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Do you have to be wealthy to be financially independent?

Going for home
Going for home

I’m such a bag lady. Not literally…but I suffer acutely from Bag Lady Syndrome. You can tell me till you’re blue in the face that I have plenty to get by, but I won’t believe it until the bills are paid and no one has carted me off to the poor farm.

Matter of fact, this morning after I’d run another Excel spreadsheet that showed, contrary to the present optimistic theory, an average shortfall in 2010’s enforced “retirement” of $740 a month, my financial adviser was on the phone, cooing in soothing tones, “You’ll be f-i-i-n-e.” Even though I don’t have anything like a million bucks in the bank, he says, there’s more than enough to supplement Social Security and cover all my expenses for about 50 years, at a 4 percent drawdown.

The other day Frugal Scholar, the professor with the penchant for thrift-store shopping, reported a delightful revelation: truth to tell, she and Mr. FS could rent their paid-for house and retire to Costa Rica. Today. Gone fishin’. Once and for all… If they so chose.

Ah hah! Financial independence: freedom to do as you please, absent the chains of debt.

Many of us, I think, assume that to enter that blessed state we need to have stashed enough in savings to make us wealthy by most anyone’s definition: a million bucks or more. But I beg to differ. With a reasonable standard of living and a paid-for roof over your head, you don’t have to be a millionaire to achieve financial independence and maintain a middle-class lifestyle. A much more modest stash can support you, given the right conditions.

The Scholars appear to be situated firmly in the financial middle class. With the exception of university presidents, certain deans, and the occasional patent-holding bioengineer, academics don’t earn much. At least, not in the larger scheme of things—compared, say, to the owner of a carpet-cleaning service, to a doctor or a lawyer, to a basketball player, or to a twenty-something kid on Wall Street. It’s unlikely that even between the two of them they’ve stashed a million bucks in their 403(b) plans. Yet they are financially independent. They could, if they wished, retire today with little or no change of lifestyle (other than moving to a tropical paradise…).

The first key to financial independence is to get out of debtAll debt, including the mortgage. You’ll notice that the Scholars had the initiative and self-discipline to pay off their house. In my own case, I’m especially grateful that I managed to do that a few years ago. Because I don’t have to come up with hundreds of dollars every month to keep a roof over my head, now that I’ve been laid off…hallelujah! I don’t have to get another day job!

And the other key? Come to terms psychologically with living within your means. Though I won’t be enjoying the Queen of Sheba’s lifestyle, neither do I expect to move to the poorhouse. The only real “sacrifice,” if you can call it that, is that I will have to drive my fully functional, very nice nine-year-old Toyota a few more years, rather than trading it in when it reaches the ten-year milepost. I will have to earn a few thousand bucks a year to cover my share of the house M’hijito and I are copurchasing, but that can be done  by taking on a couple of easy, part-time teaching gigs. Pay is low, but work is minimal and mildly entertaining.

Debt, particularly mortgage and automobile loans, racks up the largest part of most Americans’ month-to-month costs. Once you no longer have to pay an outrageous slug of interest to keep a roof over your head and wheels under your feet, your ordinary living costs are surprisingly modest.

Financial independence doesn’t necessarily mean not working. After you’ve attained financial independence—that is, your living expenses are low enough that the proceeds from modest savings and other forms of passive income will support you—you’re free to do as you please. If you want to keep working at your job, you can. Or you can take up a more interesting line of work, try to do something less profitable that you’ve always dreamed of doing, or devote your time, energy and skill to altruistic pursuits.

A friend retired from his medical practice with plenty of zing still left. He and his wife spent a year working pro bono at a hospital in New Zealand. Another friend passes his time working for Habitat for Humanity, as does my step-sister. A third decided to become an organist in her old age, an enterprise that led to a wonderful adventure in Australia. With the possible exception of the anesthesiologist and his wife (who by and large live modestly, by Seattle standards), none of these people are wealthy. They live middle-class lifestyles, dwelling in ordinary homes in decent neighborhoods, driving nice-but-not-gaudy cars, staying out of debt, and generally doing as they please…within their means.

Image by Gargoylepni, public domain, Wikipedia Commons

Pay off debt or build savings?

Over at I’ve Paid for This Twice Already, Paid Twice invites her readers to think about the relative importance of paying off debt or building savings. Which should be a person’s top priority? It is, as she points out, not a clear-cut decision.

Some people say that there’s “good debt” (such as home and student loans, owed on property or training that eventually returns more than you pay…supposedly) and “bad debt” (everything else; especially credit cards). I personally would argue that there’s only debt, and debt is slavery. Debt forces you to stay in the traces until you pay it off or until you die, whichever comes first. Over at Debt Kid, Jessica describes experiencing the same revelation.

