The first three steps to financial freedom

The hardest part of money management is just getting started. Once you have some momentum, it's easier to make the right choices. Kay has been reading personal finance blogs for almost a year now, and she knows that she needs to make some changes, but she doesn't know how to begin. She writes:

I want to get serious about being good with my money, but I don't know where to start. I never developed good financial habits, and now I'm paying for it. I was married to a man who was also bad with money, and I've only been on my own for six years, but I continued those same bad habits. I'm 39, have no savings and about $28,000 in debt.

Next May, I will lose half of my child support when my son graduates from high school, and the rest the following May when my daughter graduates. Because of that, I feel like I should focus on getting rid of the debt, so I have less money going out. But if I don't have emergency savings, then there's no way to keep from incurring more debt. Of course, I don't have any money saved for retirement, etc., which is another worry.

Basically, I have a list full of high-priority financial needs, but trying to do everything at once is going to get me exactly nowhere. (I know, because I've been trying and failing since last summer!) I did cut up my credit cards, but that's about as far as I've got. Help!

It's tough to get started because it seems like there's too many things to do. Which choice is best? Should Kay eliminate debt first? Save for retirement? Build her savings?

Here's the secret: There's no one right answer. Some choices are better than others, it's true, but the best way to take control of your finances is to do something. Action beats inaction. Taking any step in the right direction will help Kay move closer to financial stability.

All the same, some options may be better than others. As important as I think retirement savings is, I wouldn't start there. Better to get the now under control first and then worry about the future. In Kay's position, I would focus on three things:

Reduce Expenses

Kay doesn't mention what her expenses are, but if she's like most people, she's probably spending more than she needs in a variety of ways. When I was getting out of debt, I found that cutting expenses one at a time helped to create a better cash flow, giving me some breathing room.

I didn't try to slash everything, but picked one expense after another. I:

Each of us spends differently. When you decide to get your finances under control, you need to examine your own spending patterns to find the areas you can cut. Focus on one item. Once you've trimmed that, look for another. This gets easier with time.

Build Savings

As Kay boosts her cash flow by cutting expenses, she should use this extra money to save. Even when you're struggling with money, it's vital to set aside for future emergencies. If you can only afford to save $25 per month, then save $25. If you can afford to save $100, then save $100. Just get in the habit.

For many people, the best way to learn to save is by making the process automatic. I also found it necessary to create barriers so that it wasn't possible to withdraw this money on a whim. In both cases, I recommend opening a savings account at a different bank from where you hold your regular checking account.

In my case, that meant opening a savings account at an online bank. I used ING Direct, but there are many other excellent options. It doesn't matter which one you choose. Don't overthink it; you can always change your mind later. Create a link between your existing checking account and your new online savings account. Set the new account to pull $20 or $50 or $100 a month automatically. Treat this like any other bill. Use this money for emergencies only.

Tackle Debt

After reducing expenses and building an emergency fund of $500 or $1000, the third step is to make a plan for tackling debt. For me, that meant drafting a spending plan:

 

My spending plan prioritized my debts and helped me allocate future raises and bonuses. Your plan will be different. It might be more elaborate or less elaborate than mine. The important thing is to establish one.

If you're struggling with debt, I highly recommend Dave Ramsey's debt snowball strategy. Here's how it works:

  1. Order your debts from lowest balance to highest balance.
  2. Designate a certain amount of money to pay toward debts each month.
  3. Pay the minimum payment on all debts except the one with the lowest balance.
  4. Throw every other penny at the debt with the lowest balance.
  5. When that debt is gone, do not alter the monthly amount used to pay debts, but throw all you can at the debt with the next-lowest balance.

Because it emphasizes paying down low-balance debt as quickly as possible, the debt snowball provides quick wins. Those who've never been in debt frown at this strategy because it costs a little more than starting with high-interest debt. But as somebody who fought debt demons in the past, I'm here to say that the psychological boost from the debt snowball is worth the extra pennies.

Conclusion

If, like Kay, you're struggling to get started with smart money management, then break the task into smaller pieces. Don't let yourself be overwhelmed. Reduce expenses, build savings, and tackle debt. Yes, it's important to save for retirement. But I believe that you need to start with the basics, to staunch the bleeding and heal the wounds before you begin gathering strength to face tomorrow.

