A New Start & Taking Stock

Welcome to Robbins' NestEgg - this is where I will discuss my personal financial picture and my thoughts about financial news.

It’s been a while since I’ve taken stock of my financial situation, so I thought I would write a few posts speaking to where I am today. Hopefully, through them I can glean some insight into where I’ve been and how far I've come.

The first part of getting your financial life in order is cash flow and budget planning. I will take a slight detour in this post to discuss my ongoing liabilities, debts before getting into what is typically the top part of life’s balance sheet – income.

My debts are pretty easily described. Rounding up to the nearest $100, here’s what I owe:

• Mortgage - $221,000
• Wife’s Student Loans - $30,000
• Auto Loan - $8,100
• My Student Loan - $1,800
• Credit Cards - $0

There are two prevailing strategies for paying off personal debts. One, the debt-snowball method, is popularly pushed by financial writers like Dave Ramsey. This method involves paying off the smallest outstanding debt first – in this case, that would be my student loan at a paltry $1,800 (If I wanted, I have this money in reserve and could just pay it off as a lump sum immediately). The other method, the debt avalanche, in which one pays off the highest interest rate debt first, is more likely to be recommended by professional financial planners.

The Debt Snowball

A debt snowball is created by arranging debts in ascending order, from smallest balance to largest, and calculating the minimum payment for each debt. In my case, I would be paying a total of approximately $2,000 (rounded to the nearest $100) in minimum payments.

Let’s say I could definitely afford to pay $2,500 towards my debts right now – so the idea in a debt snowball is that the additional $500 I could afford to pay would be applied to the smallest debt first – my student loan. After the student loan is paid off, I would add the old minimum payment plus the extra amount available to my next smallest debt – in this case, my car payment. The snowball of my debt payment grows as I pay down smaller obligations.

The Debt Avalanche

I subscribe to the debt avalanche method of debt management. In the debt avalance, also referred to as “debt stacking,” I would take my highest interest rate debt, my car loan, and pay it down first. While the debt snowball method has behavioral benefits, as one sees the impact of extra payments earlier, it is not the most efficient method for paying down debt. It makes intuitive sense to pay down higher interest rate debt first, the longer debt is held, the more it costs you.

That’s why I no longer have a credit card balance. For most of the past 7 years of our lives, my wife and I have held between $1,000 and $13,000 in credit card debt on two-to-three different cards. We started our careers late and have had to move between states on multiple occasions in short time-spans. Carrying a little consumer debt was a necessity, until this year it never did get completely paid down, but delaying the time it took to reduce our credit card burden would have cost my wife and I thousands of dollars in revolving payments. Credit cards took priority over every other form of debt. Now that I have all of my cards paid down in full, I can use them for some expenses, pay them off immediately and collect their rewards as an alternative income stream. I am in the process of upgrading my credit cards in order to receive better rewards. More on that later.

My Situation Is Changing

I am experiencing financial uncertainty as we speak. My wife and I just lost one stream of income, from a housemate that rented one of our upstairs rooms, and we expect our expenses to increase temporarily over the next six months. I am not going to assume that I will be able to pay as much as $500 more towards my automobile payment out of the blue, a precise calculation here doesn’t have the flexibility I need in my finances over the short term. A more risk-averse person might hold off on additional payments altogether in the same situation.

Instead, I’ve chosen to gradually escalate my car payments over time, by $25 a month to start, to make sure I will be able to absorb the shock of less income and more expenses without having to compromise lifestyle, my emergency fund (more on that later) and my retirement savings momentum (much more on that later).