Freedom from debt is freedom to live as you choose. Period. If working brings you personal fulfillment, you can do it—and a debt-free worker is one who has a great deal more disposable income (to say nothing of more options) than one who labors under the lender’s lash. If you want to retire or devote your energy to low-paid but altruistic work, debt freedom will make either of those choices possible.

I’ve used savings—in direct contradiction of advice from money advisers—to pay off debt and never once regretted it. Here’s why:

1) Revolving debt cuts your purchasing power by the amount of the interest gouge. If you pay 18 percent for everything you put on a charge card, then each dollar you spend is really worth only 82 cents.

2) You don’t actually own anything when you’re making payments on it. The bank owns it; you’re just renting it.

3) For most mere mortals, the so-called tax benefits of mortgage interest are negligible.

4) If you own your home outright, the absence of a mortgage payment increases your real take-home pay enormously. I couldn’t live on my net income if I owed on my house or had to pay rent. I paid $100,000 for my first house, for which I put down $20,000. Until I paid off the loan, I owed $9,960/year on the PITI. In the best of times, that $100,000 earned $8,000 a year in mutual funds. Paying off the mortgage freed up $830 a month for living expenses and savings. Taxes and insurance on my present house, purchased with the proceeds of the sale of my first paid-off home, are about $2,200 a year, meaning that today I have to set aside about $183 a month to cover those annual bills. That’s a far cry from an $830/month bite…which at the time I paid off the loan represented half my monthly take-home pay.

5) Where real estate is concerned, in normal market conditions (which one day will return), when a house is paid off and appreciating in value, the money you put into it is growing just as it would grow in a conservative investment, at about 6 to 8 percent a year. Thus the $100,000 I paid for my first house yielded $211,000 a few years later, allowing me to buy my next house in cash. Once a house is paid off, you’ll never lack for cash to keep a comparable paid-off roof over your head.

6) This is not true while you’re paying on a mortgage, because the mortgage interest eats up the gains created by the property’s appreciation in value. Over 30 years at 6 percent, a you’ll pay $115,838 in interest on a $100,000 loan; in other words, you’ll pay $215,828.45 for your $100,000 house. If you’d put that extra $115,838 in mutual funds over the same period, the compounding interest would have been paying you, not the bank. Paying just $200 a month extra against principal would cut your payback time from 30 years to 16 years and 3 months and drop your total interest gouge to $57,386.

7) Clearing off  debt opens the way for larger and faster savings. If you could afford to make a payment on a car, a house, or a credit card, then once you’ve paid off the debt you can afford to put the amount of the payments directly into savings and investments.

So, in a way, debt pay-down is a form of saving.

On the other hand, in recessionary times when one’s income is at risk, you need a substantial emergency fund. If you find yourself starting out during a recession, your first priority obviously should be to stash enough to live on for at least six months, preferably longer. IMHO the ideal emergency fund contains one year’s worth of your present net income.  Once you have it, though, you’re justified in devoting every extra penny to paring down debt of all kinds.

In good times or bad, saving should be part of your agenda. But since freedom from debt makes your money go further and allows you to save substantially more, getting out from under debt should be your top priority.

Too much debt? Sell your house and rent it back!

For Sale--Make Offer!

Ever doubt whether your elected representatives should be your role models? Well, here’s a new twist on finance guaranteed to convince you, one way or another: the Arizona state legislature proposes to sell state capitol buildings, presently owned free and clear by the taxpayers and including the state House and Senate buildings, and them rent them back from the new owners. So deep in debt is our feckless state government that this desperation move apparently makes sense to some of our august leaders.

Think of that.

Now let’s suppose you, the personal financier, owned your house free and clear; let’s imagine it’s worth, say, $300,000. You’ve made a few small errors in your personal finance adventure…to wit, you’ve charged up $350,000 on your credit cards, and now that the economy has imploded, you’re out of work and can’t pay those pesty, interest-bearing bills.

So to raise some cash to hush up the bill collectors, you sell your house to Bob Buzzardo for $280,000, about the best you can do in the depressed real estate market. You now have 280 grand in cash, and Bob agrees to rent the house back to you for $1,678 a month (not including taxes and insurance). You propose to pay down those nagging bills at the rate of $2,000 a month, using the money you expect will soon “begin flowing into [your] coffers,” creating a monthly outflow of $3,678. At that rate, your $280,000 will last 76 months, or about six years and four months—assuming you’ve invested the principal gained from your sale in a reasonably safe instrument.  At that time—when you run out of cash—you will have paid down your $350,000 debt by $12,688.

