Summer is in full swing and in my house, it's one of the busier times of the year. Every time I turn around we have a wedding to go to, an engagement party, baby shower, lake weekend, golf outing (I'm not complaining about golfing), or something for work (whether that be a conference or semi-annual meeting).
Most of my clients are busy this summer as well. In their finances, they’re facing the dilemma of choosing between 2 areas to focus on...
Should our family....
- Focus on building savings
OR......
- Focus on reducing Debt
This rivalry runs deep! (Think Georgia/Florida, Texas/OU, Bama/Auburn, West Georgia/Valdosta State).
Let's look at the logical, mathematical side and then at the emotional side of this match up.
The Numbers:
If you think about how money works, it takes time to grow. It is believed that Albert Einstein once said, “Compounding interest is the 8th wonder of the world,” And, as we all know, one of the biggest factors of compounding interest is TIME. If you don't believe me, take a future value calculator and run these numbers:
(Starting at 0, because we’re only looking at “new dollars” going in) Present Value: $0
(What they’re saving) Annual Payment/Contribution: $20,000
(The return on their assets and investments) Growth Rate/Interest Rate: 5%
(The potential accumulation phase of a young family’s career) Study Period: 40 years
Final Number: $2,536,795 ($20k saved annually growing at 5% linear for 40 years)
Let's say we have two families that live next door to one another: The Jones family and the Smith family. The Jones family takes the route above. They have a modest amount of credit card debt, a car loan, and a mortgage.
They know they need to clean up their short-term debt, but they understand the power of getting money on their balance sheet in the asset column with time on their side so they prioritize saving first.
Conversely, the Smith family takes a different route and decide to attack the debt first. They come up with a bullet proof plan to eliminate ALL consumer debt in 60 months and they do it! They prioritize debt first. They're thrilled, relieved. (Picture Andy Dufresne when he looks up at the sky after escaping from Shawshank). In order to eliminate all their debt, here is the route they take:
Present Value: $0
Annual Payment/Contribution: $26,000 (They freed up $500/month of additional savings cash flow by eliminating their consumer debt so they can save an additional $6k/year compared to the Jones family)
Growth Rate/Interest Rate: 5%
Study Period: 35 years (Remember, they took 5 years to pay off the consumer debt. They now have a shorter compound curve than the Jones' above.)
Final Number: $2,465,744
Jones Family: $2.53 Million
Smith Family: $2.46 Million
But that's only the first half of the game. There's two sides to this, and you have to play both halves. (Insert Falcons Super Bowl Reference Here)
So, let’s not be like the Falcons and think about the other half...
The Emotion:
This is the side that will differ from person to person. Some of the clients I work with despise having debt so much they struggle thinking about anything else. At Ashford, we have a fairly significant clientele of medical residents and doctors. What do you think they're focused on financially: Student loans.
Other clients are more focused on building their balance sheet. They believe that in 40 years, it'll be irrelevant if they paid off that car note in June of 2018 instead of November of 2017. These tend to be my entrepreneurial clients who own businesses or have sales type roles. They know their next opportunity is right around the corner.
I have to understand what makes a client tick, what keeps them up at night, and what motivates them then come up with a solution that addresses both. Focusing on one will create a lack of balance.
When you are out of balance you may have short term success in some areas but the lack in others will ultimately hurt you. Last football reference that ties to this:
In 2016, against 16th ranked Oklahoma, first round pick, Patrick Mahomes led the Texas Tech Red Raiders to 59 points. He threw for 734 yards, 5 touchdown passes, and ran for 2 more on his own. 59 points against one of the top programs in college football history. Problem was they lost the game. Oklahoma put up 66 points of their own...Tech had no balance, just offense.
Financial success is all about balance. It's just like us as humans. We must focus on making continual progress in all aspects of our life. We cannot compartmentalize behavior, it’s everything; Faith, Family, Work, Health, Finances, Relationships, all of it.
When it comes to money, my bias is flexibility, options, and control. In my experience, clients with more liquid wealth on their balance sheet have more options.
The Final Score:
So which way is right? Well neither, I guess. You should do both. Build saving and eliminate debt, but in the correct order. My issue with ONLY focusing on debt is I feel like most folks end up in a revolving door. They make some progress reducing the debt, a life event pops up (medical, car expenses, vacation, home repair) and since they don't yet have the cash buffer ready for this, it goes back to the credit card and we start over. My problem with only focusing on saving is well the obvious…. when will you save enough and start paying off your debt? It just becomes an ever-involving cycle.
Bottom line, focusing on what makes you tick or helps you sleep at night is one thing but try to avoid allowing it to completely consume you to the point you ignore everything else.
My encouragement would be to run your cash flow at home to create balance in the order of:
- Protect your “today” from loss (lawsuit, injury, illness, death, job loss, etc.)
- World Class Saving (Saving 15-20% of your family's gross income)
- Becoming liquid (Building towards 6-12 months of income in savings)
- Living Debt Free (Paying Credit Card balances every month)
If you feel like you’re at a good place, professionally & personally, but ready to take that next step financially, reach out to me today to get started.
References:
http://www.espn.com/college-football/boxscore?gameId=400869616
http://www.quotesonfinance.com/quote/79/Albert-Einstein-Compound-interest
www.thelivingbalancesheet.com The Guardian Life Insurance Co.