As we fail to pay our balances in full each month, we fall deeper into debt, and credit card companies make massive profits.
This is why credit card companies hope you only pay the minimum owed on your balance each month. When you carry a balance, they make a ton of money.
If that doesn’t sit well with you, don’t complain about unfair the game is. When you sign up for a credit card, you agree to play by certain rules.
Instead of wasting your time and energy griping about high interest rates, figure out a plan to pay off your debt. Stop giving the credit card companies any more of your money.
What can you do to stop making money for the credit card companies?
Start by understanding exactly how credit card companies make money off of you. This is what we’re going to focus on today.
If nothing else, always remember that banks are “for profit” businesses, and they’re very good at making profits.
Then, you can implement these 10 tips to pay off debt as quickly and painlessly as possible.
Let’s get to it.
Understand how credit card interest works so you don’t end up paying it.
If you’re going to use credit cards as part of your everyday life, you should understand the basics on how interest is charged.
Unfortunately, failing to understand how credit card interest works is an all too common mistake.
Here’s what you need to know.
Credit card interest is typically expressed as an annual percentage rate, or APR.
If you carry a balance on your card, the credit card company charges interest by multiplying your average daily balance by your daily interest rate. You will be charged this interest until your balance is paid off in full.
Credit card interest rates are typically variable, meaning they can change over time.
In the abstract, it can be difficult to fully appreciate how penalizing credit card interest is on our finances.
Let’s look at an example to better understand the consequences of carrying a balance.
Let’s say you just moved to a new apartment and purchased a $1,400 TV using a credit card.
You don’t have enough money saved up for the full purchase, so you decide to pay off $100 each month. Your credit card charges 23% interest.
At that interest rate, it will take you 17 months to pay for that TV. You will end up paying a total of $1,645, which includes $245 in interest.
The $245 in interest equals 15% of the original price of the TV. That means you paid 15% more than the TV actually cost.
If that doesn’t catch your attention, don’t forget this is just the interest on one purchase after moving to a new apartment.
What if you want to buy a new sofa to go with your TV? How about a coffee table and a rug? Floor lamp? End table?
You can see how a 15% penalty on each of these purchases can start to add up quickly.
Think about this added cost the next time you make a purchase expecting to just pay it off slowly over time.
Never miss a credit card payment unless you like making banks richer.
Write this rule down in stone: never miss a credit card payment.
If you don’t remember any of the other credit card tips, remember this one.
It may seem unfair, but even a single missed payment can severely impact your credit history and credit score.
Because the consequences of a missed payment are so severe, it’s a good idea to set up your account for automatic payments.
You have options when setting up automatic payments. Ideally, you can pay your full balance automatically each month.
If that won’t work for your situation, you can set up automatic payments for the minimum required amount to stay in compliance with your account terms.
By paying at least the minimum amount required on-time each month, you will not be penalized with a missed payment.
What is the minimum required payment?
Credit card companies typically only require customers to make a minimum payment towards their balance each month.
By the way, the banks want you to only make the minimum payment each month. When you do that, they make a lot of money off of you.
They get richer while you fall deeper into debt.
The minimum payment is generally 2% to 4% of your balance, or a predetermined minimum fee of around $35.
It may sound enticing to only pay the minimum. However, you will be charged interest on that remaining balance. That interest compounds and will be a major drag on your finances.
Let’s look at another example to see what happens when you only make the minimum required payment.
Let’s say you have a credit card balance of $2,000. Your minimum required payment will likely be between $40 and $80 to stay in compliance with your account terms.
In this example, assume the minimum required payment is $40. If you make the minimum payment of $40 out of your total balance of $2,000, that means your remaining balance is $1,960.
On the next billing cycle, you will be charged interest on that remaining balance of $1,960. At 23% interest, you will be charged $37.39, which gets added to your total balance.
So, on the next billing cycle, your total balance will be $1,997.39.
Let that sink in.
Even though you paid $40 last month, your balance only decreased by $2.61. Ouch!
Note: this example is for illustration purposes only and may not be precisely how your credit card company calculates interest.
Know the fees associated with your account.
Beyond interest and hoping you only make the minimum payment, credit card companies profit by charging fees, such as late fees and balance transfer fees.
Let’s focus on just one of the many fees: the annual fees tied to rewards credit cards.
These fees can cost hundreds of dollars annually and cancel out the value of any points you earn.
For example, if you have a credit card that charges an annual fee of $500, and you only earn $400 worth of points each year, that’s a losing proposition.
You’d likely be better off using a credit card that does not charge an annual fee, even if that means losing out on some points.
For that reason, it’s important to do your homework before applying for a new card.
Be strategic about what, and how many, credit cards you have.
There was a time in my life when I had ten different credit cards because I wanted to maximize the points I earned on every purchase.
I had airline branded cards, hotel branded cards, and general travel rewards cards. I had credit cards with Chase, American Express, and CitiBank.
My wallet was so thick it was embarrassing.
I did earn a lot of points. But, it was so stressful.
Keeping track of what card to use for every single purchase was complicated. Making sure I paid off each card every month was even harder. In the end, it wasn’t worth it.
I now keep things simple with just two credit cards and recommend you do the same.
There’s no reason to overcomplicate it. I use the Sapphire Reserve for travel and dining and the Freedom Unlimited for everything else.
My wife and I still earn plenty of points and our finances are much simpler.
One other suggestion: if you’re in a relationship and share finances, I suggest you align your credit card strategies. Most major credit card companies allow you to combine points with a household member.
You can more quickly accumulate points by focusing on a single rewards program, instead of spreading out those points among various programs.
Unless you want the banks to get richer, don’t spend money just to earn points.
When you have rewards credit cards, the temptation exists to spend money you otherwise wouldn’t because you want to earn more points.
It’s possible to become so obsessed with collecting points that you forget about the strong personal finance habits you’ve worked so hard to establish.
It can be easier to justify careless spending when we trick ourselves into thinking that spending will eventually lead to a vacation.
For example, if you have a credit card that offers bonus points at restaurants, you may be tempted to spend more money when you eat out.
Or, you may be tempted to pick up the tab for your friends even though that spending doesn’t align with your budget.
The temptation to earn points can overwhelm your plans to stay on budget. This logic applies to any type of spending, not just dining out and bar tabs.
Use your credit cards to spend within your Budget After Thinking, not as an excuse to justify blowing your budget.
Otherwise, all you’re doing is helping the banks get richer.
Help yourself get rich, not the banks.
If anyone is going to get rich off of my efforts, I want it to be me, not the banks.
By understanding how credit card companies make money, I can plan my actions in a way where I benefit instead of them.
It starts with not overspending. From there, I need to make sure I pay my balance in full each and every month. Finally, I need to make sure I’m not spending just to earn more points.
Have you ever asked yourself what you would do with financial freedom?
I asked myself that powerful question on a beach years ago and came up with my Tiara Goals.
Debt is a major obstacle on the way to financial freedom. To help you stay motivated to eliminate debt, write down your version of Tiara Goals.
By reminding yourself what you’re actually striving for, you’re more likely to stay on track.
Whenever we talk about good money habits, it always starts with establishing strong motivations. This is especially true when it comes to debt. There are too many temptations that can push us off track.
When you’re faced with these inevitable temptations, take a look at your Tiara Goals. I keep my Tiara Goals in my notes section on my phone. I also have a picture on my phone of the original sheet of notebook paper I scribbled on.
All it takes is a quick glance at my most important life values to overcome whatever temptation is in front of me.
Getting out of debt is not easy. Make it easier by regularly reminding yourself what you would do with financial freedom.
If you’re currently in debt, it’s crucial that you stop that debt from getting larger.
Think about it. If you’re paying off $1,000 of credit card debt each month, but you’re still spending $1,200 more than you earn, your efforts will be for nothing.
Your debt is growing faster than you’re paying it off. You’re not getting any closer to being debt-free.
Once you’ve stopped the disappearing dollars and learned where your money is going each month, you can make thoughtful decisions to pay off debt on a budget.
Then, you can be confident that any money you allocate to debt will actually lower your debt balance.
3. Prioritize Later Money funds to pay off debt.
The art of budgeting is to generate fuel for your Later Money goals. The more fuel you can generate each month, the faster you will achieve your personal finance goals.
There are lots of options on what to do with your Later Money. For example, you can invest in real estate or the stock market.
When you’re in debt, I recommend you prioritize using your Later Money to eliminate that debt. This is especially true if you have Bad Debt, like credit card debt. Your number one money focus needs to be to eliminate that debt.
This is the key to learning how to pay off debt on a budget.
There’s a good reason to focus on paying off your Bad Debt.
The interest rate on Bad Debt is generally very high. The amount you pay in interest each month will be significantly greater than what you may reasonably expect to earn through investments.
If you only have Good Debt, like student loan debt, you have some more flexibility in whether to focus on that debt or your other investment goals.
This is because Good Debt generally carries lower interest rates, so your investment returns may match or even exceed what you’re paying in interest.
In this scenario, I suggest that you consider splitting your Later Money between debt pay down, savings, and investments. This is what my wife and I are currently doing in 2025.
Seeing your savings and investments grow while focusing on how to pay off debt on a budget can provide an emotional lift.
Establishing good savings and investment habits now will also have longterm benefits that should survive your debt phase.
Our Top 10 Strategies for staying on budget will help you generate more money to allocate to debt. These tips are crucial if you’re trying to learn how to pay off debt on a budget.
For example, when you see something that you might want to buy, make a note in your phone instead of buying it right away. After a couple weeks, you probably won’t even want that thing anymore. Take that money you didn’t spend and put it towards your debt.
As another example, how about playing The $500 Challenge Game? When you come in under budget that month, use the excess funds to pay down debt.
You’ll see for yourself that the emotional high of paying down debt is better than the feeling you’d get from spending that money on things you don’t care about. It’s important not to ignore these emotional wins when learning how to pay off debt on a budget.
5. Talk to your people about how to pay off debt on a budget.
Talking money is not taboo. That includes talking about our current money goals and money challenges. Of course, it includes talking about how to pay off debt on a budget.
What are your current money priorities? If you don’t want to share with us, are you sharing with your friends or family?
I struggled with debt when I began my career as a lawyer. For years, I kept that to myself. I wish I had been more open. I’ve recently learned that many of my friends were struggling in the same way.
The problem was that none of us talked about it.
I think about how much stress we could have saved each other if we were just willing to talk about money like we talked about everything else. Instead, we hid our truths from each other.
Even worse, we likely enabled each other’s poor spending habits.
I now know that it didn’t have to be that way. I would have been better off if I was open about it.
This part still bothers me today: I also might have helped my friends facing the same challenges just by starting the conversation.
6. Track your net worth and savings rate for small wins.
Remember that your net worth grows when you reduce your liabilities, meaning debt.
When we think of net worth, it’s common to focus on growing our assets. Don’t forget that reducing your debts has the same impact on your balance sheet.
For example, when tracking your net worth, eliminating $1,000 in debt is the same as an investment that grows by $1,000.
Even when you’re focused on how to pay off debt on a budget, tracking your net worth can be very motivating. Every payment you make to reduce that debt improves your net worth.
This is especially helpful if you are focused on paying off student loans or paying down a mortgage. You may not have many appreciating assets, but you can still make a positive impact on your net worth by reducing your debt.
The same logic applies to tracking your saving rate. Measure and feel good about each additional amount you dedicate to eliminating debt.
The goal is to stay motivated while you pay off debt on a budget.
There are two common strategies to consider when you hope to pay off debt on a budget. These strategies are referred to as “Debt Snowball” and “Debt Avalanche.”
Debt Snowball means paying down your smallest debt balance first, regardless of interest rate. When you’ve paid off that loan completely, you then move to the next smallest balance, again regardless of interest rate.
Debt Snowball is ideal for people that are motivated by the emotional wins that come with eliminating a loan completely, even if it costs more money in interest in the long run.
Debt Avalanche means you pay down the debt that has the highest interest rate first, regardless of the balance. Once that debt is gone, you move to the loan with the next highest interest rate.
Debt Avalanche is for people who would prefer to pay less overall interest, even if it will take longer to pay off a single loan and receive the emotional win.
I discussed the pros and cons of each strategy here. Some people will prefer the emotional wins of the Debt Snowball method, while others will prefer the mathematical advantage of the Debt Avalanche method.
I’ve experienced firsthand that our money choices have more to do with emotions than they do math. If you prefer to play it strictly by the numbers, I completely understand.
The key is that whichever strategy you pick, stick with it. You’ll save yourself a lot of unnecessary mental gymnastics by choosing one approach and then moving on.
One word of caution: whichever method you choose, be sure to always pay the minimum on all of your loans. Otherwise, you’ll be in violation of your loan terms and face devastating penalties.
The idea with either of these methods is to allocate whatever funds remain to the single loan you have prioritized after paying the minimum on all loans first.
8. Think about loan consolidation or balance transfers.
Whether you have credit card debt, student loan debt, or even mortgage debt, you may have the option to consolidate each type of loan into a single loan.
If you do your homework, you should end up with a lower overall interest rate and have only one loan payment to make each month.
If you choose to go this route, make sure you fully understand the fine print involved.
For example, if you’re thinking about consolidating your student loans, you’ll end up sacrificing certain loan forgiveness provisions that accompany federal loans.
The same caveat applies when considering a credit card balance transfer.
A balance transfer is when you move the balance from one credit card to a different credit card with a lower interest rate. Most major credit cards accept balance transfers from other banks’ credit cards.
The main reason to consider a balance transfer is if the card you are transferring into carries a significantly lower interest rate than your current card.
In some instances, you may even qualify for a promotional rate with no interest charged for a limited period of time.
I used balance transfers when I was focused on eliminating credit card debt at the beginning of my career. I did my homework and found a card that was advertising 0% interest for 12 months with no balance transfer fees.
That meant that for an entire year, I paid no interest. Every payment I made went directly to lowering my overall debt.
If you’re considering a balance transfer, be mindful that there are usually upfront fees involved, usually around 3%. That fee may end up cancelling out any benefit from doing the transfer in the first place.
9. Get a side hustle to help pay off debt on a budget.
You’re not too busy or too important for a side hustle.
At the end of the day, there are really only two ways to more quickly pay off debt on a budget: spend less money and/or make more money.
We already talked about creating a Budget After Thinking to help on the spending side.
If you still believe that your income is the reason you have debt, there are always ways to improve your income.
Of course, if you really want to get rid of your debt faster, earning more money and the same time you’re spending less money is a dominate combination.
If you take on a side hustle, you can use every dollar you earn to pay off debt. Since this is new money you’re earning, you shouldn’t need it to fund your Now Money or Life Money.
Avoid the temptation of using that money on things you don’t really want anyways. Think about how much faster that debt will disappear if you’re able to throw additional money at it each month.
If you’re not ready for a side hustle, the same logic applies anytime you earn a bonus or commission at your primary job. Put that money to good use by paying down your debt.
10. Don’t let yourself fall backwards while you pay off debt on a budget.
When you do succeed in eliminating a debt, don’t let yourself fall back into bad habits. It’s hard to pay off a debt. It takes time. It takes patience and discipline.
Don’t let it all be for nothing.
When you pay off a loan, celebrate that accomplishment!
Be proud of yourself and let that good feeling motivate you to continue on your journey towards financial freedom.
Before you know it, debt will be part of your past life. You can shift all your attention to the opportunities that comes next for you and your family.
Top 10 Tips to Pay Off Debt for Lawyers and Professionals
To recap, here are my top 10 tips for lawyers and professionals to pay off debt:
If you have credit card debt, your immediate financial goal should be to pay off that debt as quickly and efficiently as possible. To get you started, I’ll show you exactly how to make a budget to pay off debt.
On your journey to financial freedom, getting rid of credit debt is crucial.
It is nearly impossible to get ahead financially if you are paying 20% interest or more on credit card debt. That type of drag on your money is just too strong.
Think about it: the stock market has historically averaged a 10% annual rate of return.
Does it make any sense to prioritize investing in the stock market to earn 10% per year if, at the same time, you are paying 20% in interest on your credit card debt?
Each year you follow this pattern, you are losing more and more money.
So, the first thing you should do is come up with a plan to pay off your credit card debt. Once the debt is gone, use that money for investments.
Today, we’ll look at how to make a budget to pay off debt so you can begin fueling your investments.
If you can follow these three steps, you’ll have a budgeting framework in place that will serve you well, long after you’re out of debt.
Paying off debt is the hard part. If you can do it, you’ll soon realize that it is a lot more fun to see your money grow each month instead of only seeing your debt shrink.
Let’s dive in.
Making a budget to pay off debt is about having a plan ahead of time.
The art of budgeting is to know what you want to do with your money before it hits your checking account.
Otherwise, it’s too late. Those dollars will disappear.
How do you come up with a plan, or budget, to pay off debt?
I teach my students that to create a budget to pay off debt, you need to first study your own personal situation to figure out where your dollars are currently going.
Then, you can figure out a plan for how to use your next dollar before you earn it. This applies not just to bonuses or other unexpected dollars, it applies to every dollar you earn.
When you put the time in to study your own habits, you can then create a realistic budget. When you have a realistic budget, you will have confidence that your dollars are working for you.
Some dollars will be used to pay your ordinary life expenses, some dollars will be used for all the things in life you love, and some dollars will go to your financial goals, like paying off debt.
That’s all there is to it.
If you don’t currently maintain a budget, here are three steps to follow to get you started.
