A friend of mine (and loyal reader), “TC”, sent me an email with an interesting proposition for a new post: review a reader’s finances, give suggestions, and open up a forum for other readers to chime in and learn.
It sounded like a great idea to me, one that I’ve been toying with for a while. I just needed a little kick in the pants. And that came in the form of him volunteering to be the first victim… er, I mean, case. TC needed a little kick in the pants himself, you see.
So we had a fairly detailed exchange, I asked him to fill out a copy of my free budget spreadsheet, and everything started coming together.
And now, I’ll share his financial picture with you, give my thoughts, and encourage yours in the comments as well.
If feedback on this becoming a new series of posts is positive, I may open this up to other readers. So please leave your thoughts/feedback in the comments.
Here’s TC’s background:
G.E. –As you know, I have a wife and two young kids and we just moved into a new home. I want to get myself out of debt and begin investing with my monthly savings so that I can breathe a little easier. For the last 3 months I have felt like I had a cinder block around my legs while I was swimming (financially speaking). All of that pressure has been due to a move/rehab projects. Based on what I am seeing in my budget, I should be in a better situation than what I feel like I am currently in. One of our largest struggles is sticking to a budget. We tend to eat out more often than I would like because we haven’t gone grocery shopping, or (insert excuse here).Ultimately, I know that being financially independent by the age of 40 is certainly within the realm of possibility, but I need help to get started. I don’t feel like I have truly gotten a good start.
Here’s what my monthly finances look like:
- Take-Home Income: I bring home $3900/month (after taxes, insurance, and retirement), I also receive an annual bonus of $5K-8K, and my wife brings in about $2000/month (after taxes). Note: My employer match is 100% up to 6% of my salary, I currently put 10% in the 401K.
- Mortgage: $955/month – Currently owe: $134K Current value approx. $155K. It’s a 30yr fixed 3.38% no PMI. Note: moving where we did; our car insurance has been cut in half and the property taxes halved as well.
- Home Insurance: $67.00
- Life Insurance : $65.00. $250K policy on my wife and $300K policy on me.
- Auto Insurance: $121.00
- Auto Loan: $569.00 – 2007 Chrysler Town and Country (owe $7K) and 2012 Ford Fiesta (owe $16K). The van is necessary due to family size and activity, but I admit we could drive a cheaper car. Going to one car is most likely out of the question though due to our schedules and transportation needs (I have done my homework here).
- Student Loan: $165.00. Balance of $14K. We are currently paying $500/month toward tuition for another degree for my wife on top of the student loan payment.
- Cell Phone: $121.00. Currently 1yr into a 2yr contract on 2 iPhones
- Cable: $0
- Internet+VOIP phone: $60. Note: it’s $7 more for just internet alone.
- Trash: $12.00
- Daycare: $376
- Savings: $0: we had been putting $700 a month into a “high-yield savings account” (.82%), but that was recently gobbled up due to purchasing and renovating a house (primary residence) and some rental property repairs.
- Gas & Electric: $120.00
- Groceries/Household Consumer: $750.00
- Credit Cards: $560.00. Balance is $16,100 spread across 5 cards. Highest EAR is 15.68%. I had these paid down to a $1,200 balance on one card 2 months ago…then we bought a house.
- Transportation costs (fuel): $300.00
- Eating Out: $500. This is average for us, however we have been closer to $1000/month for the last 2 months due to us not having a stove in the new house while renovations were taking place and we celebrated a milestone anniversary.
I’m not sure where the rest of the money goes each month. I do know that the last 2-3 months have really been in flux simply because we had renovations to the new house, several repairs that had to simultaneously be done on two of the rental houses, and now the holidays are upon us. I know that the CC payments are the first thing that I need to cut. I also know that there is plenty of other area’s where I could cut back as well.
It’s not often that you get to try to help a friend “right the ship” and have them be receptive to it… so this should be fun.
On the Good Side
Let’s start off with what TC is doing well.
- The mortgage: $955/month is not bad at all, particularly when you consider it’s at a 3.38% fixed rate, with no PMI. When you stack this up against a take-home income of $5,900, the mortgage-to-income ratio is only 16% (before interest tax deductions), which is pretty damn good. Anything under 20% is very solid. TC happens to live in a low cost-of-living state (Michigan), which opens the door for opportunity to jump start his savings.
- No cable: Excellent! I’ve previously calculated out the lifetime cost of cable, and it’s fairly sickening. Getting rid of cable would have been one of my first recommendations, but he’s already beat me to it.
- Daycare: $376 per month with two young children, allowing both him and his wife to work (seemingly a necessity, given the expenses) is great compared to average child care costs of $18k+ in Michigan.
Now… the fun part.
Stop the Bleeding!
TC has got to go to work. And FAST. This is not an optimization, it’s an emergency!