In other words, don't worry about a Roth IRA or a 401(k) at the beginning. Focus on building a strong financial foundation so that you can meet the needs of today — and next year. Once you've accomplished this, attack retirement savings with vigor.

What advice can you offer Kay? How did you get things turned around? What were your first steps?

For more on this subject, check out my recent article about where we're starting from. Photo by Jurassic Jim.

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Gryphon
Gryphon
11 years ago

While all options are important, I am going to go with what J.D. said: emergency savings first, then debt, THEN retirement. Also, if you are about to lose major sources of income for you, I would start looking now for ways to replace it or at least supplement your income in another way. As not fun as it may sound, a second job (if you don’t already have one) is probably something that you need to consider. You may be in for a bit of a rough patch until you adapt. Getting this under control is going to take some… Read more »

Kate
Kate
11 years ago

I felt the same way as Kay – between student loans and credit cards I had over $75000 in debt. Very overwhelming. Here’s what worked for me: 1. Direct Deposit of $100 into savings straight from my paycheck. I never saw it and so it wasn’t missed. I choose to save my emergency fund and pay down debt at the same time. Because my monthly costs got cut, I have been able to pay for any minor emergencies out of pocket in cash so it’s worked out. If I had kids, I might have chosen to focus on savings first.… Read more »

Nancy L.
Nancy L.
11 years ago

Even if it seems like Mt. Everest now, you totally can do it. The trick is baby steps. First, you need to figure out where all the leaks are. Are you spending too much, or are you just not earning enough for the basic expenses? If you are tossing money at home decorations or lattes or other non-essentials, then it’s easier to find ways to cut back on spending. If you are having trouble with just covering utilities and rent, then the challenge will be about increasing income. (I should point out that there are a ton of great posts… Read more »

Beth @ Smart Family Tips
Beth @ Smart Family Tips
11 years ago

I’d echo Kate’s point #2 above — track the spending. I used to feel like there was no money left for saving, but after I wrote down every cent I spent for a month, I found lots of wasted money that could be applied to savings and/or debt. Paying off debt (and even working towards paying it off) and having at least a small emergency fund feels great.

Tracy
Tracy
11 years ago

All great tips! My problem hasn’t been the saving part, that I can do, it’s the dipping in to the savings when needed, and little by little, I have no more savings. I like the idea of using a completely different bank for the savings account. Any other suggestions for someone like me?

Linear Girl
Linear Girl
11 years ago

First, congrats on cutting up the cards – that’s a bigger step than you know. Second, have you also cancelled any recurring payments that are billed to the cards so that you’ve really stopped charging? I like to know what my goal is before I start action (with one exception, start automatic savings TODAY. Start with a modest amount, but don’t put it off for even one more day). Ask yourself how much debt do you want gone? How much do you want to have saved? Then make a plan that shows what it will take to achieve those goals… Read more »

Michael@TheCardSender
11 years ago

I would add another step – Multiple streams of income. The only way to have true financial freedom is not to be tied to one income. Create multiple through outside jobs, investments and you will be able to “walk away” from one if you do not like the direction it is going.

Brian
Brian
11 years ago

I agree with reading Total Money Makeover. It lays out the steps so nicely. Your Money or Your Life is great motivation, if you need any more.

My income is down significantly this year, so I had to face the music and make a budget. It’s one of those things you don’t want to do initially, but it is so nice! It gets easy to find places to save money to put to debt, and it gives you a concrete understanding of how much money you really need for the future.

Tyler@FrugallyGreen
11 years ago

Do your research and take in all the advice you can, but don’t be afraid to make mistakes. Like JD said, you need to act and making mistakes is a good indicator that you’re at least moving forward on your need to turn your finances around. No one can make a 180 overnight and hit every target the next day. Make some simple goals to start out with and figure out what steps you need to take to achieve them. It’s easy to over analyze things and second guess yourself, so realize when you’re doing it and make a conscious… Read more »

Denise L
Denise L
11 years ago

I completely agree with everything in this post. Furthermore, once you pay off your smallest debt, it’s one less bill! You’ll feel better already! Regarding #5 above, I have two suggestions: You won’t spend your savings if a) you’ve sacrificed to save it or b) you can visualize what it’s going to be used for in the future. For a), I would develop a healthy sense of guilt. Just think of the little things you sacrificed to save your money, and now you’re spending it on (fill in the blank). With regards to b), think about goal-oriented saving. I like… Read more »

KF
KF
11 years ago

Cut your expenses to the bone (no indulging your children even though I know it’s hard), get an extra job (the benefit of your children being old enough that they don’t need you there all the time), and put every extra cent toward debt. Hold your nose and do this as long as you can realizing that having less of a life now will mean infinitely less stress later.

