Critical mass … or critical mess

By Don Kuehn

When writing these columns, it’s hard to know the circumstances of our readers. Perhaps you are one of the few who, thanks to your union’s negotiators, earn six-figure incomes from your classroom job. Maybe you are in your first year of teaching and struggle with the costs of starting life on your own, paying down college debt and being a renter for the first time in your life. You may be a paraprofessional or classroom aide earning barely enough to get by.

I am sure there are some who have "taken the pledge" this year to really crank up the savings and investment machine with an eye toward the still-far-off goal of funding retirement, or college for the kids.

Many of you already have launched an investment program through IRAs, no-load mutual funds, 403(b) plans or stock purchases. You may even have been motivated by this column over the past nine years.

Whatever your situation, there is no time like right now to get really focused on the lifelong task of funding your future. That means taking a hard look at what you earn, what you spend and how you can live below your means so that you can set aside enough cash today to fund a better tomorrow.

Every financial decision you make will affect your life over a very long time. Small decisions—to postpone a purchase until you can afford to pay cash, for example—add up. It is important to keep an open mind about your personal finances, set realistic financial goals and stick to them.

Many readers will see the advice about living below their means and think: "I can’t cut back on anything. I’m already committed to a car payment (or two), a mortgage, credit card debt; and I really need a vacation."

But poor decision-making in the first place (model of car, neighborhood, buying on credit, etc.) created the mess you’re in. There is a fine line between appropriate decision-making and overspending or living beyond your means.

There is a concept in investing called "critical mass." It’s borrowed from the nuclear field, where it refers to the amount of fissionable material necessary to sustain a chain reaction and make a bomb.

For investors, it’s when you have enough money invested to generate more in dividends and interest than you are spending—living on the earnings of your investments and preserving the principal.

For example, say you have a net worth of more than $1 million,* with $750,000 invested in a well-diversified portfolio of no-load mutual funds. If you are growing your investments by an average of 8 percent per year, that’s an annual return of $60,000. If your total living expenses (including mortgage, taxes, insurance, vacations, car payments, etc.) are less than that, you have reached critical mass.

Unfortunately, way too many Americans have reached "critical mess." They have fouled up their personal finances so badly that they lose hope. They feel frustrated that nothing they do to repair the damage, so they might as well just keep doing what they have been doing, running up balances on credit cards and making minimum payments.

Trouble is, once you get trapped into a card balance you can’t pay off every month, you fall further behind as you try to fund current living costs while adding finance charges to your remaining balance.

Despair won’t cure your ills. Discipline will.

Getting out of debt is not easy. But keep your eye on the ball. Paying down even a small piece of your debt load has a positive cumulative impact on your financial health because it makes it easier to pay more the next month. You should always pay more than the minimum amount due and, for heavens sake, stop using those cards!

If your credit cards charge very high interest rates, call the companies and ask them to cut your rate. You might be surprised at how cooperative lenders can be if it means keeping your business.

Use those credit card offers you get in the mail as leverage: "I just received an offer from XYZ bank for its Visa card at 0% interest for one year. I intend to transfer my balance and close my account with you unless you can knock my interest rate down from 22 percent…"

Even while you are climbing out of debt, you can begin a disciplined savings plan. Use coupons, buy when items you need are on sale. Separate "needs" from "wants," and pay for what you need with cash. Set up an automatic investment account so you can put money aside without thinking about it. That may be in a 403(b) account or through a brokerage account that deducts money from your paycheck every month and adds to your no-load mutual fund account.

Of course there is also the B-word: budget. Your spending has to fit your budget, not the other way around. You need to know how much you really earn after taxes and deductions; you need an idea of how you can cut your living expenses; you should allow for the cost of accumulated expenses that come up only once a year, such as personal property taxes or large insurance premiums; and your budget should have a cushion that lets you enjoy life. An unrealistic budget will only lead to further despair and frustration and back to the old ways of spending.

If you are considering a new car purchase and have a choice between a low-mileage "program car" (a used vehicle that has been returned from lease) and a brand new model that costs $5,000 or more, go for the program car and save the five grand. Invested at 8 percent you’ll earn $400 per year. If you keep the car for 10 years, the $5,000 will have doubled with compounded interest.

In addition to ending your love affair with plastic, stop using ATM machines. You may be paying a combined fee of $3 for every transaction ($1.75 to the bank whose machine you use and $1.25 to your bank). Just two withdrawals a week means you are wasting $300 a year in fees.

Write checks; pay with real money. Keep a spending diary. Get back in touch with the reality of what you are spending, and pledge to buy only what you need, not everything you want.

If you are wallowing in debt, the party’s over. There is tremendous satisfaction in regaining control of your finances. It’s your money, and you need to make it work for you by getting right with your financial plan—today.

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*A million dollars! What’s he thinking? you might ask. Well, it is possible, and there are just three things necessary to achieve that goal: (1) how much you save, (2) how well you invest and (3) the time you have to allow your investments to grow compounded before you need to tap into them. I found a Web site called free-financial-advice.net that included the following table to show you how to become a millionaire.

If you can save $750 a month and earn a manageable 8 percent, you can be a millionaire in just 29 years.

Years To Reach One Million Dollars