He says he doesn’t know where his money is going. I’d venture to say he does, and the real problem is where it’s going. This looks like a case of lifestyle inflation to me. Costs have gone up to meet income and until buying the home, debt hasn’t been a big concern because food has always been on the table.
TC’s average monthly expenses are about $5,181, compared to his take-home income of $5,900. If you include his 10% contribution to his 401K, which we could round down to about $350, his family is left with about $369 of wiggle room per month ($4,440 per year). Of course, life happens. And I’d be willing to bet that $4,440 would not even begin to cover his “shit happens” costs (vehicle maintenance, appliances, home repair), one-off expenses (school costs for kids, an occasional family vacation, clothing, medical bills, etc).
First priority should be to kill the credit card debt. In his case, I’d actually recommend cutting up the cards and not using them again until they are paid off (and then only using them to charge essentials). Erasing that debt would free up $560 in cash flow per month alone – a 151% increase over current levels. Freed up monthly cash flow that can then be applied towards savings: $560.
So how does he do that?
- Cut the 401K contribution from 10% to 6%. Keep paying in the 6% to get the 100% match (100% > 15% that would otherwise be applied to your credit card debt). The remaining should go right towards paying off the credit cards, which would essentially result in a 15% return in saved interest payments (hard to beat that in even a bull market). You won’t hear me recommend to people to cut their retirement contributions often, but this is one example where it makes perfect sense.
- Kill the dining out: dining out can cost 3-4X what a home cooked meal costs. $500/month on average with some months around $1,000? There’s huge savings to be had there. Ban dining out completely, no exceptions. Get some cookbooks or take a cooking class if need be. Put together a meal list for the entire week and then go out and buy the stuff you need. Make cooking and eating at home with the kids fun. Monthly savings: ~$500.
- Cell phone: iPhone’s are great, but they are purely a luxury. And it does not appear that they are a luxury you can afford. Do what you can to get out of your contract or downgrade it, switch to a cheap prepaid talk/text plan for $10-15 per month, and use wifi, if you have to. You have internet and VOIP at home, so this should be super easy. Here’s a list of MVNO’s you could switch to (you may even be able to keep your phones, but selling them might be better). Monthly savings: $100.
- Autos: having two newer vehicles, particularly one that is almost brand new? Also not a luxury you can afford. The Ford Fiesta, which is a great, economical car, is just too pricey given your situation. Sell it, use half the proceeds to pay off your credit card debt, and the other half to purchase a small, used 2004-2007 vehicle that is fuel efficient. Monthly savings: $200.
- Auto Insurance: when you switch to an older vehicle from the 2012, you can downgrade your coverage from what I’m guessing is broad collision to something basic. This will likely cut your insurance costs in half. Check out my post on the various auto insurance coverages for more details. Monthly savings: $60
- Fuel: $300 per month seems VERY high. With a round trip commute of less than 10 miles or so for both of you, it seems unreasonably high. The good news is that with a round trip of less than 10 miles (and a kickass bike trail that takes you both right to work, btw!), at least one of you has the potential to bike to work. Cut back in other areas, and you should be able to kick this down by 50%. Monthly savings: $150.
6 small changes that could result (after paying off your cards) in monthly savings of about $1,570 (annual savings of $18,840)! There are additional savings opportunities on home, life insurance, and grocery expenses as well that probably total another $150-$300 per month if you make a few calls and put more work in to planning. But for the time being, focus on the big ones.
You’d pay off your credit card debt within a year. And then you’d quintuple your monthly cash flow and kick your savings in to high gear. You would boost your personal savings rate from roughly 5% to 30%. The result? You could be at least $200K wealthier over the next decade with your new-found discipline and mental framework, and you don’t even need to boost your income!
The Silver Lining
Consider yourself lucky, as I see very little sacrifice here. There is enough base income and low enough housing expenses to improve things greatly. All you are doing with my suggestions is giving up luxuries you cannot afford, particularly given your ambitious goals. If you’re sure you can’t get rid of a car completely, then don’t – just swap out the new one. Switch to basic prepaid phone plans – you’ve got internet and VOIP at home. Feed your family well – just at home vs. a restaurant. And don’t stop driving – just drive less. Easy stuff that could ultimately take you from hanging on by the skin of your teeth to killing it. You’re bleeding money in unnecessary ways that only hurt your financial situation. Stop the bleeding!
You have to work at changing your mental framework around what is necessity (and you need to be on the same page with your wife). These luxuries can be saved for when you’re a millionaire, not a family in debt. If you don’t? The dream of financial independence will never be achieved. You’ll work through your golden years and still have little retirement savings to show for it. What do you value more: financial freedom and decades to do whatever you want with your time or marginally nicer stuff now? Only you can answer that question.
You just gave yourself the greatest gift of all this holiday season, my friend: accountability. Let’s check back in a year from now to see where you’re at.
Reader Case Study Discussion:
- What else would you recommend to TC to help him improve his financial situation?