Laura O.
Laura O.
11 years ago

Like Tracy (#5), I had the problem of dipping into my savings here and there, so I would see the balance either fall or stay the same. For a long time, I could never make headway. Three things really helped me change, and now I’ve more than doubled my savings in just six months! This is what I did: 1) Thanks to J.D.’s recommendation, I read Your Money or Your Life back in November…it was such a great book because I had a real paradigm shift. Without realizing it, I was trying to keep up with the spending habits of… Read more »

Trini
Trini
11 years ago

I’m with Linear Girl on involving the kids. If they’re both finishing high school, they must be in the 16-19 range, so they’re old enough to start working their own jobs. It’s up to you whether you want to ask them to start paying rent once they finish HS, or otherwise chip into the household expenses if they’re still living there, but those are options. As for the kids, here are a couple thoughts: 1) Try to impart some of the money lessons you’ve learned from this and other financial management websites so they can start to learn good money… Read more »

Sam
Sam
11 years ago

We had over $55,000 in debt (about half in student loans and the other half cc debt) which we paid off in just over a year using Ramsey’s Total Money Makeover plan (which worked great for us). We also tracked our spending with Quicken and that help us figure out where we could cut (mostly we cut eating out and entertainment and I cut clothes shopping and Mr. Sam reduced Home Depot spending) and we created a spending plan and put us on an allowance. We are still on an allowance, although not as strict, and when our allowance money… Read more »

Jacob S
Jacob S
11 years ago

Great ideas. Personally I don’t follow the debt snowball to a T because I will never save any money that way. I know I could pay off debt more quickly that way but I need to save money because of health issues that occassionaly take me off work. So what I do is put 4% of my paycheck ino my 401K every week. Eventually I want to bring that nukber up to 20%. I reevaluate every six months to see what I can afford to put in. Secondly, I put 5 bucks into my savings every week and also deposit… Read more »

Aperson
Aperson
11 years ago

Sounds like Kay will soon be an empty-nester (no more kids living in the home). If this is the case, the biggest expense she probably has is her home, which at the moment is probably a three-bedroom. Kay will need to down-size, even though her instinct might be to keep the home to provide a place for her children to visit. My suggestion to dramtically reduce her costs and make her dollar stretch further is to rent a one-plus-one bedroom apartment. Put a futon in the “plus-one” so that if the kids need a place to crash overnight, it is… Read more »

Todd @ The Personal Finance Playbook
Todd @ The Personal Finance Playbook
11 years ago

I think your first priority should be creating a lifestyle where you spend less than you earn. If you’re starting out with debt, it just makes this change even harder. Making this one very significant change in your lifestyle is more important than having lots of personal finance knowledge. I think having the right mindset should be your first step. The good news is, you’ve already been reading and gathering information for a year. You have plenty of knowledge, but continuing to learn reaffirms that knowledge and inspires you to stay on track. Good luck. I hope things turn for… Read more »

Katrina
Katrina
11 years ago

All great suggestions for Kay. The hardest part will not so much be creating the plan, but living the plan. That’s why you want to make mini-milestones for yourself. It will take years for sure to work your plan, but once you devise the big picture, break it down into short-term goals — meaning 3-month intervals so you can review and feel the success.

Like I said, the hardest part will be sticking to it. Change is fun to imagine but difficult to live out. So you’ve got to see progress to feel motivated to continue.

