Begin at the Beginning: Step-by-step Path to Financial Independence
02 May, 2021
Whatever it is that you are embarking on that’s always the best place to start in my opinion. The beginning. Then just follow the path, in my case, the path to financial independence and eventually not being tied to a job to earn my income. It’s a long journey but it’s one worth starting.
Many people get in touch with me to ask me questions and they range from those who are just at the very beginning of starting to get their financial house in order, to those who are well on their way. But what I often uncover during our discussions is that even if you are well on your way you have often missed out a few key steps at the beginning of your journey. For example, you might have got your KiwiSaver balance up to $100,000 but you owe money on the credit card or car.
I’m often writing an email that covers the same points over and over again, so I thought that today I’d put that information into a blog post for all of the people wondering where to start and how to string all the bits of information you have learned about money into a cohesive order.
Because that’s the thing, we come across information that is useful, but totally out of order and it’s still too darn confusing about how to string it all together, but this should help!
The first thing I’ll always mention when I speak or email people is that I’m not a financial advisor, I can’t give specific financial advice. But I do read, listen and chat to an awful lot of people about personal finance so I think I’ve got a good general idea of how things work. And I’m not broke either, I think that’s helpful for you to know too.
My emails to people are pretty chatty, I’m a very chatty person, so this blog post is along the same lines.
Start here:
Calculate Your Net Worth
What’s your net worth right now? What do you own and what do you owe?
This is a crucial exercise to take yourself through so you can find out exactly where you sit today and that way, in 6 months, 12 months or 3 years from now, you can look back and see how you have progressed. The exercise is simple enough to do but can be confronting to those who have never even thought about it before. Either using pen and paper or a simple spreadsheet on your computer create two columns:
An example of a simple two column spreadsheet to calculate net worth.
On the last day of every single month, I sit down and update my net worth spreadsheet and have done so since 2015. When I graph our progress, it looks like this:
Graph showing our net worth since 2015.
It’s a very simple way of telling me if my whanau is heading in the right direction or not and also it reassures me that even after a year of COVID when we might have thought it would be disastrous financially, it simply was not. Unless I had been tracking this I would have made assumptions, which are often completely wrong.
Budget
The second most important thing in my view is to create yourself a budget because until you know where your money is coming from (income) and going to (expenses) you can’t make progress. “What gets measured gets done” is a common and entirely correct phrase. And I KNOW that some people groan at the very sound of the word “budget” but we also do other things that we don’t like in life like eating vegetables and exercising because we know that they are GOOD FOR US.
It does not matter HOW you budget, it just matters that you do. And that you do it consistently over time.
I use Dunedin company PocketSmith and have done for a couple of years now, paying about $90 each year for the service. A budgeting tool that links to your own bank accounts and automatically updates and categorises transactions is a huge time saver in my opinion. In the past, I’ve tried Everydollar which is a free, but manual, US based one. I’ve made my own spreadsheets too which I found to be a great place to start but ultimately too time consuming to manage. Sorted offers an excellent free budgeting tool too. It’s a matter of finding something that works for you and one that you will constantly return to and refer to. Personally speaking, after years spent manually updating my homemade spreadsheet, the more automated it is the better because if it’s cumbersome to update then you WILL run out motivation to keep updating it. I know this to be true because that’s exactly what happened to me.
A budget is an organic thing, it changes month by month and the longer you do it the better you get at predicting your future expenses, based on previous expenses. By budgeting, you can see where you are earning money, spending money, wasting money and saving money and the ultimate goal is to create as big a GAP as possible between what you earn and what you spend. Because that gap is the leftover money after you have lived your life and if you want to stand any chance at all of improving your net worth, you need to create a cash surplus to either pay off debt or invest.
Simple items to budget for are: Groceries, Phone plans, Insurance, Fuel, Water, Eating out etc
To get started it’s a matter of looking back over your last three months of bank statements and noting down every time you visited the supermarket. You will end up with three amounts representing three months. Take the average of these and this becomes your grocery budget for the coming months. Then, for first-time budgeters, I encourage you to just monitor this over the coming months. Does it feel low or high to you? Are you hungry or are you throwing food out? Is the budget you have set for groceries realistic or not? If it’s not, adjust your budget and keep on moving forward. Do this for each expense category. Your budget is entirely unique to you and you choose what stays or goes and what you allocate to each area.
