EMANCIPATE YOURSELF FROM FINANCIAL SLAVERY

When I started this newsletter my objective was to eliminate or dramatically reduce poverty through financial education.??My purpose was to teach you how to save and invest, to understand the basics of the time value of money and the power of compound interest.??Many of you now understand that financial health is not determined by how much you make, but by how much you keep.??And, more importantly, how you invest to build passive income.

This week I will recap some of the earlier ideas.??Please take some time to read and, more importantly, implement, so that you can begin or continue your journey to financial liberation.

IT’S NOT HOW MUCH YOU MAKE

Let me make it clear that there is no quick fix.??Achieving financial freedom will take discipline, focus and time and you must do the hard part first.??You?MUST?know your numbers, make wise choices, and put structures in place to help you to execute.

Today I would like to focus on one idea:?It’s not how much you make, it’s how much you keep.??The goal of financial planning is to achieve financial freedom.??Nik Halik and Garrett Gunderson, in their book “5 Day Weekend”, define financial independence as having a 5:1 Passive Income Ratio (PIR).??Passive Income?is earned with little or no effort by the recipient.??Put simply, its income you can earn while sleeping. It’s income from sources like rental properties, interest on bonds or dividends from stocks.

IT’S NOT HOW MUCH YOU MAKE, IT’S HOW MUCH YOU KEEP.

The PIR is the amount of passive income generated in relation to your expenses.??Your initial goal should be to develop a 1:1 PIR, which means that you’re generating enough passive income to cover your monthly expenses.??However, at a minimum your goal should be to get to a 2:1 ratio, twice the amount of passive income you need to cover your monthly expenses.??A 2:1 ratio provides a contingency of surplus funds.??So if you currently spend $5,000 every month on average, you want to develop passive income streams that earn $10,000 per month after tax.

KNOW YOUR NUMBERS

You are saying that this is impossible.??This is for rich people.??Those negative thoughts are playing in your head.??Fight them, ignore them.??Let’s focus on the next step.

START WITH YOUR NUMBERS—To build up the assets necessary to generate the passive income needed to cover your expenses you must know your numbers.??You must avoid the trap of instant gratification and the desire to borrow to pay for stuff you really don’t need.??As you think about that next purchase, consider the advice of Will Rogers, “Too many people spend money they haven't earned, to buy things they don't want, to impress people that they don't like.”??Are you one of those people?

“Too many people spend money they haven't earned, to buy things they don't want, to impress people that they don't like.”??Will Rogers

As you think about this, I want you to begin the hard work necessary to create a solid foundation of assets that will generate passive cash flow.??You must start with your numbers, your income and expenses:

• How much income are you earning every month???For most of us this is after-tax salary or wages.??How much is being credited by your employer to your bank account?
• How much money are you spending every month on your recurring living expenses: rent, electricity, food, transport, telephone, cable, etc., and on debt repayment?

Think about this carefully.??Begin by listing your income, expenses and payments using the worksheet shown below.

Your Magic Number

A lot of us fear budgeting, or find it time consuming, and would prefer to avoid doing this.??Therefore, Avraham Byers suggests that we simply find our magic number.??The magic number is the money available for spending on things like eating out, entertainment, travel and personal grooming—costs that can be adjusted or eliminated without affecting your standard of living or ability to meet your basic needs.

It is calculated by deducting the annualized amount of?non-discretionary?expenses—costs that are considered essential and must be paid to support your basic standard of living—from your annual take home pay and dividing the result by 365.??These include payments for food, mortgage, rent, utilities, car and other loan payments, insurances, health care, etc.

(Annual Take Home Income – Annual Non-Discretionary Expenses) ÷ 365

So, if you and your spouse earn $10,000 per month each after tax, your annual take home income will be about $240,000.??If your annual non-discretionary expenses total $150,000, then you are left with $90,000 for travel, entertainment, etc.??That’s $7,500 per month or $246.58 per day.??Your Magic Number is therefore $246.58—this is what you can spend each day on discretionary purchases.

PAYOFF YOUR CONSUMER DEBT

After writing down your income and expenses, you should focus on saving to build your asset base from which you will begin generating passive income.

But before you begin, you must get rid of any ‘bad debt’.??BAD DEBT?is usually debt that won’t make money for you, i.e., debt used for consumer purchases; debt used to buy an asset that depreciates in value, like a carnival costume.??However, a friend pointed out that where the interest on that debt is being paid for by the seller, i.e., there is no difference between the cash price and the sum of all the monthly installments, then it may not necessarily be bad debt.??However, make sure that you are not late with your payments.

GOOD DEBT?is debt used to invest in yourself or in an asset that appreciates over time; debt used for productive purposes, such as education, investing or building a business.??Debt used to finance an education that helps you to land a higher paying job or a mortgage to buy a home that should appreciate in value are examples of good debt.

Halik and Gunderson in the “5 Day Weekend”, advise “Never borrow to consume. Use your own cash resources for consumer items, such as furniture, clothing, and vacations, and only borrow for productive assets and resources.”??Credit card debt is the worst type of debt, unless you are desperate enough to borrow from a pay-day lender or buy consumer items on hire-purchase.

“Never borrow to consume. Use your own cash resources for consumer items, such as furniture, clothing, and vacations, and only borrow for productive assets and resources.”

Emergency Fund

After paying off?bad debt?you should begin building your emergency fund.??This money should be kept in an interest paying savings account and should cover at least three months’ and ideally six months’ minimum living expenses.

Restructure

Then, if possible, you should do like?Halik and Gunderson suggest and “restructure your loans by converting short-term, high-interest loans into long-term, low-interest, tax-deductible loans … to minimize your payments and maximize your cash flow.”??For example, you can use the difference between the value of your home and the balance due on your mortgage, referred to as ‘home equity’, to increase your mortgage loan and use the extra funds to pay off any consumer finance, hire-purchase or credit card debt.

Pay Off One Loan at a Time

You should also pay off one loan at a time using what Halik and Gunderson refer to as the Cash Flow Index (CFI).??To find your CFI for each loan, divide the loan balance by the minimum monthly payment.??The trick is to pay off the loan that gives you the greatest cash flow with the least investment.

One approach may be to pay off the debt with the highest interest rate.??In the example shown in the chart below, it is best to pay off the consumer finance loan first because it has both the highest interest rate and lowest CFI.??By doing so, you free up more monthly cash, which can then be applied toward the credit card balance.??Pay down ‘bad debt’ aggressively even if you must sacrifice and do without something you really like.??Your focus should be on eliminating these debts as quickly as possible.

I hope that this helps as you work to build your financial freedom.??If you find this advice helpful, please share with your friends and colleagues.??As usual, I look forward to your questions and comments.??Be safe.??Take good care, and if you can, help someone in need.

Cheers, Nigel

Nigel Romano, Partner, Moore Trinidad & Tobago, Chartered Accountants