You will still be in debt over your head, and now you’ll be out of money to pay against those debts and also out of money to pay the rent.

Amazing concept, isn’t it?

Okay, I admit: a state government is not a household, and government finances do not equate to personal finances. Still, raising taxes—a move our legislators stoutly decline to do, especially where business taxes are concerned (horrors!)—is roughly the equivalent of taking a second or third job. Which would you do: a) take a side job or two; or b) sell your house, rent it from the new owner, and use the proceeds to pay the rent and try to keep the wolf from the door?

If your choice is the second, maybe you should consider running for public office.


Budgeting and strategies for saving

Some time ago, a financial advisor who was helping me figure out what to do with a small inheritance remarked that I have a special talent for accruing savings by bits and pieces. Well, that does appear to be the case. As we noted the other day, by the end of this year my emergency fund will exceed $24,000—above and beyond the $21,000 squirreled away last year to pay off the Renovation Loan for the downtown house. 

So…how d’you do that?

Truth to tell, I don’t know how others would do it. But here are the basics that work for me:

1. Get out of debt and stay out of debt.

At the outset of my financial journey, I paid off a five-year car loan in 18 months by adding principal prepayments to each regular monthly payment. This freed up the $300/month payments to put into savings. Within a few years, I also paid off the $80,000 mortgage on my house, partly by renting space in my home and using the income to deal with the mortgage.

Debt consumes an enormous amount of your income. Freeing yourself of debt payments effectively “increases” your income even if you never get a raise—you end up with more money to spend or save.

2. Build savings into your budget.

“Pay yourself first” is the operative principle here. This is another way of saying “spend less than you earn.” As I was paying off car and real estate loans, I also set aside a small amount for savings each month. Bare minimum has always been $200 a month. As debts dissolve, some or all of the amount you’ve freed up by paying down debt can be added to the monthly savings.

When you create a budget, an effective way to create savings is to find a place to put every dollar of income. In other words, rather than estimating what you spend on each category (such as food, housing, utilities, transportation) and stopping when those categories are accounted for, build a set categories that will account for your entire net income. One of the categories should be “monthly savings.” This approach is sometimes called “zero-based budgeting.” 

My own approach to budgeting was to carefully track expenditures for a month or two, using Quicken or Excel. This provides a picture of where and how much you’re spending. Expense categories become evident after a month or so of observation. This exercise not only allows you to see where your money is going, it gives you some clues to where you might rein in unruly spending habits (for example, have you run amok at restaurants? did you really need all those clothes?). 

Once I understood my spending patterns, I established reasonable amounts for each category, including a category for savings. Any difference between income and expenditure was added to the “savings” category. Raises in pay resulted in raises in savings; although I might not devote the entire raise to increasing saving (you do have to get a life sometime, after all), I did pay myself better savings on the rare occasions the university gave me an increase.

3. Build side income streams.

Find ways to earn above and beyond the income from your day job. A master’s degree in anything will get you an adjunct teaching job at a community college. Night courses are a lot of fun to teach, because they’re full of adults who are there because they want to be there. Such gigs are not well paid, but every buck counts. I put all my net pay from teaching directly into savings.

You’re not forced to stop with just one side job. If you have a marketable hobby, if you enjoy collecting junk and selling it in yard sales, if you can trade a skill or a product for someone else’s skill, products, or dollars, you can create income that also can build your savings account. In addition to adjunct teaching, I also indulge in freelance editing. Every penny that comes in from that endeavor goes…yep! Right into savings.

Besides helping to build savings, secondary income streams have an enormous potential benefit: you still have them if you’re laid off your day job. Having the experience and contacts in teaching and editing will allow me to ramp up both those enterprises in my coming enforced retirement, and, as we have seen, will support me in the manner to which I intend to remain accustomed even if I never get another full-time job.

4. Take full advantage of your employer’s 401(k) or 403(b) plan.

If your employer  matches contributions to a retirement plan, for heaven’s sake, go for it! Every dollar your employer puts in means twice as much long-term savings for you. 

Allocate these investments intelligently, putting 50 or 60 percent in stocks and 40 or 50 percent in bonds and the money market. You have to assume some risk to make money in your investments; keeping it all in so-called “safe” instruments means your total savings will not keep up with inflation. Though the market does drop every now and again (sometimes with operatic drama!), over time losses and gains level out and and your investments build principal. Put your money in low-load funds to the extent possible (if your employer allows you to invest with Vanguard or Fidelity, these are good choices), because management fees eat into profits at an amazing rate.

