As I discussed in the past, Savings are an essential part of debt management. Remember Savings are 20% of your disposable monthly income. With it you build a reverse pyramid. Stage one is small. You save $1,000 to place and keep in your checking account to provide flexibility. This helps reduce worry each month and gives you a margin for some error. The second stage is to use the 20% to pay off all the unsecured debt that is zapping the financial life out of you like credit cards or personal loans. By getting rid of debt you remove the stressful burden that gnaws at you. In this process you also must free yourself from the bad habit of borrowing. This is a choice and a conviction that lightens your load in every healthy way. Once that is done, the third stage is to save 6 months worth of your Bare Necessities (which is 50% of your DMI). This creates an emergency security fund in case your income is greatly reduced or eliminated for any reason (like you are laid off or in an accident).
Once those three stages are in place, your 20% monthly Savings is money for the future. You are no longer burdened by the past debt and you can move ahead in financial freedom. Stage three has three sub-categories. They are: 1) the retirement fund, 2) the pay off of mortgage principal allotment and 3) investments.
The retirement fund is Savings so someday you do not have to work anymore. You can relax and live your dreams. Also you do not have to depend on the government to give you a meager lifestyle with social security. Your retirement fund should be 10% of your DMI (50% of your Savings) each month. Ideally this goes into a tax deferred plan where you work (if your company offers one–often with matching funds) or personally through a type of IRA. Right now individuals can place $6,000 each year in their own IRA (and more if the plan is through work). This makes a lot of money down the road if the fund is invested conservatively (which I will discuss below).
Next take 5% of your DMI (25% of your 20% Savings) and pay down the principal on your mortgage. Imagine not having any monthly mortgage payment any more! This spares you whatever interest you are paying to the lender– which places a huge amount of money in your pocket over time. You are cutting years off your mortgage.
Finally, you have earmarked 10% of your DMI for retirement and 5% for paying off the mortgage, so you have 5% left from each paycheck. This is basically for your other dreams–whatever they might be. Figure out what you want, write it down and start making your dreams a part of your every day reality. Be here to enjoy by making plans now to make your dreams happen.
*Post theory is primarily derived from the book All Your Worth by Elizabeth Warren & Amelia Tyagi which is highly recommended reading.
Iowa Bankruptcy Attorney Robert Liptak
Fairfield, Southeast Iowa