be financially independent then there’s no need to pay for Harvard. The smarter financial decision is to begin higher education at a community college and transfer the credits to a more recognized university.

Take care of yourself first. Retire first, then save for a child’s college fund if you like.

Action

Consider the positives and negatives to your investing options and think about which one(s) might be best for you.

You’re Done When

You’re done when you’ve considered your investing options.


Continue Your Journey

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