Eric and Sally have two kids, a mortgage, and a big problem. Put simply, they can’t stretch their income enough to cover all their expenses. The big monthly expenses, which include their mortgage payment, their car payments, and their credit card bills, leave too little to pay their normal food, clothing, and health care bills, not to mention the costs of childcare and their children’s many activities.
The constant financial struggles have begun to create strains within the family. Eric and Sally don’t fight much – neither is very confrontational – but they seem to get annoyed with each other more frequently. If they do have an outright argument, usually it is over where they need to cut back their spending.
Overlaying this psychological fragility is the nagging worry that, sometime in what seems the distant future, they will have nothing saved for their retirement. They do manage to put some of their income away for retirement, but they fear it will be inadequate. Every time they read or hear about the insolvency of Social Security, it feels like another twist of the knife.
To help overcome their hurdles, Eric and Sally have begun to attend a financial management seminar. They have learned that the first step to healthier finances involves understanding where their money is going. That means sorting through their expenditures and building a budget. They felt a bit reluctant at first, partly because they thought it would be time consuming and partly because, deep down somewhere, maybe they just didn’t want to know what they would find.
In the seminar, they learned that they need to save at least 10% of their after-tax income. After making a budget for the upcoming year, they realized that they’d actually been saving almost nothing. Money that they’d been putting into their retirement fund and their children’s college fund was roughly matched by the increase each year in their credit card bills.
Also in the seminar, they learned to follow the principle of First Things First. That principle says that you first devote your savings to the expenses that come due first. You can’t save for the long term at the expense of your short term needs. When those first bills arrive, if you don’t have the money, you’ll end up back in debt.
After paring their planned expenses down to 90% of their income – not an easy task, but not as hard as they had imaged it might be, once they had laid out all their real expenditures – they intend to take that extra 10% and use all of it to pay down debt. Following that plan, they’ll be debt free in about two years.
Next on their agenda will be focusing on their children’s college fund. With two kids under five, they have many years to save, but also many years for the cost of college to rise. Saving for college will soak up most of their savings for the next 20 years.
What about retirement savings? Eric and Sally won’t put much into their retirement fund for quite some time. Will it be late? They were surprised – pleasantly surprised – to learn that it won’t be too late. While it’s ideal to start saving for retirement early, many people begin saving for retirement in earnest in their fifties and still have enough time to build up a nice retirement fund. They key is doing all the other things right: staying out of debt and paying off your home mortgage long before you plan to retire.
That knowledge helped reduce Eric and Sally’s stress dramatically, and made family time more fun again.
Eric and Sally are characters in Doug Warshauer’s personal finance “novel” If I’m So Smart…Where Did All My Money Go? Balancing Your Financial Objectives for Lasting Wealth. You can find out more at www.dougwarshauer.com.