Step 1: Track your spending for at least 3 months.
I recommend everyone, regardless of where you are in life, start with this first step of tracking your spending for at least three months.
Without knowing where your money is currently going, you won’t be able to make adjustments so you can pay off debt faster.
In other words, before you can reduce your debt, you have to make sure your debt is not growing each month.
That means not spending more than you can afford to pay off each month.
That’s a problem if you’re hoping to make a budget to pay off debt.
To address that problem, you need to track every penny for at least three months. Then, you’ll know exactly how much you’re spending and can begin to think about areas of improvement.
So, before you go any further in the budgeting process, you need to commit yourself to tracking every penny for three months and only charging what you can afford to pay off.
Fair warning, you probably won’t enjoy this part of the budgeting process.
Tracking your spending is important even if it’s not enjoyable.
I won’t lie to you.
This step can be hard and you probably won’t like it. This is the step that makes people think budgeting is a nasty word.
I get it and don’t blame you for having that reaction.
Still, there’s no getting around this first step. You don’t have to budget forever, just long enough to learn your own behaviors towards money.
Please know that many of us struggle with this first step. You might not like what you learn by tracking your spending.
When I first started budgeting, I learned that I was $20,000.00 in debt and was spending way more than I earned.
That wasn’t fun, but I’m happy that I put in the effort to find my blindspots and make adjustments.
I often think to myself, “Where would I be today if I didn’t go through this process 15 years ago? How much further into debt would I have fallen?”
The good news is, tracking your spending is easier today than it’s ever been. I’ve used apps, spreadsheets, and even the notes function on my phone.
Regardless of how you track your spending, be honest with yourself. If you intentionally or mistakenly leave out certain expenditures, you won’t learn where your money is actually going.
A budget, which is just a plan, is only as good as the data it’s built off of. Be honest about your data.
Last note: Budgets are usually done monthly, so you’ll want to create a separate accounting for each month you tracked.
The reason we track three months of spending is so you’ll be able to identify any patterns or inconsistencies in your spending from month-to-month.
This helps ensure you’re making decisions based off the best data possible.
Step 2: Separate your spending into three three main categories.
Great work completing the first step! That wasn’t easy, but you did it.
Now that you have tracked your spending for three months, you can assign each expense into separate categories.
Most personal finance experts agree, though we have different names for each category, that you should divide your money into three main buckets.
I refer to these buckets as:
Now Money
Life Money
Later Money
1. Now Money
Now Money is what you need to pay for basic life expenses.
These expenses include housing, transportation, groceries, utilities (like internet and electricity), household goods (like toilet paper), and insurance.
These are expenses that you can’t avoid and should be relatively fixed each month.
If you’re making a budget to pay off debt, it’s going to be hard to cut from this category, unless you are willing to make major changes. That means moving to a less expensive home or giving up your car, which are not always feasible.
That said, if you are in the position to make these kinds of big changes resulting in serious savings, you can accelerate your path towards being debt-free.
2. Life Money
Life Money is what you are going to spend every month on things and experiences in life that you love.
This bucket includes dining out, concerts, vacations, subscriptions, gifts, and anything else that brings you joy.
We can’t be afraid to spend this money. This bucket is usually what makes life fun and exciting.
The key is to think and talk so you are spending this money consistently on things that matter to you.
If you are truly dedicated to paying off debt, this is the major category to focus on. If it costs $100 to go out to eat, and $10 to eat dinner at home, that’s $90 that could potentially go towards paying off debt.
When you repeat that decision over and over, you can aggressively attack your debt.
3. Later Money
Later Money is what you are saving, investing, or using to pay off debt.
This bucket includes long term goals, such as retirement plan contributions (like a 401k or Roth IRA), college savings for your kids (like a 529 plan), emergency savings and paying off student loan or credit card debt.
This bucket also includes any shorter term goals, like saving for a wedding or a downpayment for a house.
Most fun of all, this bucket includes any investments you make to more quickly grow your wealth, like investing in real estate or the stock market.
You’ve probably guessed it already. Later Money is the key category that fuels your ultimate life goals, like financial independence.
The more you fuel this category, the faster you can reach your goals.
When your goal is to pay off credit card debt, any fuel you generate in this bucket should go to paying off that debt.
With the exception of contributing enough to receive your company’s 401(k) match and creating a small emergency savings account, all excess money should go towards paying off your credit card debt.
Don’t worry about assigning a percentage to each category.
I have intentionally not recommended target amounts or percentages to allocate to each of your three categories.
The reason is because of what I’ve learned from my students over the years. I’ll lay out my full reasoning in a separate post.
The short version is that in my experience working with law students, assigning target percentages for each category is counterproductive.
When I used to teach my students to aim for certain percentages in each category, I could tell that they would get discouraged as soon as I put the numbers on the slideshow. I completely understand why.
Each of us is starting in a different place. If you are currently spending 80% of your monthly income on Now Money, it’s not helpful to have someone tell you to create a budget that automatically drops that level to 50%.
My students would tune me out as soon as I put those numbers on the board.
Now, I teach my students to think and talk about their current personal realities and aim for steady and lasting improvements.
I want my students to create a plan that will last, not an unrealistic plan that they give up on after a few months.
So, whatever amount you’re currently spending in each bucket, that’s what we’re going to work with as we move on to step 3.
One other thing before you move on to step 3: don’t get hung up stressing about what type of expense goes into each category.
Sometimes, it gets tricky. Do clothes you buy for work count as Now Money or Life Money?
Don’t stress. It doesn’t really matter. It’s not worth the mental energy thinking about it. Just stay consistent and move on.
If you still want a target, aim for 20% of your income added to your Later Money each month.
All that said, I know that some of us operate better if we have a specific target in mind. If that’s you, the conventional wisdom is to aim for 20% of your income added to your Later Money each month.
Obviously, the more you add to Later Money, the faster you will pay off your debt. So, if you can afford more than 20% toward credit card debt each month, do it.
If you’re curious, targeting 20% savings each month was popularized in Elizabeth Warren’s book, All Your Worth: The Ultimate Lifetime Money Plan, first published in 2005 (before she was Senator Warren, she was a law professor and author).
Senator Warren advocated for a 50-30-20 budget framework with 50% going to fixed costs (what I call “Now Money”), 30% going to wants (“Life Money”), and 20% going to financial goals (“Later Money”).
Most personal finance experts agree that the 50-30-20 framework is a solid plan for your budget.
In theory, I agree.
In reality, I’ve become convinced through working with my law students that the 50-30-20 framework does not cut it in today’s environment.
While I agree the 60-30-10 framework may be more realistic, my experience has taught me that assigning rigid percentages is just not a practical framework for most people at the beginning of budgeting process.
Step 3: Make adjustments so your spending better aligns with your true motivations and desires in life.
OK, so now that you have assigned your spending to each of the three categories, the next step is to think and talk about your current habits and whether you’re spending matches your true motivations and desires in life.
If you decide that your spending does not match your life values, then it’s time to make some adjustments.
When you’re in credit card debt, the goal of these adjustments is to create more money each month to pay off your debt.
What kind of adjustments can you target?
In essence, my budgeting philosophy is to aim for steady and lasting improvements based on your current reality and your ultimate motivations.
What does that mean?
This is where we circle back to the importance of having a clear understanding of what we want out of our money. Money is just a tool.
Ask yourself:
“Is your current spending aligned with how you want to use your money to fuel your goals and ambitions?”
If not, you can make incremental adjustments as you progress towards your ideal spending alignment.
The idea will be to continuously add more fuel to your Later Money bucket so you can eliminate your debt faster.
You can make small adjustments, which are usually easier and faster to put in place. These adjustments might include dining out a bit less, cutting out a concert, or cancelling a gym membership or subscription you don’t use.
You can also make big adjustments, like moving to a cheaper part of town or getting rid of you car.
Small or big, the key is that when you make these adjustments, you repurpose that money in a thoughtful and intentional way. When you’re in debt, that means repurposing those savings to paying off debt.
Once your debt is paid off, you can put those savings towards your other financial goals.
You’ve already done the hard part. You’ve already aligned your budget with your money motivations.
With each thoughtful decision, you’re progressing towards your best money life. Most importantly, you’re learning about yourself and developing lasting habits. You won’t get discouraged and give up on budgeting.
To help you better understand how to make a budget to pay off debt, here is exactly how I did it when I was in debt in my twenties.
Here’s an example of how to make a budget to pay off debt.
In today’s budgeting example, we’ll look at how I made a budget to pay off debt in my twenties.
The dollar amounts below are what my actual income and spending looked like back then, adjusted for today’s dollars and rounded for easier math.
For some context, I was 26-years-old, living by myself in Chicago (no dependents, no pets), and working as a “slasher.” Not a joke, that was my actual job title.
I worked for a judge with the Appellate Court of Illinois, and as the junior member of the team, my responsibilities included lawyer duties and secretarial duties. I was a judicial law clerk “slash” secretary. Hence, slasher.
Lawyers are funny, huh?
In today’s dollars, I earned an annual salary of $90,000.00. That means I earned $7,500.00 per month. We did not have bonuses at the courthouse, so the $90,000.00 salary was my full compensation.
The benefit of going through an example like this is not to compare your situation to mine. Your income might be much higher or much lower. Same with your expenses.
Instead of the numbers, focus on the thought process so you can start to think about adjustments that suit your current life to help you pay off debt.
Below, you’ll see charts showing that I completed each of our three steps to make a budget to pay off debt:
Step 1: I tracked my spending for 3 months and reflected the average monthly amount for each expenditure in the column labeled “Baseline Budget.”
Step 2: I created a separate chart for each of the three main categories: Now Money, Life Money, and Later Money.
Step 3: I made thoughtful adjustments to better align my spending with my true motivations in life. I illustrated my decisions in the third column labeled “Budget After Thinking.”
Now Money
Recall that Now Money is what you need to pay for basic life expenses.
These are expenses that you can’t avoid and should be relatively fixed each month. If you have expenses for kids, pets, and other fixed life expenses, be sure to include them in your Now Money category.
Now Money
Baseline Budget
Budget After Thinking
Apartment rent
$2,200
$2,200
Renter’s Insurance
$20
$20
Parking spot
$430
$0
Gas for car
$40
$40
Car Insurance
$50
$30
Car Maintenance
$150
$150
Utilities
$120
$120
Internet
$60
$30
Cell Phone
$55
$35
Groceries
$300
$240
Personal upkeep(wardrobe, haircuts, etc.)
$100
$75
Gym Membership
$360
$360
Budget Busters
$300
$300
Now Money Total
$4,185
$3,600
What I learned tracking Now Money.
Now Money is pretty easy to track. There is not a whole lot of variance from month to month.
You’ll notice immediately that I had one major expenditure that needed immediate adjustment. That parking spot for $430? Definitely did not need that.
I lived 2 miles from work in one of the best cities for public transportation in the country. It was frustrating at times to look for street parking, but I didn’t use my car enough to justify the cost of a parking spot.
The other adjustments resulted in more minor savings, but don’t ignore these. Each adjustment took relatively no effort to make, just a little bit of thought beforehand.
When I say relatively no effort, I mean three phone calls and three reductions for car insurance, internet, and cell phone. That’s $70 saved per month, or $840 saved per year, for about 30 minutes of effort.
Otherwise, I decided to show a bit more restraint when grocery shopping and found a cheaper place to get my haircut.
All told, I reduced my Now Money Budget After Thinking by $585 per month with a little bit of thought and hardly any effort.
That meant $7,020 per year I could reallocate to paying off debt.
Life Money
This bucket, Life Money, is what you spend every month on things and experiences in life that you love.
Life Money
Baseline Budget
Budget After Thinking
Social Life (dining out, concerts, ball games, etc.)
$800
$700
Purchases (books, fun clothes, gifts, etc.)
$200
$150
Travel
$500/mo ($6,000/yr)
$400
Cubs Season Tickets
$400/mo ($4,800/yr)
$400
Budget Busters
$200
$200
Life Money Total
$2,100
$1,850
What I learned tracking Life Money.
When you’re reviewing your Life Money expenses, don’t be overly aggressive in cutting here. These are the things and experiences that make your life enjoyable. Even modest adjustments can make a big difference in the long run.
For tips on adjusting your Life Money without sacrificing the things and experiences you love, check out my post here.
As we saw with Now Money, with some thought and very little effort, I reduced my Life Money Budget After Thinking by $250 per month.
That meant another $3,000 I could use to pay off debt.
Some bonus tips for tracking Life Money
Life Money is the most annoying category to accurately track. These expenses vary month-to-month. You may buy concert tickets or have a trip planned some months, but not every month.
So, how do we get an accurate picture of our Life Money?
This is why I recommend you track your spending for at least three months.
You’ll get a more accurate picture because you can average your Life Money spending over those 3 months and balance out any inconsistencies.
Of course, if you have the patience to track your spending for even longer, you’ll get an even more accurate picture.
Fortunately, it is easier to track our spending today with the availability of apps and online banking platforms that can automatically track your spending.
Keep it simple when tracking your Life Money.
I highly recommend you keep it simple when tracking your Life Money. Many of my students give up on budgeting because they make this category more complicated than it needs to be.
I really struggled with this at first because I was so concerned about doing it right.
What I learned was that it doesn’t matter. If you go to happy hour with friends, don’t agonize over whether that goes into your “Dining Out” category or your “Drinks” category?
It doesn’t matter. Make it easy on yourself. Have one category called “Social Life” and move on.
Don’t forget that the point of budgeting is to learn your current habits so that you can make thoughtful adjustments.
Don’t let yourself become so obsessed with the details that you get stressed and give up on budgeting.
Break down large, annual expenses on a monthly basis.
One last tip, when you have large expenses, like season tickets or a big vacation, it’s helpful to break down those expenses on a monthly basis.
That way, you can see how much those individual purchases are impacting your overall monthly goals.
I’m not suggesting you actually pay for that trip over 12 months (like on a credit card), or that you can only spend that much on travel in a certain month. Think of it this way: you likely will not take a trip every month of the year.
Using my Budget After Thinking figures, let’s say I did not take a trip in January, February or March. That would mean that for my planned April trip, I would have $1,600 available that I can use, assuming I didn’t let those dollars disappear.
Later Money
Later Money is what you are saving, investing, or using to pay off debt.
This is the fuel for your most important goals.
When you’re in debt, this is the bucket that matters the most.
Later Money
Baseline Budget
Budget After Thinking
Student Loans
$1,100
$1,100
Credit Card Debt
$150
$900
Savings
$0
$50
Pretax Retirement (401k)
$300*
$300*
Other Investments
$0
$0
Total Later Money
$1,250
$2,050
*This was pretax money to my employer’s retirement plan. For budgeting purposes, it’s easier not to count the amount here.
This is where all your efforts in tracking your spending and making thoughtful adjustments starts to pay off, IF you have a plan for your next dollar before you earn it.
My plan was to pay off debt as quickly as possible.
In my baseline budget, I was very good about paying my student loan debt in full every month. I knew enough not to mess with student loans.
The consequence was my credit card bills were the last to get paid each month. This usually meant only paying the required minimum since I had run out of money by this point. It also meant no money for savings or investments.
In my Budget After Thinking, because of the thoughtful choices I made with my Now Money and Life Money, I created $800 of excess cash.
With that cash, I had committed myself to paying off my credit card debt as quickly as possible.
I also wanted to start the habit of saving each month. So, I added $750 of fuel to my credit card bills and $50 of fuel to my savings.
I stayed true to my plan and put that money to work. Within a few years, I had paid off all of my debt.
Some bonus tips for tracking Later Money.
Make budgeting as easy as possible for yourself.
In my example, I excluded the $300 pretax retirement savings because I am creating a plan for the $7,500.00 that hit my checking account each month. These are the dollars in jeopardy of disappearing.
The entire point of your budget is to create a plan for your next dollar before you earn it. You already wisely chose to save your pretax dollars by enrolling in your employer’s retirement plan.
Those dollars are already accounted for and working for you. They are not disappearing dollars. You did your job!
Like in my example above, you can exclude the amount you’re saving for retirement in pretax dollars from your budget calculations.
Feel good knowing that you’re saving that money. It’s icing on the cake. No need to worry about it when budgeting.
Now you know how to make a budget to pay off debt.
Let’s look at the complete picture before and after I started the budgeting process:
Baseline Budget
Budget After Thinking
Now Money
$4,185
$3,600
Life Money
$2,100
$1,850
Later Money
$1,250
$2,050
Total
$7,535*
$7,500
*Income of $7,500
With some thought and relatively little effort, I was able to stop the disappearing dollars and start making progress towards my ultimate life goals.
In my baseline budget, I was spending more than I earned each month. That meant I had no money to pay my credit card bills, which kept getting bigger because I kept spending.
In my Budget After Thinking, I broke my habit of living above my means and generated $9,600 of fuel in one year to help pay off debt faster.
Taking these first steps may seem like minor steps on the way to financial independence, but they were the most important steps I ever took on my personal financial journey.
Like I did, you can follow these three steps if you are truly motivated to make a budget to pay off debt:
Step 1: Track your spending for at least 3 months.
Step 2: Separate your spending into 3 main categories.
Step 3: Make adjustments so your spending better aligns with your true motivations and desires in life.
As you start to implement these steps, you’ll start to have a clearer picture of how your money can work for you.
When you’re in debt, that means putting your money to work for you to eliminate that debt.
