The Pyramid to Financial Freedom – Second Tier

I’ve talked about setting the foundation to financial freedom by getting to know your balance sheet (net worth), cash flow (dollars in/dollars out), and your dreams. Now we’re going to move on to an introduction to the second tier, and we’ll spend time over the next few weeks working our way through each specific topic.

The Financial Pyramid will help you reach financial freedom

One note – this isn’t an order that you should complete the steps in. Something like paying off non-deductible debt may take months or years, and you don’t want to put off making an emergency plan or protecting your family for that long. On the other hand you may already have finished half of these steps – if so just do the ones that apply to you.

Pay Off Non-Deductible Debt – Planning

Debt. It can be like an anchor around your neck, and it will keep you here at the bottom of the pyramid if you don’t destroy it. Even at low interest rates, the cash flow you need to generate in order to service that debt will weigh you down, and will cause you to need more money in your financial freedom fund.

What kind of debt to focus on first? Non-deductible debt-the kind that’s not tax optimized and you can’t deduct it.

What kind of debt goes here?

• Personal loans – from a bank, Lending Club/Prosper, or family
• Credit cards  – even 0%
• Car loans – even 0%
• Possibly business loans – depending on the nature of the business and the loan

What kind of debt doesn’t go here?

• Student loan debt
• Mortgage debt
• Rental properties
• Most business debt

This is where that balance sheet you developed in the first tier will help you. You now have a clear picture of any and all debt that’s outstanding, and you can make a plan to get rid of it so you can progress toward financial freedom.

The first phase of this process is to make your plan for getting out from under non-deductible debt. We’ll return later to execution of your plan.

Protect Yourself and Your Family

It’s key to protect yourself and your family. There are lots of things that could go wrong, and putting your financial freedom on top of an unprotected base could be a recipe for disaster. I’ve talked before about my husbands near-death from septic shock at 37. I’ve known people who passed away at 34 with a new baby (brain cancer) and 41 with two young kids (blood cancer).

This is one of those steps that can be easy to dismiss with “yeah, I know” or “I’ll do it later”. Or you may be secretly thinking that other people might need to do this, but bad things won’t happen to you (or your family). Unfortunately, bad things happen to good people through no fault of their own, and they can happen at any age. So you need to walk through each item and if you haven’t done it yet – make it one of your 2017 goals. There are a few on here I need to work on myself, and I’m committed to doing it together with you!

• Insurance
  • Car insurance – Includes motorcycles and any other vehicle you drive
  • Home/Condo/Rental insurance – Covers your home, condo, or apartment
  • Umbrella insurance (important for high-net worth individuals- if you’re FI and don’t have this, look into it!)
  • Health insurance
  • Disability insurance
  • Life insurance – term only please
  • Business insurance – Various types of insurance can protect different aspects of your business
• Investing and Financial Planning
  • Write your investor policy statement (IPS)
  • Create your financial plan
  • Review IPS and financial plan  with the board of directors of your family (spouse/partner), if applicable
• Identity Theft
  • Pull your credit reports – Every year
  • Consider freezing your credit
  • Take steps to prevent identity theft – More about this later
• Preparing for disability or death
  • Wills
  • Power of attorney
  • Advance medical directive 
  • Calculate SS disability and death benefit

Make Your Emergency Plan

Many financial experts recommend an emergency fund of anywhere from three to twelve months expenses, depending on who you read. At this point in the process, creating such a large emergency fund could keep you from achieving the rest of your goals. Instead of just an emergency fund, you’ll want an emergency plan that you can pull the trigger on when needed. An emergency plan includes:

• A small amount of cash, in a checking or savings account – At least one months expenses at this point
• Plan as to how you’ll supplement that cash if needed

I’ve talked about emergency planning before, and how it’s saved my family. This step is key, because emergencies will happen while you’re working your way out of this tier. Car repairs, new tires, unexpected medical costs, and so on are a part of life. They will happen as you work your way to financial freedom.

Create Your College Compact

This is a concept I’ve created that I’m really excited to share with you. When I was a new parent (over 13 years ago now), one of the things I found most frustrating about trying to save for college was how futile and unknown it all felt. Let me know if any of these sound familiar to you:

• You need to save $500 per month per child from the time they’re born to pay for college!
  • “That’s nice,” I would think to myself as I put away $50 per month, because that’s all I could do
• College costs range anywhere from $10,000 – $60,000 per year (per child)
• You’ll need $200,000 or $350,000 or $100,000 for college!
• Your kids can get loans for college but you can’t get loans for retirement!
  • This one is only partly true as I explained in another article. Don’t fall for this if you have a high income

Given the high projections I would see when calculating college costs, the wild ranges, and the fact that there’s so many unknowns when you’re saving for something 18 years ahead of time, for a long time I just put aside what I could and didn’t think about what it could do. After doing some more research, last year I created the concept of the “college compact” to guide my strategy and clarify my commitment to my kids.

Instead  of going to calculators and popping in my kids ages, or reading articles on how much college would cost, I did a few simple things:

• Decided on the specific school I would target being able to pay for – in my case, state flagship university
• Went online to find out how much that university cost today
• Decided the specific kinds of expenses I would pay for – and wouldn’t pay for
• Determined what percentage of those costs I would pay for (could be 25%, 50%, or even 100%)
• Used Vanguards projection tool to calculate how much it might cost in x number of years, and tweaked the goal as needed
• Wrote up all these goals into a “college compact” I can look back on
• Conduct an annual re-evaluation of how much I’ve saved, what total actual costs are now, and determine any adjustments

I’m really looking forward to sharing more about this strategy with you!

Optimize Expenses

Don’t worry, this doesn’t mean you’re going to now live in the dark eating nothing but ramen and beans (although if you want to, go ahead!). Using your cash flow, and knowing your goals for this tier, you’re going to go through each expense with a fine tooth comb. Those expenses that don’t bring value to your life, don’t bring you joy (just like in the KonMari method), or don’t bring you towards your ultimate dreams will be slashed.  Doing this will free up money to go towards your dreams.

What kinds of expenses will we be looking at?

• Debt payments – Lowering your interest rate can get you out of debt faster
• Insurance payments – Shop around!
• Cable/Internet/Home Phone
• Cell phone
• Utilities and other home expenses
• Subscriptions
• Groceries and eating out
• Household expenses
• Anything else that shows up in your cash flow report

Pay Off Non-Deductible Debt – Execution

We’ve come full circle through the second tier and returned back to paying off non-deductible debt. The first step was to develop a plan – in this one you’re going to execute on your plan. Using your now optimized expenses, on a firmly protected financial footing, and with a comprehensive emergency plan, you can now get rid of that debt that’s holding you back from your dreams. There are two primary debt payoff methods we’ll look at – you can try both and see which one works best for you.

• Debt snowball – Encouraged by Dave Ramsey and backed by research from Harvard, this method focuses on achieving “small wins” by paying off debts one at a time with the lowest balance first
• Debt avalanche – Used by many in the FI community, this is the mathematically optimal method and focuses on the highest interest rates first. You’ll save more money over time with this method, but it can be more difficult to stay motivated without the “small wins” of the debt snowball

The Second Tier

When you’re done with this tier, you’ll find yourself and your family on firm financial footing to begin striving toward financial freedom. Without going through these – and I mean really doing them all, not just thinking you should – your financial pyramid is being built on sand. It can collapse on you with a single emergency, disability, job loss, or other disaster. I’m excited to walk through all of these together!

Did I miss anything in setting a firm financial foundation to get to financial freedom? Have you already done everything in this tier, or are you still working through it? Let me know in the comments!

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