Outside of an employment-related plan, go for Roth IRAs. Although these are after-tax instruments, they have the advantage that withdrawals after you reach age 59 1/2 are tax-free, which is huge. Also, they allow you to pass money to your heirs without the nasty tax gouges inherent to 401(k) plans and traditional IRAs. Here, too, set up your IRA with a low-load provider such as Vanguard or Fidelity.

5. Cultivate a frugal lifestyle.

Try to stay sane about this. You don’t really have to live like Our Hero, Scrooge McDuck. But on the other hand, neither do you have to live like an investment banker riding high. Get over the temptation to buy every new gadget just because it’s out there; to accrue stuff because all your friends, relatives and neighbors accrue stuff; to own bigger things and more things than you really need. Learn to distinguish between want and need, and then train yourself to appreciate the nonmaterial riches of life.

Frugality and simple living are the keys to living within your means. Spending less than you earn makes it possible to build savings and, eventually, to achieve financial freedom.

Dealin’ with the devil

Have you been following the “Debt Trap” series in the New York Times? Lordie! A couple of days ago they told the story of one Diane McLeod, who despite a modest lifestyle managed to sink so deep in debt she’s being evicted from her little two-bedroom home. The unholy combination of a divorce, a couple of unexpected medical problems (does one ever expect to get sick?), a job loss, and a habit of shopping to allay depression saddled her with interest payments alone that exceeded 40% of her pre-tax pay

The conversations this harrowing story generated are clustered in the usual two camps: the All-Her-Own-Fault side and the Damn-Greedy-Capitalists side. One letter to the editor in the print edition cattily remarks that if McLeod would quit smoking (she was shown with a cigarette in her hand), she’d save $100 to $300 a month. Hello? You can be a supersophisticated Easterner and never have heard “the quality of mercy is not strained”?

Rapacious Lending Practices

The point is, though, that the lenders who got their claws into this naive and unhappy woman really did not care whether she ever paid her debts. Lenders today make their money by charging usurious interest, at rates that used to be felonious. A loan is not seen as something to be repaid, but as a long-term earning asset. Says the Times:

Though prevailing interest rates have fallen to the low single digits in recent years, for example, the rates that credit card issuers routinely charge even borrowers with good credit records have risen, to 19.1 percent last year from 17.7 percent in 2005 – a difference that adds billions of dollars in interest charges annually to credit card bills.

Average late fees rose to $35 in 2007 from less than $13 in 1994, and fees charged when customers exceed their credit limits more than doubled to $26 a month from $11, according to CardWeb, an online publisher of information on payment and credit cards.

Mortgage lenders similarly added or raised fees associated with borrowing to buy a home – like $75 e-mail charges, $100 document preparation costs and $70 courier fees – bringing the average to $700 a mortgage, according to the Department of Housing and Urban Development. These “junk fees” have risen 50 percent in recent years, said Michael A. Kratzer, president of, a Web site intended to help consumers reduce fees on mortgages.

A 17% interest rate is nothing other than usury. In my state, usury laws once limited the amount of interest a lender could charge to 11%-until big lenders’ lobbyists persuaded the federal government to override state usury regulations.

The issue is not that Ms. McLeod spent irresponsibly or diddles away money on her nicotine addiction. The point is that abrogation of laws and regulations that formerly protected consumers from unbridled greed is about to drive this country’s economy into the toilet, down the drain, and permanently out to sea.

The Big Picture

Again quoting the Times of July 20, 2008:

Today, Americans carry $2.56 trillion in consumer debt, up 22 percent since 2000 alone, according to the Federal Reserve Board. The average household’s credit card debt is $8,565, up almost 15 percent from 2000.

College debt has more than doubled since 1995. The average student emerges from college carrying $20,000 in educational debt.

Household debt, including mortgages and credit cards, represents 19 percent of household assets, according to the Fed, compared with 13 percent in 1980.

Even as this debt was mounting, incomes stagnated for many Americans. As a result, the percentage of disposable income that consumers must set aside to service their debt – a figure that includes monthly credit card payments, car loans, mortgage interest and principal – has risen to 14.5 percent from 11 percent just 15 years ago.

By contrast, the nation’s savings rate, which exceeded 8 percent of disposable income in 1968, stood at 0.4 percent at the end of the first quarter of this year, according to the Bureau of Economic Analysis.

More ominous, as Americans have dug themselves deeper into debt, the value of their assets has started to fall. Mortgage debt stood at $10.5 trillion at the end of last year, more than double the $4.8 trillion just seven years earlier, but home prices that were rising to support increasing levels of debt, like home equity lines of credit, are now dropping.