Jessica
Jessica
11 years ago

My household does the Dave Ramsey plan with a few small tweaks. We saved about $3K before starting our snowball, we still contribute to 401K’s to get the matching contribution, and we have about $200 a month pulled out of our checks to go to savings. We felt like we needed to be saving for the just in cases because of the economy but are open to using those savings to pay off debts if things get better. I have worked pt jobs when I could get the hours and my husband works 60+ hours a week so he doesnt… Read more »

KS
KS
11 years ago

All good advice. The thing that wigs me out about the Ramsey plan is the $1000 in emergency fund. That seems…scary to me. Maybe because in one summer, we needed a new roof, had to deal with a downed tree, and once of us had emergency surgery. The emergency fund went – and then some. I’m trying to get to a good place on this one myself (own a house, which may mean more, but I have a very secure job, which may mean less.). We’re also in our 40s and want to save more for retirement. For now, we’re… Read more »

Christine T.
Christine T.
11 years ago

Good luck Kay!
Personally, I was not able to change my spending habits until after I started tracking all my spending. (Kate’s #2)

Diana
Diana
11 years ago

I don’t think I saw this in any of the other comments, and maybe I’m just old-fashioned.

If her kids are going to be 18 soon, she will be losing child support but she will also have fewer expenses. If the kids are 18 and out of high school, they should be on their own or contributing to the household (this concept was also discussed by Dave Ramsey’s). If they are headed to college they should still be working to off-set their expenses.

KC
KC
11 years ago

I started trying to tackle my debt almost a year ago by reading anything I could get my hands on, but while enlightening didn’t help me get things under control right away. In January I made a modified debt snowball and have seen results but was frustrated by my lack of progress (I have made progress, but not enough). Last month I started using mint.com and I love it for showing exactly how much I’m spending on groceries for example. Now budgeting is easier and I can’t fool myself. My next step is to rein in the overspending I’m seeing… Read more »

Rob
Rob
11 years ago

This is an interesting one. I can see the logic in creating a well filled savings account. The problem is it doesn’t really make financial sens. Say at a point you have saved $2000 on an account that pays 3% interest. Meanwhile you also have a debt of several thousand dollars on which you have to pay 10%. In this case, the savings account will hurt you bottom line. (You pay 7% to much interest on the first 2000 dollars of dept). I would say get out of dept first using the snowball technique described in the article above. Although… Read more »

Sam
Sam
11 years ago

In response to Rob, the Ramsey SnowBall is set up smallest to largest debt and not by interest rate because when you pay off those first couple of debts you get quick positive feedback and you keep going. Ramsey preaches that personal finance is mostly emotional and not math. Mr. Sam lobbied hard for paying off our debts from highest to lowest but I won in the end since I was doing the heavy lifting on the project.

MyFinancialIndependenceCoach.com
MyFinancialIndependenceCoach.com
11 years ago

Tried and true advice once again! Kate hits it on the head…you can’t gain control of your money until you know exactly where it’s all going. Track your expenses…every penny! In my coaching, I usually tell clients to try telling their spouse, “Honey, I will be completely faithful to you 99% of the time!” Doesn’t work…don’t track 99% of your expenses; track every cent. TIP: http://www.mint.com. Makes life REALLY easy to do this! Only then can you effectively budget, cut things out you don’t need, and gain the confidence you desire with your money. We call this step “Gaining Financial… Read more »

MyFinancialIndependenceCoach.com
MyFinancialIndependenceCoach.com
11 years ago

In response to Rob: in real life, money IS emotional for more people than for those that study the true “math” of it all. I’ve seen too many people over the years kill themselves to use every penny to pay off debt, then when “life happens”, they have no money to deal with it. Imagine taking an entire year (or more), and using every cent you have to pay off debt. You just made the final payment to good ol’ CHASE platinum (not a plug by any means 😉 and you lose your job. Or more simply, you get in… Read more »

Linear Girl
Linear Girl
11 years ago

@Rob – The purpose of the savings account (aka Emergency Fund) isn’t to earn money, it’s to stop the need to use credit if an emergency comes up. The purpose of paying off the smallest debt first is to give one a sense of achievement and to renew the motivation for getting out of debt in the first place. There isn’t a single thing wrong with doing it the way you spell out, if it works for you, but it just doesn’t work for a lot of people. I spent literally years listening to my Dad make your exact argument… Read more »

Kevin@OutOfYourRut
11 years ago

Kay has blessed herself with the magnificent benefits that come to a person who bares her soul in a difficult situation. The article and the posts contain a wealth of outstanding ideas. And hopefully I’m about to add another. Kay since you have another year (almost) of full child support, followed by another year of reduced support, and you know it’s coming to an end, try living without it now. You will need to radically cut expenses, but you have a choice either to do it now while you have the support as a cushion, or next year when it… Read more »

Patrenia
Patrenia
11 years ago

Great ideas here J.D. I wouldn’t disagree at all as the debt snowball is the method my husband and I used to pay off our debt. I don’t know why soooooo many people get caught up in the simple mathematics of highest interest vs. lowest debt. What does it matter? We are all trying to get to the same place anyways….DEBT FREEDOM!!!