The benefit to creating a Budget After Thinking is that it works whether you are in debt or you are focused on fueling other financial goals.
If you can put in the hard work now to create your budget, you’ll be in good shape no matter what you’re trying to accomplish.
Have you ever made a budget to pay off debt?
What was the key to successfully paying off that debt?
Looking at each of these explanations can help us understand and avoid common pitfalls that lead us into debt.
Of course, it’s expected that young lawyers will have student loan debt. While student loan debt may be considered good debt, the problem is that it can spiral into other forms of bad debt.
For example, student loan debt becomes the excuse for why we fall into consumer debt:
“I have to pay my loans this month, but I also want to eat out with my friends. I’ll just use my credit card.”
This is exactly what happened to me at the beginning of my career as a lawyer, and what I want to help you avoid.
If you fall into bad habits early, the problems only magnify when your income rises and your potential to spend rises.
The key is to eliminate the bad habits before they become bad habits. If it’s too late for that, now is the best time to correct those bad habits before the situation spirals.
Before we get to my theories why lawyers are in debt, realize that you’re not alone if you are a lawyer in debt.
Unfortunately, the data shows that debt is all too common in today’s world. Let’s begin with some scary stats about debt.
Here are some scary stats to help explain why lawyers are in debt.
According to the Federal Reserve Bank of New York, total household debt in the United States grew to $18.04 trillion by the end of 2024.
That’s such a big number, it’s hard to know what to do with that information.
Let’s break it down by the type of debt:
Credit card balances increased by $45 billion from the previous quarter and reached $1.21 trillion at the end of December 2024.
Auto loan balances increased by $11 billion to $1.66 trillion.
Mortgage balances also increased by $11 billion and reached $12.61 trillion.
HELOC balances increased by $9 billion to $396 billion.
Other balances, reflecting retail cards and other consumer loans, increased by $8 billion.
Student loan balances increased by $9 billion to reach $1.62 trillion.
While these numbers are still too big to comprehend, one powerful conclusion is hard to miss:
In every category, the amount of debt increased from the previous quarter.
This pattern of increasing consumer debt has been consistent for some time now.
HELOC balances have increased for eleven consecutive quarters.
Credit card balances have increased or remained the same for 10 of the last 11 quarters.
Let’s look closer at credit card debt for a moment.
According to a recent survey looking at credit card debt in 2024 by Bankrate.com:
48% of credit card holders carry a debt balance, an increaseof 9% since 2021.
53% of the people have been in credit card debt for more than a year.
The main causes of credit card debt are unexpected medical bills (15%), car repairs (9%) and home repairs (7%).
According to another Bankrate.com survey, 33% of Americans report they have more credit card debt than emergency savings.
These last couple stats help us understand why so many people fall into debt in the first place.
Some of it has to do with the failure to have emergency savings. When we don’t have savings, the first place we turn is to our credit cards.
Even more has to do with the failure to keep our spending in check, or living below our means.
Why is it so hard for lawyers to live below our means?
“Live below your means.”
“Money doesn’t grow on trees.”
“Don’t break the bank.”
We’ve all heard these common money phrases. If you were to ask someone older than you for one piece of personal finance advice, I’m betting you’ll hear one of these lessons.
Let me know if I’m right about that in the comments below.
There’s a reason these phrases are so common. They’re simple and easily reflect some of our core personal finance principles:
I didn’t have any idea how to budget or make intentional choices with my money. I had never thought about why or how to be good with money.
Like many people, I failed to create a budget and assumed that my W-2 income was plenty. I ignored emergency savings and never even thought about creating Parachute Money.
The saddest part is that I didn’t even realize that I was slipping backwards. I had no idea because I didn’t track my net worth or saving rate. I worked hard all year long and just hoped things would work out.
By the way, if this sounds familiar, you should know by now I’m not judging anyone. I’ve been very open about my money mistakes.
So, being careless with money is one common reason lawyers fall into debt. Another common reason is that bad things happen in life.
This might include medical emergencies, home repairs or car troubles. It’s not our fault that these things happen. But, it is our fault if we’re not prepared in advance.
While these events are unfortunate, and maybe even tragic, they are not unexpected. We all need to expect that bad things will happen.
Preparing for the unexpected is part of every solid organization’s planning.
In government, planning ahead means having a “rainy day fund.”
When managing properties, planning ahead for big repairs means having a “Capital Expenditures” or “Cap Ex” fund.
For our personal finances, planning ahead means having an emergency fund.
Whether it’s government, business, or personal finance, the goal is to have options other than taking on debt to get through challenging circumstances.
3. Blame the Kardashians.
Besides carelessness and emergencies, there’s another powerful force that contributes to rising debt levels across the world.
This force is nearly impossible to ignore. It’s become a part of our daily lives, whether we want to admit it or not.
What is this powerful force that contributes to our rising debt levels?
The era of social media and on-demand entertainment has made it harder than ever to avoid temptation. It’s everywhere we look.
Blaming the Kardashians realtes to another timeless, common money phrase: “Keeping up with the Joneses.”
The Kardashians are the modern day Joneses.
Once upon a time, “the Joneses” represented your neighbors, people you could observe from a distance on a regular basis.
The idea behind the phrase is that you can see what your neighbors are spending money on and are either consciously or subconsciously tempted to do the same.
If your neighbors buy a new car, you buy a new car to keep pace.
If your neighbors vacation in Australia, you research diving tours at The Great Barrier Reef.
When you notice your neighbors hosting a backyard BBQ party with lots of happy looking people, you decide to host a party the next weekend.
As humans, it can be difficult to ignore the temptation to keep up with our neighbors.
Whether we like it or not, we are concerned with our social status. Part of our self-worth gets tied to comparing ourselves to others.
Who better to measure up against than the people in our neighborhood who we probably have a lot in common with?
Keeping up with the Joneses is compounded in the professional setting.
This same idea is oftentimes compounded in the professional setting, like at law firms. It is not uncommon to compare ourselves in the same way to our colleagues at the office.
This is especially difficult for lawyers. Fair or not, society generally expects lawyers to make a lot of money and have nice things.
If a partner at your firm joins a country club, wears fancy clothes, or sends her kids to private school, you may feel pressured to do the same.
It’s easy to get caught up in expensive tastes when you’re expected to fit in, even if you don’t have the money to spare.
One of my favorite personal finance books, The Millionaire Next Door, discusses this concept in detail.
I highly recommend you read this book if you are struggling with comparing yourself to others.
Instead, the first part of the solution is to recognize when you’re making careless money decisions based on what you think other people are doing.
Making money decisions based off of your neighbors, let alone the Kardashians, is the fast road to debt.
You have no idea why or how another person is spending money. For all you know, it’s all for show and that person is barely getting by.
Do you really want to blindly follow this person’s choices? Wouldn’t it be better to confer with people you trust to help you think through money decisions?
The second part of the solution is to recognize that everywhere you look, companies are clamoring for your dollars.
Have you ever dreamed about owning a cute condo in a bustling city?
You know, the type of place where you can have your friends over and everyone gushes over how great your condo is?
If so, you’re not alone.
Many young professionals follow a traditional path in hopes of buying that cute condo as a “starter home.”
First, they spend a lot of money for an education to get a good job.
Then, after a few years of working that good job, they think about buying a starter home instead of continuing to rent.
These young professionals go into the home-buying process knowing that the home they may purchase will only be a temporary fit.
Even though it may be years down the road, they tell themselves they can simply upgrade if a significant other or children enter the picture.
For professionals living in cities, the search for a starter home typically leads them to condo buildings.
This makes sense. Condo buildings are attractive for a number of reasons.
I get the temptation to buy a cute condo.
Condo buildings are usually in locations ideal for young professionals.
Condo buildings oftentimes come with enticing amenities.
Plus, condo buildings typically offer one or two bedroom units, the perfect size for an individual.
Because of these features, condo buildings tend to attract other young professionals, making the building even more attractive.
While I never owned a condo in Chicago, I happily rented directly from owners in condo buildings for 10 years before buying my first rental property. So, I certainly appreciate the allure of living in a condo.
All this being said, I highly encourage you to think twice before buying a condo, or any other “starter home” for that matter.
That’s because owning a unit in a condo building comes with two significant downsides: (1) the actual cost and (2) the opportunity cost.
Instead, I recommend you think about these two alternatives to buying a starter condo:
Continue renting until you’re ready to buy a more permanent residence; or
Buy a small multifamily building where you can live in one unit and rent out the other units.
Before covering these two alternative ideas, let’s talk about the (1) actual costs of owning a condo and the (2) opportunity costs of owning a condo.
What are the actual costs of owning a condo?
The actual cost of owning a condo is like owning any other property, with one additional cost to be acutely aware of.
Besides the mortgage, insurance, taxes, and maintenance, condo buildings involve an additional cost that can be very expensive:
HOA Dues and Special Assessments.
Remember all those attractive amenities that drew you to the building in the first place?
Those amenities come with a price. Oftentimes, a substantial price.
On top of the HOA dues, be aware of unexpected special assessments, which can wreak havoc on your finances.
Special assessments may be needed to cover major maintenance or renovation projects in the building. When special assessments are due, you don’t have a choice but to pay up.
Ask any former condo owner why they no longer own a condo. My bet is most of them will blame the HOA dues and special assessments.
The other reason you’ll hear from former condo owners?
They outgrew their place.
This should not come as a surprise to any single person who buys a condo while also seeking a significant other.
You know how the saying goes: first comes love… then comes marriage… then the condo’s got to go.
That means additional money to prepare your condo for sale, for closing costs, and for moving expenses.
By the time you add up all these costs, you likely won’t walk away with any profit from owning a condo as a starter home because you only gave yourself a few years to benefit from appreciation.
Even if you do make a profit, it’s a gamble. Owning any home for a short period of time is not a good investment strategy. The transactional costs are simply too high.
Besides these actual costs, you should also consider the opportunity cost of owning a condo early in your career.
What is the opportunity cost of owning a condo?
While you may be OK with taking on the risk and these actual costs, don’t ignore the opportunity cost of owning a condo.
The opportunity cost refers to what you are losing out on by choosing to buy a condo.
In this context, the opportunity cost is that whatever you paid for the condo could have been used to invest in other assets. For example, instead of a down payment on a condo, you could have invested in stocks.
Or, you could have purchased a rental property that generates long-term wealth for you and your family (or future family). More on that below.
So, before you opt for the cute condo, think about both the actual costs and opportunity costs involved.
There’s nothing wrong with renting until you are ready to buy a more permanent home.
Owning real estate is a long-term proposition. The conventional wisdom is that you should not buy a property unless you plan to hold it for at least 7-10 years.
If you are not planning on staying in your starter home for at least that long, just keep renting. Invest your money elsewhere.
Save yourself the headaches of being a homeowner while building your net worth through an increased saving rate and other investments.
This is not groundbreaking information. This is Personal Finance 101.
Yet, many young professionals can’t resist the temptation to finally own a property after years of school and finally earning an income.
It’s up to you to set aside your ego, keep renting, and build a strong financial foundation.
By the way, many smart people think it’s financially foolish to buy a primary residence instead of renting.
And, I’m not just talking about buying a cute condo early in your career.
These really smart people think it’s almost always a better idea to rent instead of own in any circumstances.
While it’s beyond the scope of this post, you can find an in-depth analysis on the question of buying vs. renting in this video from Khan Academy.
I believe in the power of real estate as an asset class, especially small multifamily properties.
Instead of buying a condo for a starter home, consider these four reasons to invest in rental properties:
With cash flow, you can cover your immediate life expenses. For anybody hoping to reach financial freedom, it is essential to have income to pay for your present day life expenses.
For my money, cash flow from rental properties is the best way to pay for those immediate expenses.
If your present day expenses are already covered, you can use your cash flow to fund additional investments.
That might mean buying another rental property or investing in another asset class, like stocks.
Appreciation simply refers to the gradual increase in a property’s value over time.
While cash flow can provide for my immediate expenses, appreciation is all about the long-term benefits.
Like investing in stocks over the long run, real estate tends to go up in value. The key is to hold a property long enough to benefit from that appreciation.
To benefit from appreciation, all I really need to do is make my monthly mortgage payments, keep my property in decent condition, and let the market do the rest.
When I buy a rental property, I take out a mortgage and agree to pay the bank each month until that mortgage is paid off. At all times, I remain responsible for paying back that debt.
However, I do not pay that debt back with my own money.
Instead, I rent out the property to tenants. I do my best to provide my tenants with a nice place to live in exchange for monthly rent payments.
I then use those rent payments to pay back the loan.
As my loan balance shrinks, my equity in the property increases. Equity is just another way of saying ownership interest.
When my equity in a property increases, my net worth increases.
When you earn rental income, you must report this income on your tax return. Rental income is treated the same as ordinary income.
However, the major difference between rental income and W-2 income is that there are a number of completely legal ways to deduct certain expenses from your rental income.
Common rental property expenses may include mortgage interest, property tax, operating expenses, depreciation, and repairs. We’ll touch on a few of these deductions below.
With all of these available deductions, the end result is that most savvy real estate investors pay little, or nothing, in taxes on their rental income each year.
Yes, you read that right.
I’ll say it again, just to be clear:
Most savvy real estate investors legally pay nothing in taxes on their rental income each year.
I highly recommend you consider house hacking if you’d like to start investing in real estate.
When you buy a small multifamily property, you can live in one of the units and rent out the others.
If you pick the right property, you can end of living for free because your tenants pay your mortgagee.
The strategy of living in a building you own while tenants pay for it has been around for ages. Brandon Turner popularized the name “House Hacking” for this timeless concept.
You can read all about house hacking on BiggerPockets here.
My wife and I house hacked for years before buying our forever home.
Without a doubt, there is no better strategy for entry level real estate investors than house hacking. We talked about the financial upside earlier in this post.
Besides the financial upside, it’s like landlording with training wheels. Since you live on site, you can more easily learn how to manage a rental property, including responding to tenants and handling routine maintenance.
The naysayers will say something like, “I don’t want to live with my tenants. They’re going to stress me out. I don’t want to be bothered at 2 a.m.”
Ignore them.
My wife and I lived with our tenants for five years at our first property and two more years at a subsequent property. We did this while working full-time jobs as lawyers and raising two kids (now three kids).
Because we didn’t listen to the naysayers, we now have four income-generating properties and our “forever home” just outside Chicago.
Even though we’re no longer living for free, the income from our rental properties is enough to cover the expenses of our home.
Before buying that cute condo, think about house hacking instead.
There’s no better time to house hack than at the beginning of your career. This one decision can pay massive dividends for years to come.
No, your friends might not gush over your cute condo.
But, you’ll be well on your way to generating long-term wealth for you and your family.
Even if you’re not just starting out in your career, house hacking is still an incredible wealth-building strategy.
My wife and I house-hacked until I was nearly 40 years-old with two kids. We wouldn’t be where we are today if we instead opted for a cute condo.
Did you buy a starter home in your 20s or 30s? Any regrets?
Let’s say you are fresh out of law school working in big law.
At the current salary scale, that means you’re making $225,000 in salary, plus another $25,000 or so in bonuses. We’ll call it $250,000 in total compensation.
That’s a lot of money.
It’s so much money, in fact, that you convince yourself you can make some lifestyle changes.
For starters, you figure it’s time to leave the old law school roommates behind and move into a nicer, but smaller apartment by yourself.
Even though the tradeoff for living by yourself is paying more in rent, you justify it because your income is so high.
Besides paying more in rent, you can’t help but order in more meals now that you’re earning a high income. Plus, you’re working long hours, afterall. Who has time to cook?
Even though you survived on frozen chicken breasts in law school, that won’t cut it anymore now that you’re a practicing attorney.
Finally, you start taking Ubers to get around town. It’s only $15 per ride, and you make more than $20,000 per month.
Even though you took the bus or the “L” home in law school, you can afford a ride! Uber it is!
Does this sound familiar to you?
Maybe it sounds completely ridiculous?
Personally, this story is all too familiar.
When I graduated law school, I spent money based on my income instead of my wealth.
As soon as I started making money after law school, I started spending on things I really didn’t need.
About a year after I graduated, I moved into an apartment by myself. I started spending more freely. I took taxis (no Ubers back then) when I could easily have hopped on the bus or walked.
What made it worse in my case was that I was not even making big law money. At the time, I was a judicial law clerk making around $70,000 per year.
It was because I was careless with my money that I fell into credit card debt so quickly after beginning my career as an attorney.
On top of my poor spending choices, I had student loan debt. Because I had debt and hardly any assets to my name, my net worth was less than zero dollars.
That means I had negative wealth, even though I was earning a decent income.
This is all background for the main question behind today’s post:
Do you spend money based on your income or based on your wealth?
Let’s revisit our fresh big law attorney who’s earning $250,000 per year.
Earlier, I said “That’s a lot of money.”
And, it is.
But, what I should have said was, “That’s a lot of income.”
See, earning a lot of money is not the same as having a lot of money.
There’s a key difference.
Income is temporary. There’s no guarantee that your income will always be there. People lose their jobs all the time. People also switch careers, which can result in lower income.
Wealth is your financial foundation. When you have money, meaning you don’t spend it, you can build wealth.
Of course, when we talk about wealth, we are talking about all of your assets minus your liabilities. This is your net worth.
When your liabilities are greater than your assets, you have a negative net worth, like I did when I graduated law school. By the way, the same is true for most people when they graduate law school.
A high income is not a bad thing, but it can be a wasted thing.