I run several bank accounts at the same time (currently about 10), each with a different purpose. This is where I store my money for the short to medium term goals I have. At any point in time, we will have anywhere from $20,000 - $30,000 spread across these accounts. It’s a lot I know and it took us time to follow my own advice and build it up. But it all has a purpose. There is money there to put petrol in the car today. Money being saved up for car repairs or schooling needs over the next 12 months. Money being saved for holidays in the coming years. So, although it seems like a lot of money to have sitting in a bank and that others might say that “it should be earning money” to them I say you are wrong. Money that is going to be used for short to medium-term goals should be kept safely in the bank, that way, when I need it, it’s there. Its job is not to make money, its job is to help me run my life efficiently.
From here on in, budget your income and expenses, save up for the things you want and pay cash for them. If you see the thing you want, yet you don’t have the cash, to put it simply YOU CAN’T AFFORD IT.
Create An Emergency Fund
Things go wrong. Unexpectedly. That’s why they are often referred to as an emergency, right? One of the most important things I ever did was set some cash aside into a bank account which we could access in an instant in case we needed to. Initially, it was just a couple of thousand dollars. Now, we keep 4 - 6 months of monthly expenses in a bank account called “Emergency Fund''. For us this is $14,000, we could easily live on this for 4 months or 6 months at a stretch.
I budget to the best of my ability, setting money aside into sinking funds for specific events (schooling, pet care, health costs, car repairs etc), but sometimes, despite my best endeavours I fall short. Having this cash sitting there and ready to immediately access stops you reaching for a credit card, dipping into your mortgage or reaching for some kind of buy now pay later scheme to pay a bill. That’s all just more debt and in an emergency that’s the LAST thing you want to turn to as it has the potential to make a bad situation worse.
Pay Into Your KiwiSaver
If you are employed, make sure you are contributing to your KiwiSaver and that your employer is too. If you are self-employed, make sure you have set up a voluntary monthly automated contribution into your fund. This is you paying your future self, this is you planning well in advance for your retirement which will be upon you one day. I want you to get there with some gas in the tank, not broke because you thought that your money was better off utilized elsewhere. The 3% employee and 3% employer contributions are in the majority of cases simply not enough to create a KiwiSaver balance at the age of 65 that will see you retire in comfort. So, if you are looking at your balance and wondering why it’s rising so slowly, that is why - you are not contributing enough. 10%-15% is a better goal to aim for but one that is rarely spoken about here as we have all fallen into the default zone of 3%. Personally, I do only contribute the minimum of 3% each year to get the government contributions BUT and this is a really really important BUT, I’m investing heavily OUTSIDE of our KiwiSavers, in total we manage to save and invest about 35% of our take-home pay each month.
KiwiSaver is a REALLY important building block in your finances, so please make sure you and your family are signed up and contributing to it from a young age. I signed my own daughter up at birth and have since contributed just $40 a month with the goal being for her to take over these contributions as soon as she begins to work one day. It’s worth signing up your kids, even without the government kick start of $1,000 (which they unfortunately removed years ago) and even without the government contributions for those under the age of 18 because it gives you ‘time in the market’ and lets compound interest work it’s magic. My daughter is evidence of this when at the age of just 13 she already has a balance of over $15,000 in her growth fund!
Sorted offer a KiwiSaver Fund Finder tool which I highly recommend you use to compare the fund you are currently using with others. You are looking for a low fee, passively managed fund with a risk profile that is right for you. In my view the less human intervention in your KiwiSaver fund the better because humans often get their future return predictions wrong, yet they still want to be paid for their time, hence charging higher fees!
