In an earlier post, I talked about the attractive nature of debt – the fact that it allows you (or the government) to realize the benefits now and worry about the bill later. A simple way to think about it is that debt is simply your future earnings spent today. It is the opposite of savings – today’s earnings spent in the future. In this post, I am going to over five steps to overcome debt.
Understand the Diderot Effect
Denis Diderot was an 18th century French philosopher who lived a relatively simple life. One fine day he got an unexpected windfall when the Empress of Russia paid a huge sum for his library. Feeling content, Diderot went out and bought a fine scarlet robe. But then he noticed his other possessions did not match his new robe. So, he decided to buy new toys. One thing led to another and soon Diderot had spent all of his money on useless objects that he did not need.
Its amazing how the experience of a 18th century person still strongly resonates in today’s society. Why did I mention the Diderot effect? If you are in debt, especially consumer debt, understanding and overcoming the Diderot effect is the first step to take. If you feel the urge to buy something, then ask yourself – is this something that you truly need? Here is a link to a great article that provides excellent information on how to master the Diderot effect.
Start doing the basics
Once you have started your journey to debt elimination, here are three simple actions you must immediately undertake:
Stop taking on more debt: This one seems really obvious but you would be surprised how often it happens. Those going on a debt diet often get seduced by sales promotions and “zero payments for first three months” types of offers. In an earlier post, I talked about how achieving financial freedom requires you to become disciplined. This is where it comes into play. All new purchases must be made through cash or debit cards, effective immediately.
Make all of your minimum payments: When it comes to all types of debt, make sure you make the minimum payments. This is critical to avoid going into default. Going into default will affect your credit score and seriously impair your ability to manoeuvre your existing debt.
Avoid debt advisory services: Do not under any circumstances, pay any service to help you with your debt. It will only add to the cost and they don’t have any silver bullets. You, and you alone, need to do the heavy lifting.
Follow the 80/20 rule to lower your expenses
I want to give full disclosure on my approach. You will find a volume of information on the internet on tricks, tips and hacks you can use to save money such as grocery coupons, car-pooling, avoiding $5 lattes, etc. I don’t recommend those approaches – not because I don’t believe in them, but because I am not good at it. In my opinion, you can have as many lattes as you want. Its much more important to focus on needle movers, rather than lattes. I am not here to make your life miserable! Also, generally whenever you ask anyone to make drastic lifestyle changes, quite often what happens is that the person simply reverts back to the old habits because the change is too much, too soon.
However, having said that, I do put an emphasis on big-ticket items – such as buying a new car or a used car. I recommend following the 80/20 rule – 80% of your returns will come on focusing on 20% of the most important items.
So, how do you identify the 20% of the most important items? You can do it two easy steps:
a. Create a personal budget spreadsheet in MS Excel. It is a simple document that lists all your income and expenses. Make a habit of logging every expense in that sheet. Break down the expenses by month and by category (groceries, bills, childcare, etc..)
b. Next, you can use Excel to visually show the expenses in a simple bar chart that will rank your expenses from highest to lowest. You can do this for every month. A simple example is shown below.
There are other fancy software you can find on the internet that will basically produce the same results, in somewhat more colourful form. Go ahead if you feel like using them. Whichever path you choose, don’t let the use of the medium distract you from actually doing.
This is a simple yet extremely powerful exercise. Quite often you will find that once you complete this activity, you will discover that your largest expenses are usually structural in nature and there is not much you can do reduce them in the immediate short-term. For example, if you are in the six month of a one-year rental lease, you are committed to that expense for another six months.
However, the biggest benefit of this exercise is that it allows you to develop the traits of a rich mindset – start thinking about options now that will provide you a benefit in the medium to long-term. If you are a renter and you identify that rent is your single biggest expense, then you can actively start seeking cheaper alternatives straight away, knowing fully well that you will putting your efforts into areas that will provide the maximum value.
Diversify your income
In today’s day and age, you will have probably heard how technology has caused wide-scale disruption across traditionally safe industries. As someone who spent years working in the oil and gas industry, I have experienced first-hand of how the emergence of electric cars (and the subsequent reduction in oil demand) has forced oil giants to retreat into survival mode. In many cases, the disruption is viewed negatively.
However, one of the biggest benefits of the technological disruption is the emergence of two different types of economies:
a. Sharing economy – using personal assets to earn revenue
b. Gig economy – jobs that are based on short-term contracts or freelance work as opposed to permanent ones – or more popularly known as side hustles. According to MBO Partners, freelance work has increased by nearly 34% just in 2021 (thanks largely due to the COVID-19 pandemic).
You can use both of these means to increase your income. Some excellent examples for the sharing economy where you can make extra cash with little or no upfront investment are:
1. Airbnb – If you have an extra room, rent it out.
2. Uber or Lyft – if you have your own car, consider becoming a part-time cabbie.
3. Postmates – if you own bike or car, you can make deliveries at your own schedule.
4. Dogvacay – this is perfect for dog owners. You can paid for pet sitting.
There are pros and cons for each one of them. So check out the websites for the latest information. Plus, the industry is constantly evolving. There are many other avenues as well. Find out what works best for you. For those of you who are in specialized fields, there are avenues you can utilize to use your skills to generate extra income on the side. Here is a list of 10 side gigs you can do from home. Don’t under-estimate side gigs. Initially, you might not make too much but as your credibility develops, you can earn a lot more!
Get help from family
As I stated in my post about the water not being fine, there is no doubt that the deck is heavily stacked against young people because of the student debt and housing prices. However, there are young people whose parents have done relatively well financially, thanks in large part due to real estate gains. While I understand that everyone’s situation is different, the one option you can consider is seeking financial help from your parents. Most parents are more than willing to help their children – it’s a natural thing. Here are a couple of guidelines:
a. Your chances of success are much better if you present a clear plan to become debt-free and can show that you doing everything possible to increase your income and lower your expenses.
b. Don’t ask for a handout and do promise to pay it back. For example, if you have $20K in credit card debt, you can ask your parents to pay off the bank directly and then you can pay back the money every month over the course of a year or so. In this way, the money saved in interest will be massive! I am sure that your parents will not charge you interest on what they lend to you. Working as a team is better than going at it alone. Remember, the key is trust and staying true to your commitments.
That’s about it.
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