A high income means you have a lot of money coming in.
That’s not a bad thing, but it can be a wasted thing.
What you do with that money is what determines your wealth and financial progress.
If you use your high income to acquire assets, you are winning the game. The same goes for paying off your liabilities.
If you use your high income to buy expensive things, you’ll be stuck in place. At the end of the year, you’ll likely be in no better shape than someone making a fraction of what you make.
That’s why I prefer to think about how much money I keep each year, instead of how much I make.
You may think that a new lawyer earning $250,000 per year should be splurging on life’s finer things.
Would your opinion change if you acknowledged that lawyer’s net worth is a negative number?
Think about it: most new lawyers leave law school with hundreds of thousands of dollars in debt. They also have little to no assets. That means they have a negative net worth.
Should someone with a negative net worth really be splurging on a fancy apartment?
If that person is looking to build a solid financial foundation, the answer is obviously, “No.”
This person should continue living like a law student and spending in accordance with his net worth, not his income.
I recommend you use your high income to acquire assets and eliminate liabilities.
Don’t get me wrong. I am not suggesting that earning a lot of money is a bad thing.
Having a high income is a major benefit.
In fact, I recommend that all of my law students take the high paying job right out of school, if they can get it.
A high income means you can pay off your debt faster. It means you can build up your emergency savings and fund your investment accounts sooner.
There can be no doubt that a high income can accelerate your progress to financial freedom.
You just need to use that income to acquire assets and eliminate liabilities.
As you take those steps, you’ll see your net worth climb, and you’ve earned the right to start spending more.
We all know that it’s bad to live beyond our means. The problem is we don’t evaluate our means properly.
You don’t have to be a personal finance expert to know that living beyond your means is a bad idea.
Most of us intuitively understand that we should live within our means. Actually doing so can prove to be more problematic.
Part of the explanation may be that we don’t think of our spending in terms of our net worth.
We may not appreciate that if we are spending extravagantly while our net worth is still low, or even negative, we are living beyond our means. It doesn’t matter what our income level is.
That’s why I recommend you spend based on your level of wealth (your net worth) instead of your income.
Of course, this lesson applies to all of us, not just recent graduates.
This is challenging for lawyers and professionals who feel compelled to keep up with the Joneses.
When you’re making $750,000 per year, you may think you need to buy the $100,000 luxury car. Or, you may not hesitate to spend $10,000 to upgrade your family’s plane tickets to first class.
But, can you really justify that level of spending when your net worth does not match up with your income?
What happens if that income goes away?
Instead, you should prioritize saving and investing until your net worth justifies that higher spending threshold.
Spending money based on your wealth does not spending from your wealth.
When I say spend money based on your wealth, I don’t mean that you should spend from your wealth.
In other words, this is not a post on spending down your wealth in retirement.
Rather, what I mean is that you should consider your net worth before deciding how much of your income you are comfortable spending.
For example, if you earn $250,000 per year from your job and have a negative or low net worth, you should continue living like a law student.
If you earn $250,000 per year and have a net worth of $1M, you would be justified in splurging from time-to-time.
If you earn $250,000 per year and have a net worth of $10M, you shouldn’t worry about spending extravagantly with all of that income.
Why not worry about spending so much?
The reality is that your investment earnings on $10M will far exceed your $250,000 income from work.
Even a 5% investment return on $10M would earn $500,000 per year, double what you earn from your job. You actually might start thinking about why you still have that job in the first place.
These numbers are just for illustration purposes. Still, the idea is that your spending decisions should factor in your net worth at least as much, if not more so, than your income.
Don’t ignore your wealth when it comes to spending.
Whenever you are evaluating your current financial position, especially your spending decisions, I recommend that you focus on your wealth at least as much as your income.
Income is temporary. It can go away at any moment.
If you are fortunate enough to earn a high income, use that high income to acquire assets and pay down liabilities. That means you’ll have to avoid spending extravagantly until your level of wealth can justify it.
Wealth is foundational. Yes, there will be drops in the markets and your net worth can decrease. That is to be expected.
However, if you focus on spending in line with your net worth, you’ll naturally adjust your spending if your net worth temporarily drops. When it rises again, you can justify spending more. The key is to be flexible.
If you can think in these terms, you will build a strong financial foundation that will give you choices down the road.
Making headlines this week, the federal government shut down, resulting in hundreds of thousands of federal employees being furloughed.
When someone is furloughed, he doesn’t receive a paycheck. Even if that person eventually receives backpay, furloughs can be a huge problem for those individuals.
Why?
Because most people, even high-earners, live paycheck to paycheck.
When you’re furloughed, money stops coming in. But, money keeps flowing out.
But even federal workers who eventually receive back pay can suffer during a shutdown, as many of them live paycheck to paycheck, [Dan Koh, former chief of staff of the Labor Department] added.
“Even if you are entitled to back pay, a lot of people can’t go even a couple of days without their regularly scheduled paycheck,” he told CBS News. “If you have to pay your subway fare, for gas, if something breaks in your home, and you’re not getting paid, it places extreme stress on government employees,” he said.
So, what can we do to help protect ourselves from furloughs or any other sudden loss of income?
The first savings account you need is commonly referred to as an emergency savings account. This is your ultimate security blanket for whatever life throws at you.
For example, if you are furloughed and lose your source of income, your emergency savings will keep you afloat until you’re working again.
The idea is to use your savings so you don’t have to pull from your long-term investments.
Your emergency savings is not just for when you get furloughed or lose your job. Your emergency savings will also protect you in times of emergency (brilliant, huh?), like unexpected medical bills or expensive home repairs.
The idea remains the same: instead of pulling from your investments, you will have cash available in your savings account to cover your needs.
Aim for 3-6 months of Now Money saved for emergencies.
Aim for building up 3-6 months of your Now Money saved in a dedicated emergency savings account.
In your Budget After Thinking, Now Money represents the consistent, reoccurring expenses that you need to pay every month to take care of yourself and your family.
Since you will only be using this money in times of emergency, you can, and should, forego some of life’s luxuries until you get back on track.
The same is true for fueling your Later Money goals. Take a pause until you sort out whatever it was that caused you to spend your emergency savings in the first place.
While your emergency savings account is your first line of defense when you are furloughed, I prefer having an extra layer of protection.
Parachute Money is one of my favorite concepts in all of personal finance.
The analogy goes like this:
Pretend your life is like flying on an airplane.
For whatever reason, you decide you need to get off this airplane. Maybe conditions outside of your control have forced you to jump. Or, maybe you’ve decided that it’s time to take control and make a change.
Either way, you’re ready to jump.
All you need is a parachute.
You have a choice between the only two parachutes on the plane.
The first parachute has only one string (or line) connecting the canopy to the harness . You think to yourself, “This doesn’t seem very safe. What if that one string breaks? That would end very badly for me.”
Then, you look at the second parachute.
The second parachute has 10 strings. You say to yourself, “OK, this one looks much safer. If one string breaks, the parachute still has nine other strings to keep me safe. Even if something goes wrong with one or two strings, I would glide safely to the ground.”
It’s obvious which one of these parachutes to choose, right?
OK, cool.
But, what does a parachute have to do with money?
Each of your income sources is like a string on your parachute.
The central idea of Parachute Money is to create multiple sources of income so you are not beholden to any one source.
Picture each source of income as a string on your parachute. The more strings on the parachute, the stronger it is.
With Parachute Money, if one of your sources of income dries up, like when you are furloughed, you are more than covered with your other income sources.
Of course, the more sources of income you have, the stronger your personal finances are.
Parachute Money includes your primary job, any side hustles, any income generating assets, and your emergency savings account. It also includes the income of your significant other, if you share finances.
The key to Parachute Money: protect yourself with as many investment and income sources as you can.
That’s why in addition to my primary job as a mesothelioma attorney, I invest in the stock market, own rental properties and am an adjunct law school professor.
It is not easy to maintain an emergency savings account of 3-6 months.
Having 3-6 months of emergency savings is a wonderful achievement. It takes time and discipline to build up that level of savings.
Personally, I’ve struggled to accumulate a sufficient emergency savings account.
It’s that I’ve chosen to prioritize investing in real estate for the past seven years. Whenever I had enough money saved up for a down payment, I bought another property.
Admittedly, this was a risky strategy.
That’s why I do not recommend this approach for most people.
Instead, for just about everyone reading this, I would recommend you build up your emergency savings account before moving to other financial goals.
Did you notice that I said “just about everyone reading this”?
That’s because I think people who are protected by parachute money have earned the right to take more risks at the expense of their emergency savings.
Let me explain.
If you have parachute money, you can get away with a smaller emergency savings balance in the short run.
I was comfortable underfunding my emergency savings account in the short run because I had a strong parachute with multiple income streams.
As I mentioned, my wife and I were both working as attorneys and had various income streams. If one of our income streams dried up, such as during a furlough, we would have been protected by our other income streams.
Because of these multiple income streams, we were comfortable taking on the risk of having a low emergency savings balance.
If you are in a similar position and have multiple streams of income, you may also feel comfortable with a smaller emergency savings balance.
From where I sit, you’ve earned the right to invest your money rather than letting it sit in a savings account. If that’s your choice, I wouldn’t blame you. I made the same choice.
That said, I would not recommend you shortchange your emergency savings in the long run. While it’s OK to temporarily prioritize other investments, I still believe that an adequate emergency savings account is essential to a healthy financial life.
That’s why I am now focused on building up my emergency savings instead of acquiring more real estate. I’ve reached a good place with my investments. Now it’s time to focus on protecting my family.
I think of it like this: my parachute is otherwise very strong between my primary job, my adjunct teaching job, my rental properties, and my other investments.
The one string that I need to add is a sufficient emergency savings balance. That’s why building up my emergency savings will be my top money goal for 2026.
When you combine emergency savings and parachute money, you are as protected as possible.
The ultimate level of financial protection comes from having an emergency savings account and parachute money.
You are protected in a variety of ways if one of your income streams dries up.
If you haven’t prioritized an emergency savings account or developing parachute money, let the recent government shutdown serve as a reminder of how important these concepts are.
Whether you are in the tech industry or an attorney or a consultant, there’s no guarantee that your job will last forever.
The overall economic outlook is hazy at best right now. Ask five “experts” what the economy will look like in two years and you’re likely to get five different answers.
It’s up to each of us to build in multiple layers of protection in our financial lives to avoid disaster if our primary source of income dries up.
It’s where I’m from, where I’ve chosen to raise my family, and where I primarily invest in real estate.
Last night was a good night for Chicago sports fans.
My favorite team, the Chicago Cubs, won a playoff series for the first time since 2017.
While watching the game at home, I couldn’t help but think of how different my life is today than it was in 2017.
Back then, I had season tickets and rarely missed a game. My wife and I were just about to get married. Life was good and about as easy as can be.
From a financial perspective, we were pretty boring.
By the way, being boring with money is not a bad thing.
When it comes to money, boring is good.
Back in 2017, my wife and I each made good incomes as attorneys. More importantly, we were happy saving a lot of the money we earned.
We rented an apartment and had minimal expenses besides travel and our social lives.
At that time, we had a good amount of savings because we were planning to buy a house after the wedding.
Our only investments were in retirement accounts, like a Roth IRA and 401(k). We didn’t own any real estate.
Life’s a bit different for me now.
I don’t have season tickets anymore. We don’t travel as much.
We have three kids and different financial priorities.
Life is better than ever, but maybe not as easy as it was in 2017.
OK, what does all this have to do with baseball?
Last night at home, while watching the Cubs pull out a stressful victory, I started thinking about these things. I wasn’t in the crowd like in 2017, but I knew exactly how the fans were feeling.
Each pitch was tense. The crowd went nuts after every Cubs hit or strikeout by a Cubs pitcher. Whenever the San Diego Padres had a rally going, every Cubs fan was nervous.
In the end, the Cubs pulled out the victory and thousands of people now have memories they’ll never forget.
There’s nothing better than playoff baseball. I love it and hate it at the same time.
Watching the game, I thought of some of my favorite baseball memories. It was a good reminder of why it’s so important to think and talk about money.
We say it a lot around here: money is only a tool. When used properly, you can use money to build lifelong memories. You can create stories that you’ll remember for the rest of your life.
Stories like the ones I have from 2016 when the Cubs won the World Series.
That’s when I met Phil and April.
My nice friends, Phil and April.
Throughout that World Series run, we sat next to the nicest couple in the world, Phil and April.
Phil was a diehard Cubs fan. April was more reserved.
Both were smart and very friendly. They were enjoyable people to sit with.
We chatted baseball, mostly. Pitching changes. Send the runner. Question the manager. That sort of thing. Completely normal, unremarkable stuff.
Game 5 was played on a crisp, October evening. Jackets and beanies weather in Chicago. Phil and April were sitting next to my brother and I, as usual.
Mike Napoli was playing first base for Cleveland. Around the 3rd inning, a jerk four rows in front of us taunted Napoli with a crude, juvenile insult.
It was apparent the jerk was doing his part to keep Old Style in business for another year.
None of us liked what this jerk yelled.
Phil especially didn’t like it.
Phil was nice…and tough.
Phil did what the rest of us were thinking but were too scared to do ourselves.
Phil stood up. In so many words, Phil sternly recommended that the jerk knock it off and show some class.
The jerk turned around, aggressively scanning the crowd for the man who had publicly shamed him. The jerk had that unmistakable look in his eye that meant, “Let’s dance.”
My brother and I were a bit worried for our nice… and all of a sudden tough…friend, Phil.
Phil’s wife, April, did not look worried. She sat there like nothing strange was happening. Almost like she had seen this movie before.
When the jerk locked eyes with Phil, he immediately saw that Phil was not backing down. If anything, Phil looked a little too eager.
Well, the jerk was sloppy, but he had enough sense to recognize that he wanted no piece of Phil. He wisely turned back around and sat down quietly.
That was the last we heard from the jerk that night.
Our nice (and tough) friend, Phil had restored order.
On the day of the Cubs’ championship parade, my brother called me excitedly, “Phil’s on TV! Phil’s on TV!”
It didn’t register right away who he was talking about.
When I turned on the TV, sure enough, there was Phil, our World Series friend. I was so confused. Phil was giving an interview on set with the Cubs announcers.
Our nice (and tough) friend, Phil? On TV?
I turned up the volume and listened to Phil talk about his experience watching the Cubs win the World Series. Maybe I was hoping he’d mention his nice friend, Matt. (He didn’t.)
I still couldn’t figure out why Phil was on TV.
Why won’t they just put his name on the screen already!?
It wasn’t until the end of the interview that I learned who Phil was.
All I could do was laugh.
Our nice, and confirmed tough, friend Phil is better known as World Wresting Entertainment (WWE) champion and icon, CM Punk.
Unknowing watching the Cubs win the World Series with two celebrities with a combined 3.5 million Instagram followers?
Yup, that’s a story I’ll be telling for a while.
A memory I wouldn’t trade for anything.
As much fun as the World Series was, my favorite Cubs memory actually took place during the 2015 season, the year before they won the World Series.
It was during the 7th inning of Game 4 of the NLDS. This was the game where the Cubs knocked the rival St. Louis Cardinals out of the playoffs.
In the 7th inning, with the Cubs up 5-4, Kyle Schwarber hit one of the most epic home runs in Cubs history, landing his moonshot on top of the new right field video board.
It was such a feat, the ball is now enshrined where it landed.
The entire stadium was rocking so loud, you could feel the ground shaking beneath your feet. Every fan was jumping up and down, hugging anyone close enough to touch.
We were all dancing like nobody was watching. That moment was pure happiness.
I was there with my mom.
A lifelong Chicagoan, she too was jumping up and down and high-fiving all the other diehard fans in our section.
After the game, we met up with my wife at a restaurant and relived the victory over Champagne.
That day with my mom and my future wife is one of the best memories I have.
When I say money is a tool to create stories and memories, this is what I mean.
My brother and I still joke about our nice friends, Phil and April. I wouldn’t trade that memory with my mom for anything.
These are the types of experiences that I want more of.
These memories, and the desire for more like them, continue to motivate me today.
I want to be good with money, not so I can stash it in the bank, but so I can use that money to create joy for me and my family.
Beyond that, watching the crowd at Wrigley Field last night reminded me of why I started a personal finance blog.
It excites me to try and help people make intentional money decisions for meaningful experiences with meaningful people.
Talking money is really just talking life.
You may not be a baseball fan, but this conversation illustrates a foundational concept of Think and Talk Money.
Yes, we discuss money.
But, we’re really talking about our lives and our experiences.
Money is just a tool to help us.
And before you get cynical on me, of course money is not required for good experiences. That’s not the point.
What I’m suggesting is that if we’re all spending so much of our time each week at work, shouldn’t we spend some time thinking about the money we earn so we can maximize experiences like I had with my mom?
Think and Talk Money is all about awakening that thought process so we can use the tool of money to fuel meaningful lives.
You might not use that tool to get Cubs tickets.
But, what if you started thinking about money as just a currency that you trade to get your time back so you can do more of what you want with who you want?
Whatever it is that you’re after in life, thinking and talking about money will help get you there.
Have you used money as a tool recently to create stories and memories?
If you have a travel rewards credit card, you likely have the option to use your points for cash back instead of transferring them to travel partners.
With the cash back option, you can exchange your points at a 1:1 ratio, meaning one point equals one cent. It may be easier to think of it as 100 points equals 1 dollar back.