Think of ‘risk’ this way:
If you go into a high growth KiwiSaver fund, the market crashes and you panic and switch funds, well, you should never have been in a high growth fund because the volatility scares you. Basically, the younger you are the more risk you can tolerate because you have a long time until you get access to this money and therefore a long time for it to ride the highs and lows of the markets. Remember that over time the market only goes up! You just need to select the right fund for you so that you won’t falter along the journey and just continue to contribute to it regularly. Then just leave it be! This ‘go go’ world we are in where we always feel we have to be ‘doing something’ is exactly the opposite of what your KiwiSaver fund requires from you! Get in the right fund, invest regularly and leave it alone.
Become Debt Free
All the people I know who have debt are still at work.
And don’t get me wrong, working in a job you enjoy is awesome, but it’s even more awesome when you know that you don’t have to be there if you don’t want to be!
Personally, I’m trying to make work ‘optional’ so it was priority number one for me to become debt free as fast as possible, SO THAT I can then give myself a massive pay rise because I’m no longer handing over half of my paycheque to service debt, therefore creating a big gap between what I spend and what I earn. This money can then go into investments that increase my net worth. Jonny and I have managed to do this, become debt free and I can’t express to you the freedom that comes from not having to pay things off.
Someone asked me the other day how we can be ‘content’ when we are not working full time and it’s a question I’ve mulled over quite a bit. Being debt free gives you options to explore other parts of your life and in our case we get immense enjoyment out of things we do outside of paid work. I could not write this blog if I worked full time, so me pouring hours each day into this, with little financial reward, is still immensely rewarding. And that makes us content, even though we now earn less.
When I see people debate with themselves whether or not to pay off debt, I’ll always advocate for becoming debt free and the words of Dave Ramsey come to mind when he says “if I’m wrong about this and paying off debt is the wrong thing for you to do, well you can always just go out and take on more debt”. People rarely, if ever, do. Becoming debt free gives you both a pay rise and FREEDOM.
Whatever your debt of choice, pay it off FAST: Student loans, credit cards, car loans, a dozen Afterpays, your mortgage…
It’s all debt, it’s all money you borrowed and every day of your life you will be handing over your income to pay both it back and all of the interest you have been charged. List out your debts smallest to largest and begin to hit them one by one while keeping up the minimum payments on all of them while you do. It’s called the debt snowball way of becoming debt free. If your first debt is $100 on a pair of jeans you put on Afterpay, then make additional payments as fast as you can until it's gone, then move onto your next smallest debt, maybe the new iPhone you are paying off. Hit it hard, using all the income you can spare until it's gone. Because you are budgeting now, you will know exactly how much income you have spare to throw at debt. Then onto your credit card, your student loans, your mortgage. Keep making progress until you are done. You will pay off these smaller ones FAST and that’s going to give you motivation to keep going. Once you hit the big ones, such as student loans and your mortgage things are going to slow down, in many cases this will take years and it's a long grind to the finish line. I’m watching my own sister nearing the end of her mortgage and it’s been a really tough slog of about ten years, but come mid 2021 she will have ‘knocked the bastard off’. I think a party to celebrate is appropriate, don’t you? The effort is worth it, the journey is worth it and I’m in touch with a lot of people who have spent years clearing debt. The emails I receive and conversations I have with people who have become debt free for the very first time are some of the most motivating I will ever hear.
Don’t let anyone tell you that debt does not matter. It does. It holds you back, it restricts your options either consciously or subconsciously. To me, debt was simply a stage of life and once I moved away from it I’ve never looked back. It made us far better managers of our money because we felt the effort of the work we did and the wrench of handing over our income month after month to a bank. And we have never looked back.
Invest
This is where we all get very nervous about ‘giving financial advice’ and it’s the reason why a fee-only independent financial advisor really comes into their own. It’s their job to analyse a person’s entire financial situation and then make a plan based on that complete picture. When people get in touch with me wanting to start investing it’s a minefield because I don’t know your situation and because investing does not happen in a vacuum, it’s part of the big picture of your life. My general rule of thumb is that you can’t make money while you owe money, which is why ‘investing’ comes in at this stage of this blog post and not earlier.
This is the part that everyone wants to jump to, particularly once the likes of Sharesies, Hatch and Kernel came about, but it’s really something that you need to do once you have all the above points covered off.
“Oh, but Ruth, what about time in the market, what about compound interest”, I hear you cry!
