I wrote a contributor post for Camp FIRE Finance this week. I hope that you will take a look at the post and also the other great articles on that site. This is a website with articles for people who are attempting to become Financially Independent and Retire Early. Some individuals who achieve FIRE have large incomes and just live a modest life. Others have normal incomes but then decide to live very frugally so that they can put money away to retire early. This second group would be the tiny house types, cutting things down to the bare necessities so that their cost of living was very low.
My post was on cash flow. Specifically how the way to gain financial independence is to create a large free cash flow, defined as the money that you have left over after paying for everything and putting money away for things like retirement and healthcare. In both of the cases described above, the high-earning couple who live modestly and then put a lot of money away and the couple who cut their expenses to the bone so that they can save up, really what these individuals are doing is creating free cash flow. If the high-earning couple makes $500,000 per year but lives on $400,000, it is no different than the couple earning $120,000 per year who lives on $20,000. Both have a free cash flow of $100,000 per year. This means that they will both be in the same condition financially in ten years. They will both have $1 M, assuming they both put their money in their mattresses rather than investing.
Hey – if you like The Small Investor, help keep it going. Buy a copy of the SmallIvy Book of Investing: Book1: Investing to Grow Wealthy or just click on one of the product links below, then browse and buy something you need from Amazon’s huge collection. The Small Investor will make a small commission each time you buy a product through one of our links.
A comment on my post really made me think. He said that what I was describing was what Dave Ramsey calls the “Debt Snowball,” but done in reverse. That is almost correct. What I am really doing is telling you what to do after you’ve paid off your debt and done the debt-free scream on the show.
The Dave Ramsey show tells people how to pay off their debts using his “baby steps.” He advises people to first 1) build up a baby emergency fund, then 2) get current on all of your bills, then build up a full emergency fund (3 to 6 month’s worth of expenses) 3) start attacking the smallest debt while paying the minimums on the other debts, 4) once the first debt is paid off, use the money you’re saving on payments plus the money you were using to pay the smallest debt to attack the next highest debt, 5) continue to pay off debts, adding the money you’re saving to your payments each time, 6) pay off your largest debt, becoming debt-free, then call up the show and scream about it.
The trouble is that he then kind of leaves you hanging. He will talk a little about putting money away into mutual funds, particularly for retirement. He will also tell you to continue to budget to avoid going into debt in the future. But he really doesn’t keep you focused, continuing to use your snowball of free cash to build wealth now that you have gotten this far.
And that is really what the debt snowball is – building up a snowball of free cash. At the start, because you have so many obligated expenses each month – things that you are forced to pay like the mortgage, car payments, student loan payments, and credit card payments – you have very little free cash flow. Pretty much every dollar that you have is already spoken for before the month even begins. But you gather up the little bit that you have, forming a little bit of free cash like the kind of snowball you can hold in your hands and use it to attack the first debt.
When you kill off the first debt, you now have a little more free cash flow. The money that was going towards payments on your smallest obligated expense is now free since that obligation is gone. Maybe it was $50 you were sending in each month to pay on a credit card for a department store. You add this to the $300 per month you had in free cash, and now you have $350 in free cash each month. The snowball gets a little bit bigger.
Maybe you now attack a $3000 debt you have on another credit card that you were paying $75 per month on. You attack this debt with your $350 per month in free cash flow and pay it off in 10 months. Now you have $425 in free cash flow to attack the next debt. You continue on this path, increasing your free cash flow each time that you pay off a debt.
Once you have paid off your last debt, you now have a huge free cash flow snowball. Maybe you have $2500 per month that you were spending on student loans, car payments, and credit cards. Maybe you even pay off your mortgage and now have $4000 in free cash flow each month. You can use this free cash flow to start building up assets, which now pay you interest each month instead of charging you interest. (We’ll talk about how you do this in the next post.) That is how you go from being debt free to financially independent. If you can do this while you’re still young, perhaps you’ll reach FIRE as well.
Have a burning investing question you’d like answered? Please send to email@example.com or leave in a comment.
Follow on Twitter to get news about new articles. @SmallIvy_SI
Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.