Cash back is the easiest way to redeem value for your points. With a few simple clicks, you can either receive a direct deposit in your checking account or have a credit applied to your statement.
Sounds pretty good, right?
Yes, it may be tempting to exchange your points for cash. Before you do, I have a suggestion for your consideration:
With only slightly more effort, you can get so much more value out of those points by transferring them to a travel partner.
Today, we’ll look at an example to drive this point home. We will focus on three ways to book the same flights using only points earned with my favorite credit card, the Chase Sapphire Reserve.
After reviewing the options, you should see that the cash back option is by far the least attractive.
First, let’s think about why credit card companies make it so easy to redeem your points for cash.
Credit card companies want you to take cash back for your points.
The truth is that credit card companies are hoping you take the cash back offer.
When you take cash back, you are saving the credit card company money. That’s why they make it so easy for you to receive cash back with just a few clicks.
When you transfer your points to travel partners, it costs the credit card companies more money. That is one of their justifications for the higher annual fees on travel rewards cards.
They are hoping to recoup some of that cost by charging a fee.
For the same reasons, it’s also why rewards cards that don’t charge an annual fee only offer the cash back option.
Are you more interested in saving the credit card companies money or in saving yourself money?
If you want to save yourself money, read on.
But, isn’t cash more valuable than points?
I know how enticing it can be to have 70,000 points in your account and immediately turn that into $700.
That’s real money.
However, those points could be worth so much more money if you stay patient and use them to pay for your next vacation.
While putting a specific value on credit card points is not an exact science, there are some reputable companies that have undertaken the task.
For example, The Points Guy currently values Chase Ultimate Rewards points at 2.05 cents per point.
Credit Karma values Chase Ultimate Rewards points at 1.71 cents per point.
As mentioned above, cash back typically rewards you with 1 cent per point.
That’s a real difference.
But, that cash can offset my credit card bill! Who has time to travel anyways?
I want the cash back to help pay my bills this month!
I’m too busy to travel!
These are some of the justifications I hear from people who choose to take cash back.
I encourage these people to think about what they’re really saying.
For instance, if you really need to trade in your points to pay off your credit card bill, then you need to revisit your budget and spending choices.
I understand that sometimes money is tight and unexpected expenses pop up. That’s what your emergency savings account is for.
Ultimately, your credit card points should be viewed as a fun bonus, not as a key factor in paying your bills on time.
Now, if you are too busy to take even one trip a year, it’s probably time to think about why you’re working so much.
And, if you don’t even like to travel, you probably shouldn’t have a travel rewards credit card in the first place.
OK, with this context behind us, let’s take a look at a sample itinerary and see which option you prefer.
Three ways to book flights to Colorado for a ski vacation without using money.
For this example, we’ll focus on Chase Ultimate Rewards points, which is what you earn using the Chase Sapphire Reserve.
My favorite way to redeem my Chase Ultimate Rewards points is to transfer them to United for free flights.
Let’s say you live in Chicago and want to go skiing in Colorado this winter. You have plenty of points saved up and you want to put them to good use.
You are a savvy traveler so you’re not messing around with peak holiday travel prices.
Instead, you wait until the holiday rush is over and plan your long-weekend trip from January 8 to January 13 (Thursday to Tuesday). That allows for four full days of skiing with a couple of easy travel days built in.
Let’s consider three options for booking these tickets without using any actual money:
Buy the tickets directly from the airline then reimburse yourself with cash back from your points balance.
Transfer your Chase Sapphire Reserve points to United and purchase the ticket with United miles.
Purchase the ticket through the Chase travel portal and pay with points.
Option 1: Buy the tickets directly from the airline then reimburse yourself with cash back.
In this first option, you check out United.com to see what decent flights would cost you if you paid in cash. The good news is that United has direct flights from Chicago to Denver (two United hubs) throughout the day.
You want to work a half-day on Thursday so choose the 2:36pm departure.
Coming home, the last thing you want to do is wake up early on your final day of vacation. So, you choose the 5:42pm return flight.
For a refundable roundtrip ticket, this itinerary will cost you $304.96.
Not bad, right? It pays to wait for the holiday season to die down.
You decide to purchase the ticket using your Chase Sapphire Reserve, earning 4 points per dollar for a total for 1,220 points.
Of course, you know that $304.96 is the equivalent of 30,496 Chase Sapphire Reserve points (1 point equals 1 penny; 100 points equals 1 dollar).
After buying the ticket, you go to your Chase portal and convert 30,496 points into cash back, which equals $304.96.
The end result is that this option costs you 30,496 points but no real money.
One side note: Because you purchased this itinerary with your Chase Sapphire Reserve, the 1,220 points you earned reduced the true cost of the ticket to 29,276 points. However, these points will be deposited into your account after your next statement closes so don’t actually help you here.
Option 2: Transfer your Chase Sapphire Reserve points to United and purchase the ticket with United miles.
Next, let’s see what happens If you wanted to book this exact same itinerary by transferring your Chase Sapphire Reserve points to United.
Looking at United.com, this exact same itinerary costs 19,000 points.
You login to your Chase account and instantly transfer 19,000 points to United. Then, you return to United’s website and book the flights.
Remember, the cash back option cost you 30,496 points for this same itinerary. By transferring your points to United, you saved 11,496 points.
That’s 60% of the points you need to book another plane ticket on this itinerary. You may have enough points leftover to bring a friend!
And, if you really wanted to, you could even book this itinerary using United miles, and then give yourself $114.96 cash back as a thank you gift with your remaining points.
I personally wouldn’t do that- I would just save those points for the next plane ticket.
You should now see how much money you’re leaving on the table if you opt for cash back instead of redeeming your points for travel.
On just this one trip, you saved $114.96. Think about how much that savings adds up if you book more than one plane ticket each year.
Option 3: Purchase the ticket through the Chase travel portal and pay with points.
As a third option, you could use your points to purchase this itinerary directly through the Chase travel portal.
Pursuing this option would cost 20,331 points. That’s definitely a better option than the cash back option, but not quite as valuable as booking directly through United.
If you choose to go this route, be aware that you may lose out on certain perks available when booking directly through the airline.
That’s because using the Chase portal is the equivalent of booking through a travel agent. You may not get to choose your seat, receive upgrades, or other benefits you’d get by booking directly with the airline.
Regardless, since it’s less expensive to book directly through the airline, I don’t see any real benefit to choosing Option 3 over Option 2 in this scenario.
That said, don’t write off Option 3 in every circumstance. There are certainly times when it’s a worthwhile option to consider.
I have used the Chase travel portal extensively to book boutique hotel overseas. These types of smaller, independent hotels are not typically affiliated with any credit cards and may not have rewards programs.
In that instance, I can use my points instead of cash to stay at these wonderful hotels.
So, what option would you choose?
With very little effort, you can save yourself real money by transferring your credit card points to travel partners.
I encourage you to think about this strategy before you elect to take cash back.
Do you prefer cash back? What is your favorite points redemption option?
Kudos to you if you can answer that question quickly and relatively accurately.
Knowing your net worth indicates you are likely making intentional choices with your money. You likely are more concerned with how much money you keep, not how much you make.
It also likely means that you have a plan and are well on your way to financial independence.
Well done!
If you know your net worth, you might be wondering how you measure up to people your age.
That’s what we’re going to look at today.
First, let’s discuss why it’s important for all of us to track our net worth.
Think of tracking your net worth in terms of keeping score during a basketball game.
If you don’t know the score of the game, you don’t know if your strategy is working. You don’t know if you need to make adjustments before time runs out.
The same applies to tracking your next worth. The point is to educate yourself on your current financial situation so you can make adjustments while there is still time.
How do I know if I need to make adjustments based on my net worth?
Speaking of making adjustments, it can sometimes be helpful to look at datasets to see how you measure up to the rest of the population.
So today, we’ll look at two potentially helpfully net worth metrics.
First, we’ll look at the average net worth of Americans by age.
Then, we’ll look at the average net worth by age of the Top 1%.
The goal is to give you some benchmarks so you can assess where you’re currently at. Then, you can decide if you want to make any adjustments.
In other words, the point is to educate yourself so you can make intentional choices for your own situation. The point is not to start comparing yourself to your neighbors.
Below is the average and median net worth of Americans by age based on research from Empower.
Keep in mind these studies are not perfect.
It’s not an easy task to track and study net worth across a wide population. Not everyone tracks her net worth, let alone makes it easy for outsiders to track it.
Use these figures as a rough guide to help your own decision-making. Just don’t get too caught up in the exact figures.
Net Worth by Age
Age
Average Net Worth
Median Net Worth
20s
$121,004
$6,609
30s
$307,343
$24,247
40s
$743,456
$75,719
50s
$1,330,746
$191,857
60s
$1,547,378
$290,447
70s
$1,444,413
$233,085
80s
$1,342,656
$233,436
90s
$1,212,583
$205,043
High school math refresher: The average is calculated by adding up all values in a dataset and dividing by the count. The median is the middle value of a dataset with an equal number of values above and below. Averages can be skewed by extreme values, so the median can give you a more accurate picture.
Here are some observations about the average net worth of American by age:
Net worth tends to increase with age. No surprise there, right? As our careers progress, we tend to earn more and invest more money.
Net worth tends to peak in our 60s. This also makes sense. When people reach retirement age, they start to draw down their portfolio. They’ve spent decades accumulating wealth and eventually it’s time to spend that savings.
Notice the effects of compound interest. From the 20s to the 30s, we see that the median net worth nearly quadruples. That’s a 400% increase! However, it equates to a median net worth increase of only $18,000.
Compare that to the change from the 50s to 60s. We see that the median net worth increases by only 50%, but the result is an increase in nearly $100,000.
The takeaway is that when you have more money invested, smaller gains result in higher earnings. You could say, “the rich get richer.”
What is the net worth by age of the top 1%?
Next, let’s take a look at the average net worth by age of the Top 1%, thanks to an analysis of Federal Reserve data by DQYDJ.
Remember, these are only rough figures. Use this data to help you strategize based on your current financial situation.
Net Worth by Age of the Top 1%
Age
Top 1% Net Worth
18-24
$653,224
25-29
$2,121,910
30-34
$2,636,882
35-39
$4,741,320
40-44
$7,835,420
45-49
$8,701,500
50-54
$13,231,940
55-59
$15,371,684
60-64
$17,869,960
65-69
$22,102,660
70-74
$18,761,580
75-79
$19,868,894
80+
$16,229,800
Are these dollar amounts lower or higher than you expected?
If these dollar amounts seem unattainable, remember that 99% of us will never hit these marks. Don’t get discouraged. You’re doing great work if you’re anywhere close to these numbers.
Did you notice that the trends in the Top 1% net worth data are very similar to the average net worth by age data we previously looked at?
We again see the net worth of the Top 1% peaking in the 60s.
We also see the same effects of compound interest.
This data reinforces the point that investing favors people who start early, even if the results do not materialize for decades. It takes time for compound interest to work its magic.
When you reach FIPE, you are free to pivot to a new challenge, if that’s what you want.
On the other hand, maybe you looked at this data and learned that you are not as far along on your financial journey as you had hoped.
Don’t panic.
The benefit is that you can now make adjustments.
What kind of adjustments can you make after learning your net worth?
When you track and study your net worth, you can make adjustments while you still have time on your side.
For example, you may decide that it’s finally time to boost your saving rate.
After all, your saving rate is the one thing you can actually control on your way to financial independence.
Or, you might take a fresh look at your Budget After Thinking to find ways to generate more fuel for your investments.
And, it might mean saving and investing that one-time windfall instead of spending it on stuff you don’t really care about.
Whatever decisions you make, knowing the average net worth by age can help point you in the right direction.
It takes me less than 30 minutes per month to track my net worth using the TATM Net Worth Tracker™️.
It takes me less than 30 minutes each month to track and study one of the most important numbers in personal finance.
Each month, I’m only looking for progress compared to what my net worth was previously.
If my net worth increases over time, it means I am heading in the right direction.
It means that I am continuing to fuel my Later Money goals. I am paying down debt. I’m letting my investments do their thing.
If my net worth is not increasing, it means I need to figure out why and consider making adjustments.
Sometimes my net worth decreases because the markets are heading down. If that’s the case, I don’t do anything. At this stage in my life, I can afford to wait while markets tick back up.
If the issue is that my debt is increasing, or I didn’t fuel my investments that month, I know I need to make adjustments.
By studying my net worth each month, I can catch these setbacks before they become a continuous problem.
Do you track your net worth?
Are you happy with how you measure up?
If not, are you prepared to make the necessary adjustments?
At least you’ll have something to show for it come pay day.
Wait, you go through all that effort every day and you’re not saving a good portion of your paycheck?
Let’s talk about that.
When I take the train downtown, I can’t help but notice my fellow passengers.
Some people are already cranking away on their laptops. Some are even on conference calls, which always surprises me.
Why don’t they care that everyone is annoyed with them? Do the other people on the call know that they’re talking to someone on a train?
But, I digress.
Some passengers are reading books. A good portion of passengers are doomscrolling. Just about everyone has headphones in.
It’s not that people look unhappy. They just seem to want to be somewhere else.
Do you have similar observations?
Most people don’t have a plan.
It’s at times like these when I start to wonder how many of these people have a plan.
I’m not talking about a plan for lunch or for getting to the gym after work.
I mean a plan for how to spend their time and their money.
Ideally, this plan would be based upon spending time on meaningful pursuits with meaningful people.
My guess is most people have never really thought about this kind of plan.
Instead, it’s go to work. Get a paycheck. Pay the bills.
Same thing tomorrow. That’s as far as the plan goes.
This routine may be enough for some, or even most, people. If that’s enough for you, there’s no shame in it. Holding down a steady job and providing for your family are accomplishments to be proud of you.
But, let’s be real.
You’re reading a personal finance blog.
We spend a lot of time talking about financial freedom and creating options.
You wouldn’t still be reading if you didn’t feel there was more to life than the daily train ride, right?
You may not know how or when to get off the train, but you’re interested in finding out if it’s possible.
Well, it’s definitely possible. But, you need to break the cycle and commit to a plan.
Let’s say you work 2,000 hours per year to make money (40 hours per week, 50 weeks per year).
We won’t even count all the hours you spend getting dressed and riding the train.
Also, we will pretend you’re not looking at your emails in the evening, on weekends, and on family vacations.
We definitely won’t count the hours you’re staring at the ceiling fan worried about tomorrow’s challenges at work.
OK, so you’re working 2,000 hours (plus) per year to make money.
My question is:
How many hours per year do you think about what to do with that money?
Let that sink in for a moment.
You work a lot of hours. I’m guessing many of those hours are stressful.
Yes, you get paid money in exchange for those hours.
But, do you still have any of that money?
Do you care more about making money or keeping money?
Think back on how much time, energy, and sacrifice you dedicated to making that money.
Hopefully, you saved and invested a good portion of that money.
The problem is that most lawyers and professionals work incredibly hard, make good money, and don’t keep enough of it.
They somehow find 2,000 or 3,000 hours per year to work.
But, they won’t set aside even a few hours per month to think about what to do with all that money.
This is why I am passionate about money wellness.
Most people spend the vast majority of their lives worried about making money and practically no time at all thinking about what to do with that money.
No, I’m not suggesting that you need to think about money for 2,000 hours per year.
What I am suggesting is that even a little bit of time each week spent thinking and talking about money is just as important as the time you spent earning it.
That’s how you break the cycle of mindlessly riding the train to work and start progressing towards financial freedom.
It’s not how much money you make. What matters is how much you keep.
Robert Kiyosaki put it best in Rich Dad Poor Dad, “It’s not how much money you make. It’s how much money you keep.”
If you knew someone who made $1,000,000 per year, and at the end of the year, had only saved $20,000, what would your reaction be?
Sadly, this is how most people behave with their money.
They inherently know that they should be saving more, but they come up with excuses. They assure themselves that they’ll start saving more next year.
On the other hand, what if you knew someone who made $100,000 per year and saved $40,000?
Did your reaction change?
This is the kind of person who will actually achieve financial freedom and have choices in life.
It all comes down to how much you keep, not how much you make.
It’s why your personal saving rate is so important.
Don’t forget, your saving rate is the one thing you can truly control.
As summer turns to fall, it’s the perfect time to revisit the money goals you made at the beginning of the year.
Summer travel season is over. The kids are back in school. For most people, this is a quieter time of year before the holiday season kicks into high gear.
Plus, many professionals earn raises and bonuses as we move towards the end of the year. It’s crucial to have a clear idea of what to do with those raises and bonuses ahead of time so that hard-earned money doesn’t disappear.
But, Matt, I didn’t make any money goals at the beginning of the year.
That’s OK- you still have three months left this year to accomplish something you’ve been putting off.
There’s no reason you can’t make a goal today and see how far you can get by New Year’s Eve. Why let these three months go to waste?
To help you refocus on your money goals, here’s a status update on how I’m doing with my 2025 money goals.
Let’s start off with some context.
My goals in 2025 look a lot different than previous years.
Leading up to 2025, my wife and I were focused on acquiring real estate. We now own five properties and are very happy with our current portfolio.
We self-manage our 10 units in Chicago and work closely with a property manager in Colorado. If we were to continue expanding, the headaches could end up outweighing the financial benefits.
We want to build a life full of experiences and memories. That means we need more time, not more money.
Acquiring and managing more properties right now would take up a lot of time. That tradeoff is not currently worth it to us.
That’s the main reason why our goals look different this year than they have in the past.