Thanks for your insight and keep up the good work!!!

Rob Bennett
Rob Bennett
11 years ago

You have to get to enjoy saving, not to see it as a negative. Try cutting out one big item and see if it is as painful as you worried it might be. For example, cut cable. If you end up being happy that you have more free time, you’ll soon be looking for other ways in which to “sacrifice.”

Rob

Kevin@OutOfYourRut
11 years ago

Excellent point Rob! She’ll need to detach from the idea that happiness is found in stuff. Happiness is what you do, not what you have.

Sandy E.
Sandy E.
11 years ago

About debt snowballs – credit card debt. I haven’t seen it mentioned anywhere on any financial blog (and I don’t have time to read many, so maybe it’s there somewhere…) but — If you are in a situation where you can only pay the minimum payment per month on your credit card debt, then try to pay just $10 more above that each month. This has been pointed out by Suze Orman. Here’s an example: If you owe $1,100 at 18.5%, and if you pay the minimum (say 1.7%) of your balance every month, and you never charge another item,… Read more »

PW
PW
11 years ago

Thanks so much for this post. I am in a similar situation and keep losing hope due to mistakes I keep making over and over. All these comments are helpful to know that if I take steps back, I can still get up and try again and that success is possible. Thanks!

Sandy E.
Sandy E.
11 years ago

Actually, timevalue.com has a user friendly credit card calulator, and I would recommend theirs over bankrate. It really is amazing at the different in interest payments alone that that extra $10 per month makes. (Ten dollars a month is only 35 cents a day).

Diana
Diana
11 years ago

Just to clarify, I ment when the kids were out of High School. Once they are legal adults (and they will declare themselves as such, teens are like that 🙂 They should be taking care of or contributing to support themselves. My family was poor, heck they’re still poor. My parents gave me the choice of getting a job to have spending money, be able to purchase my clothes or not have a job and not have spending money and be able to buy clothes when we could afford it (and what we could afford). They provided for my needs… Read more »

reallysparkle
reallysparkle
11 years ago

Good post, J.D. My advice to her is to set a goal, and stick with it. Break up the big goal into manageable chunks, and set timelines to keep you on track. Make up a real budget (not a guesstimate), and STICK WITH IT. Easier said than done. For me, I realized that I am in my early 20s, but going the way I was going would screw me up eventually. I like having my money to myself, not having to pay a big portion of my paycheck to Mastercard, and not being at the mercy of whatever I see… Read more »

WP
WP
11 years ago

If you consider getting out of debt in the same light as moving a heavy object, it is much more difficult to start that object moving from a standstill than to keep it moving. Kay is suffering from something like this as she is trying to motivate herself to start paying off her debt. It does no good to sit around and worry about what to do, or to lament your past mistakes. The time to take action is now, using the knowledge she has gained over the past year. Personally, it makes sense to me to begin with some… Read more »

Kevin@OutOfYourRut
11 years ago

Excellent point WP. The crucial point is to get something going even if it doesn’t solve the immediate problem, and even if the plan isn’t perfect. Worrying about it only makes things worse. Action is the antidote to anxiety.

Theo
Theo
11 years ago

Here’s a minor suggestion, and one that is more useful in today’s enconomy. Not only take into account how much you owe but how much your payments are. For most credit cards the payment is only 2% of the lone, but many other loans are fixed. So, if you have a car payment that is $450 a month, and you only owe $150 on your credit cards it might be worth trying to get the car paid off as soon as you can so if lose your job you don’t have that large payment hanging over your head every month.… Read more »

Linear Girl
Linear Girl
11 years ago

@Kevin – “Action is the antidote to anxiety.” It’s worth repeating. Thanks.

