Financial Framework
This financial framework is not designed to tell you what to do — it’s designed to help you take real action and implement the financial advice from guru’s all over the internet. When I had my “Oh Sh!t” moment, I dove headfirst into the personal finance world and read, watched and listened to everything I could get my hands on. While I learned a lot and was motivated to improve my situation, I found it difficult to figure out exactly where to start. I had all kinds of advice floating around my head that it gave me paralysis — I spent over a year consuming all this great content without taking any action.
The financial framework laid out below is designed to incent real action. It doesn’t say anything about cutting up your credit cards, it doesn’t mention 50/30/20, it doesn’t force you to ask for a raise or work 80 hours a week. The education, advice and motivation side of the equation is well covered. Listen to Dave Ramsey, watch The Money Guy, read “I Will Teach You to be Rich” — you won’t be disappointed and will certainly learn a lot. But when you’re ready to take action, follow the steps laid out below to ensure you see real results and to put you in the best position to follow through.
1. Build your balance sheet
No matter who’s plan you’re following to get out of debt, the first step is to assess your current situation. It’s hard to build a helpful plan if you don’t know where you are starting from. To do this, you will need to build a balance sheet and calculate your net worth.
2. Analyze your recent spending
Many people jump right into building a budget without looking at their historical actions. They estimate how much should be spent on various categories and act surprised when actual results vary widely from their budgeted amounts each month. Instead, it’s important to look back at your last six months of spending across all accounts to figure out where you money has been going.
3. Budget your living expenses
After analyzing your recent spending, you’ll be able to build a budget for your everyday living expenses that will make sense for your lifestyle. Because everyone’s lifestyle is so different, there is no right or wrong answer when it comes to budgeting — as long as it’s achievable and accomplishes your debt paydown goals, you have the freedom to build it as you wish.
4. Build debt paydown waterfall
List all your debts including size, interest rate, and minimum payment. Calculate how long it will take you to pay off all your debt based on the available cash flow from your budget. You should know the date at which you’ll be debt free and monitor this number each month to ensure it stays consistent. It may be helpful to calculate both the debt snowball method and the debt avalanche method as payback times could vary significantly depending on how your debt amounts and interest rates break down.
5. Analyze and track metrics over time
The most important part is to track your performance over time. This is how you ensure you stay motivated and hold yourself accountable to your original plan. Each month, you should know your net worth, your bad debt amount, your debt paydown rate and your debt free date. The most important rule here: never go backwards!
Bonus Step - Determine your retirement goals
Once you’ve taken care of steps 1-5, you’ve stopped the bleeding and have proven you can begin to pay down debt, it’s important to shift your mindset to start thinking longer-term. One might think “who cares about my retirement goals when I’m in this much debt?” Identifying your retirement goals and calculating your retirement number will help you adjust your plan as you pay down debt and ensure you’re effectively transitioning from debt paydown mode to investment mode without taking steps backwards.