My wife and I came up with 3 money goals earlier this year.
Here are the three money goals my wife and I came up with in early 2025:
Pay off the HELOC debt. Our first goal is to continuing paying down HELOC debt that we used to help acquire some of our rental properties. Now that we’ve determined that “enough is enough,” we’re focused on paying back these loans.
Build up our emergency savings. Our second goal is to build up our emergency savings. We mostly ignored our emergency savings between 2017 and 2024 as we focused on buying investment properties. It was risky and led to some touch-and-go moments that we’d like to avoid moving forward.
Fully fund college for our second kid. Our third goal is to boost our contributions to our kids’ 529 college savings accounts. We have three kids. We previously hit our savings goal for our first kid. Now, we’re focused on the next kid.
Why is it so important to have a plan for your money ahead of time?
Money goals are all about having a plan ahead of time so your dollars don’t disappear.
Having a plan in place ahead of time means we know where every dollar is going before we earn it. At the end of each month, all we need to do is make our transfers to each account.
Also, we can rest easy knowing that we’re making progress towards our personal finance goals.
This takes the anxiety out of trying to figure it out after the money has already hit our bank account.
And, it eliminates the risk that the money sits in our checking account and slowly disappears because of mindless spending choices.
If you don’t have a plan in place, it’s going to be very difficult to accomplish your goals.
How am I doing with my 2025 money goals?
As I revisit my 2025 money goals, it’s fair to say that I’m happy with our progress but still have a ways to go.
We’ve made major progress on this goal. I anticipate that at our current saving rate, we’ll have the HELOC debt fully paid off by the end of the year.
It will be an incredible feeling to have this debt load off of our shoulders. We’ve been carrying it for too long now.
By the way, I don’t regret using HELOC debt to help purchase investment properties and build our portfolio. That said, at this stage in my life, I’m ready for that debt to be gone.
If you are similarly working towards paying off debt, check out my top 10 strategies for paying off debt on a budget:
My top 10 strategies for how to pay off debt on a budget.
Throughout the year, I have been especially focused on prioritizing funds for debt, using the debt snowball approach, and not letting myself fall backwards.
For a deep dive on each of the 10 strategies, check out my full post on paying off debt on a budget:
My challenge is that I’ve been so focused on eliminating my HELOC debt this year that I haven’t been able to address this goal yet.
I’m still hopeful I’ll have a chance before the year is over.
My goal is to have four months of living expenses saved up.
Why four months?
Most personal finance experts recommend three to six months. Much of it depends on your current income situation and overall comfort level.
I have income from my primary job, rental properties, and part-time teaching. Taking all that into account, four months of emergency savings feels like the sweet spot to me.
Admittedly, it will take some time to complete this goal. If I can’t achieve this goal by the end of the year, it will become my top priority for next year.
I recently used an online calculator to figure out how much money I would need to invest right now in my son’s 529 savings account to fully fund his college. We already hit our mark for my first kid.
I learned that with an investment today of $67,000, I could fully fund my son’s in-state tuition.
Of course, the key is to let that money grow for the next 15 years to take advantage of compound interest.
What an accomplishment that would be to not have to worry about his future college. I could cross that item off the “to-do” list once and for all.
Then, it would be onto the next kid.
Because my son is only three years-old, this goal is not as pressing as paying off my debt and fully funding my emergency savings account. Looking back, it was probably overly ambitious to include it as a goal for this year.
Aim for the stars, land on the moon, right?
Like my emergency savings account, this will be a top priority for next year.
Are you making progress on your 2025 money goals?
Don’t wait until the end of the year to look back on your goals. Take a few minutes today to assess your progress.
There’s still plenty of time ahead of you to make any necessary adjustments.
Maybe you’re getting a raise or a bonus soon. Maybe you’re about to earn a big commission.
Revisit your goals so you have a plan for that money before it hits your checking account.
In the world of premium travel credit cards, you’ll typically get the best redemption value by transferring your points to travel partners.
My favorite premium travel card is the Chase Sapphire Reserve, which earns Ultimate Rewards points. You can transfer Ultimate Rewards points to certain travel partners, like United.
Then, you can use those United miles to book airfare directly through United’s website.
This is my preferred method for getting maximum value out of my credit card points.
This is true regardless of the credit card that you have.
What you’ll notice is that most premium travel credit cards, like the Chase Sapphire Reserve and American Express Platinum card, have a designated set of travel partners.
If you prefer to fly Delta or stay at Hilton hotels, the American Express Platinum is a better card for you.
Pay close attention to who the travel partners are.
In my opinion, what matters most is who a credit card’s travel partners are, not the number of travel partners.
In this context, it’s helpful to think of credit card travel partners in terms of “quality over quantity.”
Why quality over quantity?
As you can see, there is some overlap in transfer partners when it comes to foreign airlines. Both programs also allow transfer to Marriot Bonvoy.
The thing is: I have my doubts that the average flyer will receive much benefit from these foreign airline transfer options.
For starters, the major airlines like United and Delta have alliances with the major foreign carriers. You can easily book international flights through the big US airlines.
Besides that, it takes a lot of effort to research and become an expert in maximizing transfers to these foreign carriers.
Yes, it’s possible. But, is it worth it for the average traveler?
I don’t think it is.
Of course, I can say that based on personal experience.
For a time in my life, I did put the effort in to become an expert in point transfers.
I used to exert significant effort to maximize point transfers.
However, those days are over.
My favorite strategy was to transfer my Chase Ultimate Reward points to British Airways so I could then book domestic flights on American Airlines metal.
It worked well for flights to Florida and Colorado because the British Airways redemption chart at the time was based on distance flown instead of the actual cost of the ticket.
Confusing, huh?
It took time and effort, but the tradeoff was worth it at that point in my life. However, the program changed and this particular advantage went away.
If you’re interested in playing the points game, there are endless websites dedicated to these kinds of strategies. Just know that it takes effort and time.
What I’ve come to realize is that most of us don’t have the time or energy to become credit card transfer experts.
That’s why I recommend you focus on the quality of the transfer partners instead of the quantity.
On top of that, I recommend you focus on one airline.
Select one airline to be your primary option.
When you look at the above lists, you’ll notice that each credit card is partnered with a major US domestic airline.
The Sapphire Reserve partners with United (and Southwest, if that’s your preference).
The American Express Platinum partners with Delta.
My recommendation is that you commit to one of these major airlines and then choose the credit card that matches that airline.
How can you select the right airline for your situation?
The advantages of committing to a single airline include more free flights and status.
When you commit to a single airline, you have a couple of main advantages when it comes to rewards.
1. You’ll earn free flights faster.
The first advantage is that you’ll earn free flights faster.
That’s because you earn miles whenever you buy a ticket and fly with that airline. The more you spend, the more miles you’ll earn.
This is like supercharging your credit card points balance.
For example, if you buy a $500 plane ticket on United with the Sapphire Reserve, you’ll earn 2,000 points (4 points per dollar spent on travel).
For that same ticket, you’ll also earn 2,500 United miles (5 miles per dollar spent). If you have status with United, you’ll earn even more. More on that below.
Assuming you transfer your Sapphire Reserve points to United, that’s a total of 4,500 miles earned on this one purchase.
If you stay committed to United and repeat this same process for even a few flights, you’ll have enough points and miles to trade in for a free plane ticket.
On the other hand, if you bought tickets on multiple airlines, the odds are you won’t have enough points and miles on any single airline to get yourself a free ticket.
You may end up with an equivalent amount of points and miles, but they’ll be too spread out over different carries to be of use.
This is one of the main reasons why I prefer to stay loyal to a single airline. I can more quickly earn free flights by focusing on a single rewards program.
2. You have a better chance of earning status.
The second big advantage of choosing one airline is that you have a better chance of earning status.
With status, you’ll benefit from earning more miles, better boarding groups, free checked bags, better seat assignments, and a chance at free upgrades.
For today’s conversation, let’s focus on the part about earning more miles.
When you earn status on United, you earn bonus miles for every dollar you spend. The bonuses range from 2 to 6 miles per dollar spent depending on your status level.
Even the lowest bonus level of 2 miles per dollar is the equivalent of 40% more miles earned. Using our example above, you would earn 3,500 United miles on a $500 ticket purchase (up from 2,500).
If you bounce from airline to airline, you’ll have a hard time earning status.
You may not care about free bags or upgrades, but you will be sacrificing miles and eventual free flights if you bounce around.
If you don’t already have it, now is a great time to consider the Sapphire Reserve.
Chase is currently offering a sign-up bonus of 125,000 points for the Sapphire Reserve, the largest bonus ever offered.
That translates to $2,562.50 in value, according to The Points Guy.
The bottom line is that I will still earn a ton of points each year, not to mention the other benefits, that the Sapphire Reserve will remain the primary card in my wallet.
Check out my post to learn how I evaluate credit cards and how I came to the no-doubt conclusion that the Sapphire Reserve is still worth it for me.
Is there value in keeping both your Sapphire Reserve accounts open?
After I wrote that post, a number of readers (with spouses, partners, kids, etc.) reached out asking if there is value in keeping separate Sapphire Reserve accounts.
It was such a good question that I wrote a full post addressing it:
The short answer is that my wife and I each had Sapphire Reserve cards before we got married. We eventually closed one of the accounts and kept the other one open.
Today, we still each have a physical Sapphire Reserve card through the “authorized user” option on just the one account.
Keeping just one account between the two of us saves a bit of money, but more importantly, keeps things much easier for us.
As I mentioned, I value simplicity right now.
I recommend most couples with two accounts do the same.
Nonetheless, there may be valid reasons why you would want to keep both accounts open.
The big news this week was that the Federal Reserve cut rates for the first time in 2025.
Naturally, those of us who bought homes in the past couple of years are starting to think about refinancing.
In case you missed it, here’s a key takeaway from the announcement, as reported by CNBC:
The Federal Reserve on Wednesday approved a widely anticipated rate cut and signaled that two more are on the way before the end of the year as concerns intensified over the U.S. labor market even as inflation is still in the air.
With the rate cute, the important question people are asking is: should I refinance my mortgage now or wait for rates to drop even lower?
Today, I’ll share exactly what I’m doing with my mortgage.
First, let’s discuss one common point of confusion.
The federal funds rate is not the same thing as mortgage rates.
When we see news like we did this week that the Fed is cutting rates, many of us think that means mortgage rates automatically drop.
Nope.
The federal funds rate is not the same thing as a mortgage interest rate. That said, mortgage rates are indirectly tied to the federal funds rate.
No need to overcomplicate things. The typical homeowner (and I include myself in this category) does not need to fully understand how mortgage rates and the federal funds rate relate to each other.
Instead, the typical homeowner just needs to know that when the Fed cuts rates, mortgage rates also tend to drop, but not always.
For those curious, here’s a quick synopsis from Bankrate:
The U.S. Federal Reserve sets borrowing costs for shorter-term loans by changing its federal funds rate. This rate dictates how much banks pay each other in interest to borrow funds from their reserves, kept at the Fed on an overnight basis.
While this rate isn’t the same as the rate you’ll pay for your mortgage, they are related. As the cost for banks to borrow increases or decreases, the cost for you to borrow tends to follow suit.
And when the Fed doesn’t change the federal funds rate, it generally encourages lenders to maintain mortgage rates in the current range.
The takeaway is that when the Fed cuts rates, it’s likely that mortgage rates will also drop.
But, there’s one more piece to the story.
Mortgage rates often drop before the Fed actually cuts rates.
It may sound backwards, but mortgage rates usually factor in pending rate cuts before the Fed actually announces its decisions.
To that point, look at how mortgage rates were already dropping over the past month in advance of this week’s announcement:
The Federal Reserve’s rate cut this week is rippling through the housing market, sending mortgage rates lower and spurring a jump in refinancing.
The 30-year fixed mortgage rate averaged 6.26% for the week ending September 18, down from 6.35% last week, according to data released Thursday by Freddie Mac.
This is the fourth-straight week of declines as mortgage rates fell in anticipation of the Fed’s quarter-point rate cut on Wednesday.
As you can see, mortgage rates were already declining for weeks in anticipation of the Fed’s rate cut.
The point is that it’s not always clear when the right time to refinance is. It’s not as simple as saying “the Fed cut rates, so now I’ll refinance.”
To help you make a good decision, I’ll walk you through my current thought process when it comes to refinancing.
First, here is some context about my personal situation.
I bought my home in early 2024 when rates were high.
When I bought my home in early 2024, we took out a 30-year fixed-rate mortgage at 6.875%. At the time, we were very pleased with a rate under 7%.
In the back of my mind, I hoped I would have a chance to refinance in the next few years. But, I didn’t hinge my decision based on whether I could eventually refinance or not.
I’ve long been an advocate for buying a house when the time is right in your life, regardless of mortgage rates.
My wife and I decided early last year that the time was right to buy our “forever home.”
I was about to turn 40. We had two kids and were thinking about a third. It felt like we had started to outgrow our small apartment in the city.
Of course, we enjoyed the short commute downtown. We liked walking to stores, restaurants and coffee shops. But, those opportunities to enjoy the city were harder to come by with two young kids at home.
Plus, my daughter was one school year away from starting kindergarten. We thought it would be nice if she made some friends in the neighborhood before kindergarten started.
Add it all up and the time was right for us.
Besides these personal factors, I had a suspicion that home prices were only going up.
For years, buyers in the Chicagoland area have struggled with a limited supply of quality homes. I had been watching the market and observed that the good houses went under contract quickly.
I had no way of knowing for sure that prices would continue to rise, but time has proven that we were right to buy when we did.
Since early last year, prices have only gone up in Chicagoland, despite elevated mortgage rates.
That’s why my advice is to buy a home when you’ve decided it’s the right moment in your life to do so. Make that decision regardless of what current mortgage rates are.
In other words, ignore mortgage interest rates.
Here’s why.
Why do I recommend you ignore mortgage rates when buying a home?
There are really only three things that can happen to mortgage rates over time.
Mortgage rates can:
Stay the same.
Go up.
Go down.
In any of those three scenarios, there’s no point in basing your decision to buy a home only on the current rates.
Let me explain.
Let’s say you have a crystal ball and can look three years into the future. Looking into your crystal ball, let’s play out each of the three scenarios mentioned above.
1. Your crystal ball shows you that mortgage rates stayed relatively consistent.
Since rates stayed the same, there would be no point in waiting to buy a home because of rates. The rates three years from now are the same as they are today.
By waiting, you’re likely going to experience that homes have gotten more expensive. The longer you wait, the more expensive they are going to be.
On top of the recent trends, the historical data confirms that homes have become more expensive. In 2024, U.S. homebuyers paid nearly double what they paid for homes in 1965, accounting for inflation.
So, even if rates stay the same, prices are likely to go up the longer you wait. In this context, you shouldn’t sit around waiting for them to drop.
2. Your crystal ball shows you that mortgage rates went up.
If rates go up, it’s easy to conclude that it’s a mistake to delay your home buying decision. Higher rates, combined with higher prices, is… not good.
Let’s move on to the third scenario, which is the scenario people sitting on the sidelines are usually waiting for.
3. Your crystal ball shows you that mortgage rates went down.
This is the scenario that many people are waiting for. When rates go down, you can afford a more expensive home. That’s a good thing, right?
Not so fast.
Do you think you’re the only person sitting around waiting for rates to drop? For the same reasons that you’re waiting, many other people are also waiting.
So, what happens when lots of people are waiting to buy the same thing?
Demand goes up. When demand goes up, you have more competition to buy that same house. That means prices go up.
You’ll end up paying more money for the house, even with a lower interest rate.
Take it from me, bidding wars are not fun. I would much prefer to get the house I want without the added competition.
If mortgage rates end up dropping later on, you can always refinance (the topic of today’s discussion).
You may pay more on a monthly basis in the short term, but long term, you have the house you want at the best available current rate.
So, there you have it. No matter what happens to rates, in my opinion, you’re best off shopping for a home when the time is right in your life.
And, this leads us back to our question of the day: is now the right time to refinance?
Should I refinance now or wait for mortgage rates to drop?
We would need to dust off our crystal ball again to know exactly when the time is right to refinance. Just like everyone else, I cannot predict if mortgage rates will continue to drop.
Rates have already been dropping for the past month in anticipation of the Fed cutting rates this week.
Plus, in the announcement, the Fed signaled two more rate cuts this year. That means rates may continue to drop.
Of course, there’s no guarantee the Fed will cut rates. Economic factors can always lead the Fed to change course. And, further rate cuts do not guarantee that mortgage rates will continue to simultaneously drop.
So, am I personally going to refinance right now?
For now, I’m holding off on refinancing.
My guess- and it’s only a guess- is that mortgage rates will continue to drop. In my current financial situation, I’m OK with taking that risk.
My current rate is 6.875%.
As a general rule, I wait to refinance until I can qualify for a rate at least 1% lower than my current rate. For this decision, I’m waiting until rates drop into the “5s.”
Besides the monthly cost savings, which could be substantial, I am excited for the potential emotional high of dropping my rates into the “5s.”
By the way, this is the emotional side of money that has nothing to with the numbers. It will just feel good to be under 6% for the next 30 years.
How will I know when I can qualify for a rate under 6%?
I don’t have the qualifications or the time to closely monitor the mortgage rate market. By keeping in touch with my mortgage broker, he’ll know exactly where my head’s at.
Then, he can keep an eye on things for me and let me know when the rate I’m personally eligible for drops below 6%.