It puts me in mind of a quote, Tom Stoppard I think, “Happiness is equilibrium; shift your weight.”

Kevin@OutOfYourRut
11 years ago

Linear Girl–thanks for the compliment! You didn’t do so bad yourself back at #28 with “The purpose of paying off the smallest debt first is to give one a sense of achievement and to renew the motivation for getting out of debt in the first place.” Don’t be suprised if it turns up in one of my future posts! Theo–solid take on car payments. Even more with a big payment/low balance account. Eliminating $450/mo on a $4000 loan balance might be better than having an emergency fund. It would be a serious blow to lose a car that’s in the… Read more »

J Brown
J Brown
11 years ago

Sell, Sell and Sell. My income is good, but I need to see the results to keep me moving. I have cleaned out the closets, basement and piles of stuff to sell on craigslist or buyback sites for books. Sometimes I got $1 for a book or other times I got $45. Keep in mind any progress is still progress. My area is less cluttered and my ‘snowflakes’ have added $1200 to my debt snowball in 4 months. Automate. Instead of paying my debt bills monthly, I pay then weekly. The credit card interest is based off a daily percentage,… Read more »

Rob
Rob
11 years ago

I’m glad so many responded to my post. Some of the comments were expected. First of all I need to explane I’m from the Netherlands and have no real life experience with credit card debt (other then the one I pay off the same month). So the emotional part is probably very different. (so any of my advice on emotional issues concerning credit cards should be discarded 😉 ) Everyone should choose the style that they think is best for them. I guess my biggest point is to look at your cashflow. Debt can be good and bad depending on… Read more »

Kathryn
Kathryn
11 years ago

I’m a big believer in breaking the debt habit..not just paying off debt. Emergency accounts are an important part of breaking the CC habit. Without savings, you’ll end up borrowing when something comes up, and you’ll continue to think of borrowing as a way of life. But I have another idea for Tracy who spends her savings. If you are spending your savings for those little irregular, regular things…gifts, small home repairs, etc, try this: What I did was set up two savings accounts. One is at ING –the real emergency account, with automatic withdrawal from my checking, for if… Read more »

Paul
Paul
11 years ago

Without any doubt, getting out of debt is THE key to financial freedom.

Think about it. In order to get out of debt, almost everyone needs to make adjustments to their lifestyle and spending habits, and once you are out of debt, saving is easy as pie.

Getting out of debt = freedom. Do it. Now.

Bulldog Gin Co.
Bulldog Gin Co.
11 years ago

I max out my 401K every year. If I did no other savings and had no other debt, is this good enough to retire on w/ SS in 30 years assuming a 4% rate of return?

MyFinancialIndependenceCoach.com
MyFinancialIndependenceCoach.com
11 years ago

@bulldog Gin Co. – This is a great question that so many people have. To answer it though, the biggest thing you must figure out is how much your lifestlye/expenses in retirement will be. It sounds like you are in Accumulation phase of life, socking as much money away as possible which is great. What many are not realizing is the only way to know if it’s “enough” is to forecast, or try to predict what your “tomorrow” looks like and costs. I run clients through a process of identifying exactly what their “today” is costing (i.e. budgeting), then have… Read more »

MyFinancialIndependenceCoach.com
MyFinancialIndependenceCoach.com
11 years ago

@Paul – exactly! You reminded me of a thought I share with clients. If you had NO EXPENSES right now, would you be financially independent? Most look confused at first, but then realize how simple it really is…our living expenses are what dictates becoming financially independent (f.i.). I could bring home $100 per month, and if I have no expenses, or debt, I’m F.I. While I know this isn’t realistic, with car insurance, gas bills, phone bills, etc., sometimes it’s just important to know that our chosen lifestyle and spending is what determines whether we ever reach financial freedom or… Read more »

King
King
11 years ago

Rainy day fund is more important and the best thing to do is make saving a habit. When our finances are squeezed, cutting the expenses is more important. As mentioned this could be done on dinning out. Power consumption at home, Telephone bills etc., can also be reduced. Traveling in public transport can reduced our fuel bill a lot. There are a lot other things that can be in our control which has to be identified and controlled. Also, our child’s education is more important and we cannot compromise on such factors but other expenses that our child do can… Read more »

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