The “Why” of getting out of debt
I believe our treasure ships come in over calm seas. So, it is important to reduce uncalming influences. One main uncalming influence is financial stress, which is often created by inappropriately high debt levels.
Reducing your stress around finances improves financial results to a correlated degree. And for the avoidance of doubt, this improvement is quite independent of and in addition to, the improvement in cash flow created from the lower debt repayments themselves. An “air of financial expectation” can more effectively exist when stress is absent. One often gets what one expects, this is no exception.
At a more practical and obvious level, a reduction in debt clearly improves financial position. That said, some types of debt could be good debt. Take care for your own particular circumstances.
Reducing debt gives you more cash to play with and also more long term investments. Result = lower stress and more enjoyment. As long as the steps are simple and you get real results, why not give the following a go, just to see what you achieve? Only takes a few minutes here and there.
The “What” of debt reduction
Money style impacts one’s appetite for debt reduction. It is best to work to your strengths on this. “Spenders” need different strategies compared with “Savers” and “Self Sabotages” need different strategies from those “Disconnected” from their finances.
Here are some questions to ask yourself.
- Can you pay your debts as they fall due?
- Are you able to pay yourself market wages and can you pay yourself first every time?
- Do you save anything on a regular basis no matter what else happens? In percentage terms, is it as much as 10% of your income – more? Or less? What percentage do you want it to be?
- Do you put money aside for income tax, wages, PAYE and GST regularly, so the funds for these things are always available?
- Do you have a fund for saving towards big-ticket items such as vehicles, equipment?
- Do you save for your children’s future/education?
- Do you compare actual with budget for both personal and business finances as appropriate?
For the questions answered “no”, how might things be different for you if that changed to “yes”? That is likely to be your reason for giving these simple steps a go.
The “How” of debt reduction – 6 Steps
- Are you living within your means? – A reality check– complete both the personal budget and business fixed costs worksheet.
Find out what the personal pre-tax income equivalent you will need to have your needed and desired lifestyle. Drop us a line and we can tell you the pre-tax amount if you want. Compare this number with what you are paying yourself now – you may be surprised how it often differs significantly.
- Keep a record of ALL you’re spending– this may sound overly detailed, but it is quite important to do fully. Buy a small notebook and for 30 days, write down literally every single purchase you make personally– coffees, parking, anything. This will get you focused onto the small items as well as big-ticket items and bring a high level of awareness.
- Setting goals– next step is to have targets for each of your main spend groups in terms of quantum each month – examples might be to only go out for dinner x times per month, or $100 for x activity each month. Importantly know what the goal is for areas you have least discipline over.
- Keep spending to within 90% of your income– this is a valuable skill to learn and consistently apply – regardless of how much your income might fluctuate over your lifetime.
Think about the financial situation you would be in now, if you had always saved 10% of your income. Yeah, I know, me too, wish I started earlier than I did…. but before getting too depressed, remember it is never too late to start to do this -results make a psychological difference to your stress levels. Lower stress levels means money flows to you easier. Just start now.
Importantly, sometimes the remaining 10% can be used for savings or investments, and sometimes it is used instead for debt reduction. The choice between the two is where sound financial judgment occurs. If it is used for debt reduction, then your financial situation is still improving. Remember that.
I perhaps contentiously state that living within your means includes only buying items you can afford now. Old-fashioned adages such as only going into debt for items that will increase in value is something to consider very carefully.
Whether to put vehicles onto a leasing arrangement rather than buying a cheaper car outright can impact your monthly budget required and again depends in part on money style and circumstances. Self-sabotages are better with cheaper one off purchases they can afford now– savers are okay with leases in my opinion. Only one party makes money out of a leasing arrangement though but tax can be a good carrot.
“18 months interest free deals” and the like for certain money styles are good, but if financial discipline is absent, these can create a rod for your own back. These type of deals should be taken up where you can put the money aside and pay for them in full once the interest free period is up. If you can’t put the money aside, don’t do them unless you can change your habits enough or the amount is so low relative to your income it is just noise and can be repaid quickly once the time is up.
- Debt reduction itself– your overall budget will likely have payments on business loans, equipment HPs etc., as well as personal mortgages, car repayments etc.
How to reduce each individual debt (and in what order) depends in part on which money style you are. Self-sabotages and spenders need a different debt reduction approach to savers and disconnected styles. However applying the 10% bits on top of regular payments is key to all styles.
If you are not currently living within 90% of your means, make a decision to not make your debt any worse. Today. Just stop making it worse! Have a “not for sale” attitude about your commitment to this. It can be like a 12 step programme for some people and if that is what it takes, that is what it takes – “just for today, do not make your debt any worse”. And then do that again tomorrow. I say that a little tongue in cheek – but it is relevant for many.
The Self Sabotage style should be aware to keep themselves in check after a few weeks or months, so they don’t just blow all of the hard work achieved thus far. This particular money style is often well placed to build up a play account so that they are “allowed” to self-sabotage whenever they want, as long as they only use that designated account – it is a happy middle ground.
Disconnected styles can be easy to work with as long as they live within their means. (These people can save heaps via A/Ps without even realising they have). If they don’t live within their means however, they need to become a lot more connected with their finances first. Often setting up a savings A/P can achieve this reconnection as well though.
Spenders and Self Sabotages often both need a mentor or buddy to report progress to – often fortnightly until they have new habits in place. Then six monthly forever in my view.
Sometimes Savers could benefit from enjoying life more but if they are happy, not a problem huh. Savers tend to be more risk averse so might watch out for having a balanced approach to saving so their investments are maximised – sometimes their debt is almost too low and they sacrifice higher investment achievements as a result.
- Educating yourself– once you are living within your means and have reduced credit cards, business and personal loans to an acceptable level, you can have more fun with investments, using that 10% spare. In some cases, this can be more than 10% of your income, but remember it is also good to have fun along the way so have a good balance between now and your future.
Important to utilising the place for the 10% spare, is to learn more about different types of investments – and to do so before you actually want start investing. Attend workshops about various investment types so you can assess the risks, rewards, tax treatments etc. Sure, we all have advisors to help with this, but you should have a good level of awareness yourself as well. These type of things can be delegated but never fully abdicated to an advisor, in my opinion.
Please contact us if you would like some assistance in applying any of this in practice.
Love to Grow (Wgtn) Ltd
Chartered Accountants
Email: info@lovetogrow.co.nz
Tel: (04) 972-4182 or (09) 282 3054
www.lovetogrow.co.nz