Never underestimate the importance of having a great mortgage on your side. The right broker can save you thousands and thousands of dollars over the long run.
If you need help evaluating mortgage brokers, check out my post:
Is there risk involved with waiting for rates to drop?
Is there risk in waiting?
Absolutely!
Rates may not drop any further. They could even start to go back up.
I’m willing to take that chance right now.
I can comfortably afford my current housing expense, so I’m not desperate for the cost savings that might result from a refinance.
Plus, there are costs involved with refinancing.
Just like when you initially buy a home, there are closing costs associated with refinancing. Those costs can eat away at any savings generated by refinancing if your new rate is not low enough.
There are also time costs involved in refinancing. If you haven’t had the pleasure, it’s not a whole lot of fun to track down and provide all of the required documents to the underwriters.
At this point, those costs are too high for me to justify refinancing. That’s why I usually target a 1% drop in rates, which should be enough to make the cost and effort worth it.
Are you refinancing now or waiting?
Now you know exactly how I’m thinking through the decision on whether to refinance.
I’d like to see a 1% drop before I commit to a refinance. That will save me enough money each month to make it worth it.
It will also give me the emotional high of dropping into the “5s” for the next 30 years.
On the other hand, if rates don’t drop, I’m comfortable with my current situation.
Without a crystal ball, I feel good about this thought process.
On your journey to financial freedom, there is only so much you can control.
The reality is, like most things in life, much of our financial journey is out of our hands.
If your gut reaction is that I’m wrong about that, that’s OK. I get it. I used to be in denial, too.
Really smart people, like Think and Talk Money readers, don’t want to acknowledge that they aren’t in complete control of their financial lives.
To illustrate my point, here are just a few things that you can’t control on your way to financial freedom:
You can’t control the returns you’re going to get in the stock market. It’s reasonable to project 10% average annual returns based on historical performance. Also, we use 10% merely as a projection for planning purposes. But, there’s no guarantee anybody will earn 10% per year.
You can’t control whether a real estate investment appreciates. We all certainly hope our properties increase in value over time. We do our best to target areas where appreciation is likely. But, once again, there’s no guarantee.
You can’t control if your employer is going to give you a raise. Of course, you can work hard. Also, you can outperform all the metrics. You can go above and beyond to deliver massive value to your company. However, when it’s time for your annual salary review, it’s not up to you how much all that is worth.
So, am I wrong about any of that?
Gee, thanks for the doom and gloom, Matt.
I know, I know. Not what you want to hear.
Don’t be discouraged. All is not lost.
There is one crucial element that you can control on your way to financial freedom.
Today, we’ll focus on the one crucial element that you actually can control on your way to financial freedom.
Your saving rate is simply the amount of money you save each month divided by the amount of money you make.
Saving rate = Money Saved / Money Earned
Just like staying on budget with two simple numbers, you can monitor your progress with this simple formula.
I find it helpful to measure your saving rate based on your monthly income and savings. This way it matches up with your Budget After Thinking.
I also find it most useful to express your saving rate as a percentage. To see your saving rate percentage, all you need to do is multiply your saving rate by 100.
Moving forward, when I refer to saving rate, I will be talking about your saving rate percentage. It’s more informative to see what percentage of your money you are saving, rather than an amount with no context.
What I mean is this: if someone asked me if saving $10,000 per year was a good target, I wouldn’t be able to comment with more context.
If that person was making $75,000 per year, I would say that seems OK. That’s a saving rate of more than 13%.
On the other hand, if someone told me they were making $750,000 per year, and only saving $10,000, I would recommend that person revisit their Budget After Thinking.
Whatever your current saving rate is, the goal is to seek personal improvement. Just like with tracking your net worth, the purpose is to see if you are making personal progress over time.
When it comes down to it, there are really only two ways to improve your saving rate.
You can spend less, and save more, of the money you’re currently making.
You can make more money and save most of that money, all while keeping your expenses the same.
Combining those two ideas is even better. Like we just said, make more money, spend about the same.
Use the excess money you make to fuel your Later Money goals.
If you can do that, your saving rate and your net worth will steadily climb. You’ll experience that your Later Money goals are closer to becoming reality than you think.
Why it’s important to focus what you can control, like your saving rate.
My point here is show you how dramatically one decision can accelerate your progress towards your goals.
Each additional amount saved is one step closer to financial freedom.
Sometimes, we all need to ask ourselves:
“Is spending more money right now on things I don’t really care about going to make me happier?”
“Do I even want to go out to more restaurants? Or fancier restaurants?”
“Do I despise my home/my car/my wardrobe so much that I must replace it immediately?”
Only you can answer these questions.
Maybe you’ll realize that your life is pretty good right now as it is.
You might just decide that you don’t need the extra money at this moment.
Here’s an example showing the importance of your saving rate.
Scott Trench, author of one of my favorite money wellness books, Set for Life, is a big advocate of improving your saving rate.
In a recent episode of his BiggerPockets Money podcast, Trench emphasized just how important your saving rate is using a simple example.
Let’s use that example to explore how improving your saving rate can accelerate your journey to financial freedom.
Assume that you earn $100,000 per year (after taxes for simplicity).
You are a pretty good saver and save 20% of your income, or $20,000. For most people, targeting a saving rate of 20% is pretty solid.
Of course, if you save 20% of your income, that means you spend 80% of your income, or $80,000 per year:
Take Home Pay: $100,000
Annual Spending: $80,000
Annual Savings: $20,000
Based on the above, we can project how long you will have to work to fund one year of your life.
Because you spend $80,000 per year and you save $20,000 per year, you would have to work four years to save enough money to fund one year of your lifestyle:
$20,000 saved x 4 years = $80,000 saved (1 year of spending)
In other words, you would need to work four years to buy one year of financial freedom.
Not bad, huh?
But, look what happens when you improve your saving rate.
What happens if you double your saving rate from 20% to 40%?
Now, let’s see what happens if you double your saving rate to 40%. That means you are saving $40,000 per year and only spending $60,000 per year.
The result is that you now only need 1.5 years of work to fund one year of financial freedom:
$40,000 saved x 1.5 years = $60,000 saved (1 year of spending)
Notice that two things are happening at the same time when you increase your saving rate.
First, you are saving more money each year. That’s a good thing.
Second, you are spending less money each year. That’s another good thing.
The result is that when you spend less money, you need to accumulate less money to fund your lifestyle.
It’s a double whammy. In a good way.
Should we complete our example by taking it one step further?
Let’s say you have a 50% saving rate. That means you save $50,000 per year and spend $50,000 per year.
How long do you have to work to buy one year of financial freedom?
Only one year.
$50,000 saved x 1 year = $50,000 saved (1 year of spending).
Now, that’s cool.
It’s motivating to think of your saving rate in terms of years to financial freedom.
So, what’s the takeaway here?
It can be extremely motivating to think of your saving rate in terms of how long you have to work until financial freedom.
Each incremental amount that you save means you’re boosting your savings at the same time you’re reducing your spending.
When you pull both of those levers at the same time, you accelerate your progress towards financial freedom.
This thought process is especially helpful for people who feel that math is not their thing. It doesn’t get much simpler than viewing savings in terms of buying financial freedom.
The cool part is that once you hit a 50% saving rate, you can essentially buy a year of financial freedom for every year that year work.
Keep in mind that that this simple illustration ignores any investment returns you may get from your savings.
Don’t worry, those investment returns will generally reduce the length of time you need to work even more. Check out Mr. Money Mustache’s post for more on that point.
Setting aside investment returns, the purpose here is to drive home the point that the more you save, the faster you’ll reach financial freedom.
That’s why it’s so important to focus on your saving rate. You can’t control everything, but you can certainly work on your saving and spending.
Have you ever calculated your saving rate in terms of how quickly you can achieve financial freedom?
Why I’m happy I learned how to responsibly use my Sapphire Reserve points.
Redeeming credit card points for travel has been a major factor in allowing me to stay on budget and continue fueling my investments.
Have you heard?
It’s expensive to take a family on vacation.
But, I’m of the mindset that it’s also extremely important and a whole lot of fun.
So, instead of skipping out on travel, I use my credit card points to offset the cost.
Airplane tickets these days can be around $500 per person. By using my credit card points, I easily save $10,000 per year on flights.
Over the past five years, that totals $50,000. That’s enough money to fully fund my son’s future college tuition in his 529 savings plan.
To get all these points, you may be thinking that I must have 10 credit cards and constantly stress about which one to use for every purchase.
Nope.
I have just two credit cards.
Here’s how I do it.
Never spend money on your credit cards just to earn more points.
With all credit cards, the more you spend, the more you earn. That’s true whether you are accumulating points or utilizing shopping or travel credits and other discounts.
Before we go any further, please remember the first rule of responsible credit card usage:
Don’t spend money just to earn rewards. That’s a recipe for financial disaster.
Using the Sapphire Reserve to get free flights is no exception to this rule.
The bottom line is that I will still earn a ton of points each year, not to mention the other benefits, that the Sapphire Reserve will remain the primary card in my wallet.
Check out my post to learn how I evaluate credit cards and how I came to the no-doubt conclusion that the Sapphire Reserve is still worth it for me.
Is there value in keeping both your Sapphire Reserve accounts open?
After I wrote that post, a number of readers (with spouses, partners, kids, etc.) reached out asking if there is value in keeping separate Sapphire Reserve accounts.
It was such a good question that I wrote a full post addressing it:
The short answer is that my wife and I each had Sapphire Reserve cards before we got married. We eventually closed one of the accounts and kept the other one open.
Today, we still each have a physical Sapphire Reserve card through the “authorized user” option on just the one account.
Keeping just one account between the two of us saves a bit of money, but more importantly, keeps things much easier for us.
As I mentioned, I value simplicity right now.
I recommend most couples with two accounts do the same.
Nonetheless, there may be valid reasons why you would want to keep both accounts open.
The Freedom Unlimited earns 1.5 points across the board for every purchase. In contrast, the Sapphire Reserve only earns 1 point per dollar spent in non-bonus categories.
Same as me, my wife only carries the Sapphire Reserve and Freedom Unlimited. That means we can combine points to maximize our rewards.
Together, we have a simple approach and still earn plenty of points.
If you have the Sapphire Reserve, the Freedom Unlimited is the natural companion for your wallet. These two cards work extremely well together to maximize travel rewards.
Here’s why.
As mentioned above, the Freedom Unlimited earns 1.5 points across the board for every purchase. For that reason, this is my default card for just about all spending other than travel and dining.
But, there’s a catch.
If you only have the Freedom Unlimited, the points you earn must be redeemed as cash back or through the Chase travel/shopping portals.
As a rule of thumb, cash back rewards like this are not as valuable as transferring your points to a travel partner.
Let’s emphasize that point for a moment: the best use of your credit cards points is almost always to transfer those points to a travel partner.
This is true for Chase, American Express and any other credit card that offers point transfers.
But, we just said that you cannot transfer your Freedom Unlimited points to travel partners.
With the Sapphire Reserve, you earn Ultimate Rewards points. You can transfer Ultimate Rewards points to certain travel partners, like United. Each point translates into one United mile.
Then, you can use those United miles to book airfare directly through United’s website.
This is my preferred method for getting maximum value out of my credit card points.
To recap the strategy:
Use your Freedom Unlimited for all spending other than travel and dining.
Transfer your Sapphire Reserve points to a travel partner of your choosing, like United.
And, that’s all there is to it.
One final note: Make sure to send your Freedom Unlimited points to your Sapphire Reserve account, and not the other way around.
As soon as I have enough Sapphire Reserve points, I transfer them to United and book a flight.
I’ve found that the best use of my points is to transfer them to United for free flights. There are other options for travel partners, but with flights being so expensive, this is the best use for me.
To take it a step further, my personal strategy is to purchase flights as soon as I have enough points.
That’s because points tend to be worth less as time goes on.
For example, a roundtrip ticket that costs you 30,000 points today might cost you 35,000 points the next time you look. You can think of it the same way you think of inflation reducing the purchasing power of your cash.
Just last week I transferred my Sapphire Reserve points to my United account to purchase flights to visit my sister in California.
Once I build up my point balance again, I’ll look to book another flight.
My brother-in-law is getting married in Arizona next year. I’ll probably book those flights next.
I even love O’Hare Airport because I can use my Chase Sapphire Reserve points for free flights anywhere in the world.
Why am I talking about my love for Chicago?
Because I regularly get questions like this from newbie real estate investors:
“What markets are the best markets to invest in right now?”
Or:
“Should I invest in Chicago rental properties?”
I’ll never tell you what you should or shouldn’t do. We all need to do our homework and take responsibility for our choices.
But, I can give you some insight as to why I invest in Chicago.
Whether you have any interest in Chicago or not, you should get some ideas on how to evaluate markets for yourself.
Let’s get to it.
What real estate markets are the best markets to invest in right now?
This question comes up a lot when people start thinking about investing in real estate.
The thing is: there’s no right answer.
You might talk to 10 different investors with 10 different ideas on the best markets. No two investors evaluate a market (let alone a specific property) in exactly the same way.
Some investors rely heavily on analytics. Even amongst these investors, you’ll get a difference in opinions. One investor may prefer quickly appreciating markets. Another investor may target cash flow.
I like investing in Chicago because it’s a strong cash flow market. Cash flow is king, after all.
Other investors prefer to trust the “feel” of a neighborhood over data. These investors typically invest locally and have an intimate knowledge of each block in the area.
Through life experience, they have a good sense for what properties in their area will perform well.
Personally, I combine both approaches. I look to local data and trust my common sense and life experiences.
One of the reasons I prefer to invest in my local market of Chicago is because I’ve lived here my whole life.
Not only that, I lived for years in the primary neighborhood I invest in.
I know where the best restaurants and coffee shops are. I’ve experienced what the commute is like. There’s not a park or a playground that you could name that I haven’t been to with my kids.
I keep tabs on developments and improvements in the area. I talk to friends and other local investors.
Plus, I try to be a good steward for the buildings I own. They were built long before me and will be here long after I’m gone.
Because I am personally connected to the neighborhood, I feel a certain pride and responsibility to do my part.
Add it all up and I believe that I have a hometown advantage over outsiders who look at data but don’t know the neighborhoods and the tenant pool like I do.
The funny thing is most national investors want nothing to do with Chicago.
If you read enough blogs or listen to real estate podcasts like I do, national investors have tended to shy away from the Chicagoland area.
There has been a preference to invest in faster appreciating metros, like in the sun belt area.
By the way, I’m totally cool with national investors targeting other parts of the country. That leaves more opportunities for me.
Before you blindly follow what “everyone else” is doing, I encourage you to do your own research and trust your own instincts.
Here’s an example to illustrate what I’m getting at.
If I asked you what housing markets currently have the fastest selling homes, what would you guess?
Phoenix?
Charlotte?
Tampa?
Dallas?
Nope.
Milwaukee is first.
Chicago is second.
Be honest, did Milwaukee jump to your mind? What about Chicago?
My guess is you ignored the Midwest entirely.
If that was your initial thought, you might be surprised to learn that the Midwest has 12 of the fastest selling metros in the country.
On top of that, 6 of the 12 fastest selling metros are in the Midwest.
Here’s a breakdown from a recent report from Realtor.com on the fastest selling metros:
Even as the national housing market slowed to a crawl in August, a handful of metros, half in the Midwest, defied the trend with the fastest-selling homes in the U.S.
Yet in Milwaukee the median for-sale property remained unsold for just 32 days—roughly half the national days-on-market figure for August, making it the fastest-selling metro among the top 50.
Notably, of the 12 metros with the lowest median days on market (below 40), six were located in the Midwest, three in the Northeast, and three in the South.
As an investor in, and resident of, the Chicagoland area, it did not surprise me that Chicago is the second fastest selling market.
Anecdotally, I have plenty of friends and family currently looking for homes. There is very little inventory and high demand.
That means quality homes sell quickly and for a premium.
If you’re not overpaying, you’re not playing.
I don’t need studies like this to convince me that the Chicago market is hot.
That’s not good news if you’re a new investor trying to break into Chicago.
However, if you already own property in Chicago and are ready to sell, you should be able to make a hefty profit.
How about another recent study highlighting why investing in Chicago may not be a bad idea?
In another recent report from GOBankingRates, Chicagoland dominated a list of the top 50 “safest, wealthiest” places to live in the country.
A Chicago suburb was the number one city on the list. Also, Chicagoland claimed 12 of the top 50 suburbs in the country. That’s just about 25% of the top spots on the entire list.
When I see data like this, it gives me confidence in my investments in the Chicagoland area.
Having 12 of the top 50 “richest and safest” suburbs in the entire country nearby reassures me that Chicago is still a major economic hub. That means lots of good paying jobs and economic diversity in the area.
That, in turn, leads to a deep tenant pool of young professionals who want a part of the action. These young professionals want to rent apartments in trendy areas, such as I where I invest.
Do reports like this mean Chicago is definitely a good market for you to invest in?
I can’t answer that for you.
What I can tell you is that I certainly plan to keep investing here.
Historically, Chicago’s real estate market is often described by experts as a “mature market.”
That means property values have steadily risen over time, but you don’t typically see major swings in value in either direction.
In other words, you may not experience 30% annual appreciation, as was experienced in places like Tampa and Phoenix during the pandemic.
At the same time, you won’t see double digit declines, like we’re currently seeing in some other cities.