The combination of increased debt, falling asset prices and stagnant incomes does not threaten just imprudent borrowers. The entire economy has become vulnerable to the spending slowdown that results when consumers like Ms. McLeod hit the wall.

If you don’t think what happened to Russia can happen here, think again. Right now the world has one superpower with a (fading) supereconomy. It could very well end up with none, at least until China or the EU takes America’s place

And the Small Picture

As individuals in a megasovereignty run by entities with vast quantities of money, there’s little or nothing any of us can do about this, other than get out of debt and stay out of debt. I would suggest that far from being un-American, putting the brakes on your spending impulses and shucking off as much debt as you possibly can is the best thing you can do for your country. It may take us into some hard times, but a change in habits among consumers is about the only message that will get through to elected representatives who are supposed to speak for us, not for those who can purchase their attention.

On the individual level, avoid rapacious mortgages and watch your credit card spending carefully. If you agree with me that a credit card can be a useful tool, remember that every time you use it, you are entering into a deal with the Devil. Proceed accordingly

2 comments left on the iWeb site


The graph on the NYT website depicting average savings vs. debts for all Americans really surprised me.Aside from a few years in the 1940’s, there has never been some mythical time when people were all prudent and frugal, making average savings exceed average debts.People are people, apparently; if you give them credit, they’ll use it.What’s changed in the past decade is how much credit people have been offered.

Why would lenders offer more and more credit to more and more people?One reason that lenders, particularly mortgage lenders, are repackaging loans and reselling them, so they don’t suffer the consequences if people default.By the time the loans were repackaged three or four times, no one knew what the real risks were.People were modeling risk based on historical models that weren’t accurate because people had never been offered such large loans before.The incentives for the financial companies were to encourage personal irresponsibility.

For individual people, I want to emphasize personal responsibility.After all, you’re the only one who can dig yourself out of your own debt, and people who take responsibility are generally more proactive about fixing their own problems.But, the financial system should also be changed to encourage more responsible lending.The system will partially fix itself- now we have better data on what people will do if you offer them dangerously large loans, and credit will tighten.We’ve begun to see this already.But there’s also a role here for regulatory changes.

Wednesday, July 23, 200811:03 A

Funny about Money


About regulation: We all could do without being treated like children by the federal government. However, it’s one thing when your own stupidity harms only you and your family; it’s another when mass stupidity and greed bring down the entire country’s economy. In “killing the beast,” the idealogues who acceded to power over the past two decades may have succeeded in killing America’s well-being. It is, in a word, inexcusable.

As more and more Americans retreat into enforced frugality, our economy will continue to suffer, because its operation has been based on a false perception of affluence. People have confused debt with buying power, with the predictable result.

Thursday, July 24, 200808:18 A

Personal finance nerds 1, spendthrifts 0

So, who’s “funny about money”* now? In the face of a recession that could deepen to the point of (dare we say it?) depression, frugality is suddenly a trend. Such a trend, we might add, that think-tank scholars are climbing aboard for the ride.

David Brooks, writing in today’s New York Times, reports on a paper from the Institute for American Values titled For a New Thrift: Confronting the Debt Culture. To make 19 column inches short, the gist of this document, to which 62 scholars have signed their names, is “get out of debt, stay out of debt, and live within your means.”

Brooks puts an interesting moral spin on the issue, suggesting that fundamental American values have been corrupted by an evil confluence of forces: credit-card debt, the growing financial polarization between the haves and the have-nots, lotteries, pay-day lenders, and even Wall Street with its obscene executive compensation.

Uh huh.

“The Devil tempted me and I did eat.”

Brooks offers a few half-baked attempts at solutions to this metaproblem, none of which are worth much. But he does point out something that probably is correct:

Benjamin Franklin spread a practical gospel that emphasized hard work, temperance, and frugality. . . . For centuries [the United States] remained industrious, ambitious, and frugal. . . .

There are dozens of things that could be done. But the most important is to shift values. Franklin made it prestigious to embrace certain bourgeois virtues. Now it’s socially acceptable to undermine those virtues. It’s considered normal to play the debt game and imagine that decisions made today will have no consequences for the future.

Lordie! Let’s hope we reform our evil ways before we’re all tossed out of Eden!

*Funny about Money’s title came from a (former) friend who, imagining no one was listening, remarked on another friend’s voicemail that I was “a little funny about money.” She’s in her mid-70s now, working three jobs to pay off the huge debts her million-dollar appetite racked up. Observers tell me she looks very tired.