When people first wake up to being better with their money they always want to run before they have even learned to walk because they realise how much TIME they have wasted being poor with money and they want to set things to rights. Right now! I’ll often mention that it took someone years and years to get to the point they are currently at financially, so they can take the time that’s required to clear up the situation they have already created for themselves, before moving onto the next step, which is investing.
For those who have FOMO and are desperate to start investing, just remember that with your KiwiSaver, you ARE already investing. And with every $1 you pay off your debt, you have just increased your net worth by $1.
So, just chill out a bit.
If you fail to consistently stick to all of the above points: Know Your Net Worth, Budget, Have An Emergency Fund, Pay Into Your KiwiSaver, Become Debt Free
Then if you were to jump straight to investing, you will muck it up. That’s a promise. Because all of the steps I’ve just run through, to get to this point, to be an investor, you need routine, consistency, planning and the ability to work towards a long term goal. If you fail to do any of the above you will dive into investing, win some, lose some, chop and change and fail to grow long term wealth.
Investing for me is easy and very straight forward. You’ve heard me say it many times but it’s index funds or ETFs all the way for Jonny and I. I’ve no time for picking individual companies, I’m no good at it. Nor are you. In fact, nor are the money managers and fund managers whose job it actually IS to pick stocks. They might be able to get it right in the short term, but not over the longer term and I’m a long term investor.
Sharesight graph showing my Smartshares NZ Top 50 ETF which currently has a return of 15.26% p.a.
In fact just last week I caught a snippet of the news when they were saying how poorly A2 Milk (ATM) is performing, which took me by surprise because were they not the darling of stocks just last year? They certainly were, topping out at $21.50 a share in August 2020. Their current price is $7.75. Individual company stocks are just too volatile and you and I can’t predict their movements or their future, so best to stay clear.
Therefore by buying just a couple of funds that cover the New Zealand stock market and the United States stock market, I’ve invested in hundreds and hundreds (and hundreds) of companies which has spread my risk. I do own A2 Milk, it’s in the NZ Top 50 fund that I buy, but if a time comes that it performs so poorly that it drops off the index, then it’s replaced by the next top-performing company. So, I’m always holding the top companies in NZ and the US. All without having to read a single news bulletin, all without having to buy and sell a single share and move my investments around. I have an automated monthly investment into just two funds and for the last five years, we have invested without fail. It feels like pure lazy genius to invest this way and since I began investing there have been a number of fund providers that have come about making this process of buying index funds or ETFs simple, cheap and straightforward.
They are: Kernel Wealth, Hatch Invest, Sharesies, Smartshares, Investnow
With our investing now on autopilot, if ever we came into a lump sum of money, this is where it’s invested. Because I have the rest of my financial life in order and have worked through the process as I’ve described above, all of this money can then just be added to our investments.
Yes, you can have a wee dabble on the side if you have a particular fondness for a company and want to directly invest in it but don’t kid yourself that you have the inside knowledge on where this company is headed, what it’s doing or how society will react to those moves. If you take on a single company just make sure it’s a teeny tiny part of your entire net worth and comfort yourself that whether it goes well or poorly, you already probably own it in your index fund anyway!
What’s next?
The entire point of this structure is so that I can create investments for my whanau that can be built up to such a point that the income they generate from dividends and capital gains is enough to replace our annual expenses, making work completely optional at that point. Every financial move we make has this goal in mind and it’s a process and a journey that we are still on and I estimate that we are about halfway there. For every dollar that we don’t spend now, that money invested translates to less time spent working in the future. We have already cut back to part-time incomes each, yet we still continue to invest and our investments continue to grow, telling me - showing me rather - that this strategy I’ve laid out does actually work.
So, there you have it, hope I have not bored you too much and I hope that you take something for your own journey out of this post.
Finally, nothing is set in stone, everything is fluid, and with a good financial structure in place, it really does give you the ability to pull different levers as required with the end result being that money is not something that gives me angst, in fact, quite the opposite, it’s a source of strength knowing that whatever life wants to send our way, we are in a good place to cope with it financially, which also sets us up to cope well emotionally.
All the very best, please add your comments below if you have something to share.