This reality played out during the pandemic years. Chicago’s market did not appreciate as fast as other areas nationally. However, as those markets cooled off during the past couple of years, Chicago has stayed red hot in comparison.
In fact, for the past couple of years, Chicago has been one of, if not the, fastest growing markets in the country (alongside New York).
So, what does all this data suggest?
Should you rush off to invest in Chicago?
There’s no right or wrong answer.
I’m certainly not trying to convince you to invest in Chicago.
It would be better for me if national investors continued to shy away so I can scoop up more undervalued properties in good neighborhoods.
The bottom line is that as investors, we are all making the best decisions we can based not only on the available data, but also our own common sense.
I would certainly avoid relying on AI or a single Google search to find “the best markets.”
Keep in mind that within every major market, there are numerous submarkets. You may not realize that if you only looked at city-wide data.
As much as I love the city, I would not invest in every Chicago neighborhood. I focus on 4-5 neighborhoods that I know well.
The data didn’t lead me to that conclusion. Living in different neighborhoods and experiencing daily life convinced me where I should invest.
I support my investment choices with the available data, but I don’t ignore my common sense and personal experiences.
When you are choosing between markets, do your own research.
But, don’t ignore your common sense.
Investors, how do you balance the data with your own experiences?
Remind yourself why you bought a rental property in the first place.
I know there are tough moments. I’ve been there. Many times.
In fact, my wife and I had a couple of experiences recently that pushed us close to that point of quitting.
With the passage of enough time to reflect, I’m happy and proud of us for sticking with it.
We’re still on track to achieve financial freedom quicker than we ever could have without our rental properties.
Today, I’ll share a couple of experiences I’ve recently had as a landlord that had me thinking about quitting.
If you’re a landlord, I’m sure you’ve had moments just like these.
Here’s a look back at our recent experience leasing out two apartments.
This past lease renewal season started off looking very strong. We were thrilled that 80% of our tenants signed on for another year.
That left only 2 apartments to turnover.
This was great news because vacancy is a rental property investor’s worst nightmare. Every week that an apartment sits empty is money down the drain.
Vacancy can eat away your entire year’s profits. That’s why we usually offer current tenants the chance to renew at the same rent.
When you do the math, it almost always works out than continued occupancy beats the prospect of higher rent plus vacancy.
When you have an empty rental unit, doubt creeps into your mind. You start telling yourself that you’ll never find a new tenant and your place will sit empty forever.
I know, I know. A bit extreme, right?
But, I’m telling you. That’s where your mind goes. Any landlord out there knows what I’m talking about.
So, when 80% of our tenants renewed for another year, we were very happy. We assumed that meant we would have an easy leasing season.
As it turns out, that was not the case.
Here’s what happened in each of these two apartments.
For one apartment, we received an odd request.
Before these tenants decided to leave, they made an odd request.
As a side note, this apartment was the unit where my wife and I lived for about five years. We brought two babies home to that apartment.
It’s located in the first building we ever bought and will always hold sentimental value for us.
OK, back to the story. This past spring, we actually thought the former tenants would renew for another year. That would have meant 90% of our units would have stay leased for another year, a major win.
When we first approached these tenants about renewing, they indicated that they wanted to stay. They were great tenants, so we were happy.
Then came a unique request.
These tenants were students and wanted to live at home for the summer. They asked if they could keep their stuff in the apartment but not pay rent for July and August since they wouldn’t actually be living there.
We’ve had all sorts of requests from tenants over the years. Keeping an apartment without paying rent for two months was a new one.
I understood the request from their perspective. Rent is a major expense. They didn’t need an apartment for the summer. They liked the apartment, but it was hard to justify paying for something they didn’t need.
The problem from our perspective is not hard to spot. If we agreed to their offer, we would be left with the equivalent of 2 months of vacancy.
Losing out on 2 months of rent payments is the equivalent of foregoing 17% of the total rent for the year.
We thought about it. And as tempting as it was to not have to find new tenants, that arrangement was not going to work for us.
Turnover is a chance to make property improvements.
After they moved out, we took the opportunity to refresh the apartment. We knew this would take some time and result in at least a few weeks of vacancy, but the apartment needed some love.
So, we replaced the flooring and painted the entire apartment. We did some needed repairs in the bathrooms (i.e. caulk, grout, new shower rod).
Plus, we made a point to tackle any deferred maintenance throughout the apartment.
We used a contractor for the work, so our involvement was limited to paying the bills and supervising the projects. Not exactly time intensive, but not exactly cheap either.
When the work was finished, we lined up a number of showings and had the apartment rented out after a few of weeks of effort.
In total, the apartment was vacant for 6 weeks.
What did we learn from this experience?
On the positive side, we now have a rehabbed apartment and fresh tenants. Plus, the apartment was empty for only 6 weeks instead of 8 weeks.
On the negative side, it was stressful to get the apartment fixed up and re-leased.
To state the obvious, it’s not fun spending money to fix up an apartment without a signed lease in place. Every week that goes by, money is going out without any money coming in.
During that phase, you can’t help but doubt yourself as a landlord.
Did we make the wrong choice?
Should we have let the former tenants stay, even if that meant automatically sacrificing two months of rent?
If we had gone that route, we would not have spent any money this year turning over the unit.
We also would have had a less stressful leasing season. We would have saved a lot of time and mental energy if we didn’t have to worry about this unit.
On the other hand, the apartment would still have needed a facelift as soon as it was empty. At some point, we were going to have to do the rehab. Now, that project is behind us.
We also have great new tenants who seem more likely to stay for an extra year or two.
In the end, I’m happy with the decision we made. That doesn’t mean it was right or wrong, but we made it through a unique challenge.
The second learning experience involved letting our tenants out of their lease after two months.
In our other vacant unit this past spring, the former tenants bought a condo so needed to move out. They had lived there for two years and were wonderful tenants.
This unit was located in a different building from the one we just discussed. The building is in a terrific location and the units are in great shape.
We’ve never had any trouble finding tenants. This year was no different.
After three showings and very little effort, we happily signed a lease with new tenants. As a bonus, the former tenants had moved out early, so we were able to fill this unit with zero days of vacancy.
All was well… until it was not.
Let’s just say that after about six weeks, it was apparent that the relationship with our new tenants was not working out. The tenants were not bad people, but it was clear that we could not meet their expectations.
Instead of living through a difficult year with these tenants, we offered them the chance to break their lease, without penalty. They accepted our offer and moved out two weeks later.
We all remained civil and amicably split up. The tenants left the apartment in good shape and we all avoided unwanted confrontation.
We re-listed the apartment and found a wonderful new tenant after one showing.
In the end, we lost out on three weeks of rent between leases but now have a very happy new tenant.
Upon reflection, I’m confident this was the right decision for all parties involved.
The tenants could find a place more to their liking, and we could start over with a new tenant.
So, what’s the takeaway from our experiences with these units?
As a landlord, you are running a business. It won’t always be easy.
You have to make business decisions, even when there’s no clear right answer.
Sometimes that means foregoing profit and dealing with confrontation.
In each of these instances, I’m happy with how things worked out. In the first instance, I sacrificed some of my profit this year to improve my asset.
For the second apartment, it was clear that the relationship was not working. Even though we lost some money in the process, all parties involved should now be happier.
These are tradeoffs I would readily make again.
Even with stress like this, I’m not ready to give up on being a landlord.
Compared to my day job as a lawyer, this is nothing.
Should you become a landlord?
The truth is my wife and I know so many people who have owned rental properties but did not like being landlords. There’s nothing wrong with that. It’s not for everyone.
If you’ve been in, or are currently in a similar boat, I hope these experiences resonate with you.
In the end, as stressful as it can be to run a business, this is also what makes being a landlord fun.
What do I mean, fun?
When you are a landlord, you are a business owner. You get to make the final decision. It’s your business and you are in control.
Having that autonomy is a nice change of pace for most W-2 employees.
Still, you may be faced with tough decisions. You may not know what to do in the moment. It’s helpful in those moments to have people to talk to so you can make the best decision possible.
I happen to like being a business owner. However, it’s not for everyone.
If just thinking about making decisions like these stresses you out, I would not recommend that you become a landlord.
If you can handle the job, you can benefit immensely.
Landlords- have you been in situations like this before? How did you handle the stress of the job?
I know it’s not as exciting as thinking about what you would do with $1 billion, but I think it’s more important because it is actually realistic.
Yes, I said realistic.
I truly believe that if you are a high-earning professional, like a lawyer, consultant, or real estate investor, it will happen.
There will come a point in your career (hopefully multiple points) where you earn a one-time windfall of $178,000.
For example, it may come in the form of a bonus, a commission, or profits from a sale.
When that time comes in your life, you want to be ready.
The last thing you want to do is waste that golden opportunity. You may never get another chance to materially impact your life so much in one shot.
So, let’s have some fun and plan out what we would do if we wake up tomorrow with an extra $178,000 in our bank accounts.
Here’s exactly what I would do.
The first thing I would do with $178,000 is pay off high interest debt.
I think of a bonus like this as a one-time “Get Out of Jail Free” card.
With $178,000, the first thing I would do is pay off any high interest debt that I have. High interest debt includes credit card debt, personal loans, and any lines of credit.
My main financial goal this year was to pay off the rest of the HELOC we used to buy our last rental property. That’s my first move with this windfall.
Once the debt is eliminated, I’ll be free to pursue more fun life goals. And, I’ll feel better without having that debt hanging over my head.
Next, I would set aside $15,000 to $20,000 for fun money.
I would use about 10% of the money for fun right now. That comes out to approximately $15,000 to $20,000.
That is the equivalent of a really nice vacation or two. Or, it could be new furniture for the house, new gadgets or toys (like a bike or golf clubs), or anything else that brings me joy.
I’m a firm believer that we have to enjoy the journey while we’re on it. Having eliminated all high interest debt, I’ve earned the privilege to have some fun with a responsible portion of this money.
The strange thing is that for people who are dedicated to achieving financial freedom, spending money can be very difficult.
The temptation is to save and invest every possible dollar. As tempting as that may be, I encourage you to resist the urge to “live in the spreadsheet.”
This is a chance to do something for yourself that brings joy and happiness. Whatever that is for you, take advantage.
Otherwise, what’s the point in working so hard in the first place?
I refer to my ultimate life goals as my Tiara Goals. Before I save and invest the remaining $100,000, I’m going to look at my Tiara Goals for inspiration.
With my Tiara Goals in mind, my top priorities right now are to eliminate HELOC debt, pay for my three kids’ college, and build my emergency fund.
Each one of these priorities align with my Tiara Goals and help me get closer and closer to true financial independence.
Because I have been aggressively acquiring real estate for the past seven years, college savings and emergency savings have been secondary goals.
Now that I’m not presently in the market for more rental properties, I can prioritize saving for college and emergencies.
With this windfall, I can make significant headway to satisfy both of those goals.
I would then use $67,000 to fund my son’s college education.
I recently used an online calculator to figure out how much money I would need to invest right now in my son’s 529 savings account to fully fund his college.
For my calculations, I targeted the premier in-state university where I live (the University of Illinois). I assumed a 10% average annual rate of return on my investment and a 5% annual increase in tuition.
I learned that with an investment today of $67,000, I could fully fund my son’s in-state tuition.
The key is to let that money grow for the next 15 years to take advantage of compound interest.
What an accomplishment that would be to not have to worry about his future college. I could cross that item off the “to-do” list once and for all.
So, with the next $67,000 of my windfall, I would fully fund my kid’s in-state tuition.
Disclaimer: if you’re doing this math for your own three-year-old, keep in mind that I’ve already begun to fund my son’s 529 account. The $67,000 is the difference that I need to add today in order to hit my goal. If you do the calculations yourself, you might come up with a different number.
With my son’s college tuition taken care of, I would move onto my next goal, which is to fund my emergency savings account.
Before we get to that, you may be wondering why I targeted the in-state school for my projections instead of aiming for a more expensive private school.
Why did I target in-state tuition?
It’s not that I don’t want my kids to have the option to attend a more expensive private school.
It’s that I have other goals that I want to accomplish in my life at the same time I’m saving for college. I view the in-state tuition target as a reasonable, minimum goal to strive for.
And, if my kid chooses to attend a more expensive private school, I plan on having additional ways to pay for it.
For example, my overall financial plan includes owning rental properties even after my kids go to college. I can use that rental property income to help pay for college.
Additionally, I plan on still earning income through a primary job. I can use that income to help pay for their college.
Between now and then, I can invest in more rental properties, a traditional brokerage account, or any other investment vehicle of my choosing.
I’ll still have the option to use that money to pay for college. The benefit is that I’ll have more flexibility.
Plus, you never know. Maybe my kid will earn a scholarship. Maybe my kid does not end up going to college.
Having different investments besides a college savings plan means that I’ll have options.
Finally, I would take the remaining $33,000 and put it into a high-interest savings account.
I have no immediate needs for this money. I have income coming in from a variety of sources, including my primary job, my rental properties and my job as an adjunct professor.
However, it’s been a goal of mine for a few years to bump up my emergency savings. It’s been a risk not having much saved up for emergencies, and I’m taking this chance to eliminate that risk.
Because I’m not currently in the market for more real estate, I can save this money for emergencies instead of worrying about a down payment for my next acquisition.
With my emergency savings account more adequately funded, I can better protect myself should disaster strike.
That’s why I’m putting the final $33,000 in my emergency savings account.
How would you use $178,000 today?
So, that’s how I would use a $178,000 windfall today.
It’s not as fun as thinking about $1.78 billion, but it’s a more realistic thought experience.
In case you’re wondering, if I had more money to invest at this point, I would focus on my baby girl’s college. I would use the same methodology that I used to plan for my son‘s college.
No matter the amount of money, it’s good to have a plan ahead of time. As a high-earning professional, the odds are that you will earn a significant bonus like this at some point in your career.
It might not be $178,000, but the thought process will work no matter what the amount is.
The takeaway is that it’s always a good idea to have a plan before you earn the money.
That’s why I never encourage anyone to cut out spending on things and experiences that make them happy today.
Does this mean we should all go out and spend every dollar we make?
Of course not.
No matter what, you’ll always need to live within your means.
If you are spending more than you’re earning, you’ll never be financially independent.
However, if you earn decent money and invest it the right way, you will reach financial independence.
And, you don’t need to stop spending money on the way.
FIRE has taken on an unintended meaning.
One of the problems in the personal finance space is that many people first learn about financial independence in the context of FIRE (Financial Independence, Retire Early).
Unfortunately, there’s a stereotype that FIRE is only for people willing to aggressively lower their expenses.
In other words, the mistaken belief is that people who practice FIRE can only survive if they cut out most of life’s luxuries.
Even though this misconception fails to capture the true spirt of FIRE, the damage has already been done.
Too many people who I speak with get so discouraged by hearing “cut, cut, cut!” that they lose all interest in pursuing financial independence.
It’s not that these people are financially irresponsible. They mostly live within their means and save for important goals.
At the same time, they want to enjoy everything that life has to offer. And as mentioned above, I don’t mean enjoy life “years down the road.” They work hard and want to spend money to enjoy life today.
For people like this, FIRE’s perceived focus on deprivation is unappealing.
That way, you can benefit from long-term wealth generators like compound interest and appreciation.
Generating more money to invest, of course, involves making spending choices. These types of choices are the essence of the budgeting process.
However, instead of focusing on cutting your expenses to the bone, I recommend you create a reasonable Budget After Thinking that you can actually stick to.
If you eliminate all the fun stuff, no budget will last very long.
In a lot of ways, this advice is like dieting. Sure, you can lose 10 pounds in a few weeks if you eliminate every indulgence. But, how long is that diet going to work?
I recommend that you have a budget that you can stick to long term. Then, commit yourself to fighting lifestyle creep as you start making more money.
If you can do those two things, you don’t have to dramatically cut your expenses.
Yes, you have to keep your spending within reason.
No, you don’t have to cancel all your subscriptions.
Focus on earning more, not just spending less.
A good friend of ours just made $750 by doing one property showing. In total, she probably worked an hour to earn that money.
Compare that to the advice of cutting out your daily coffee ritual. If you consciously deprive yourself of coffee every day for an entire year, you could save about $1,000.
What would you rather do?
Work just a little bit more with a side hustle of your choosing, or cut out something that you enjoy each morning?
Do you really have to think that long about it?
Of course, you already know which option I’m pursuing.
I’ve had side hustles for just about my entire career as a lawyer.
My first side hustle was as an adjunct professor at a local law school, teaching just one class. I eventually turned that into teaching four classes.
In the meantime, I also launched a rental property business with my wife, now managing 11 units in Chicago and Colorado.
We’re doing this with three young kids at home. I’m not bragging. My point is that I roll my eyes whenever anyone tells me he is too busy to make extra money.
By the way, earning more money does not only apply to side hustles.
There are always ways to make more money within your primary job.
For example, can you earn a larger bonus by performing better?
Can you ask your employer for more responsibilities and a corresponding raise?
Or, can you earn additional money by generating business for your company?
Lawyers, like most professionals, have the ability to earn more money if they generate business. That means bringing in clients.
How can you find these clients?
You can make it a priority to go to more events where you might meet potential clients.
You could launch a blog or create other content to help people find you and know what you do.
Either one of these pursuits could be your side hustle.
There are endless opportunities for anyone that is motivated and is looking to earn more money.
And when you earn that additional money, you’re on your way to financial independence without having to sacrifice the things that make your daily life enjoyable.
OK, but I don’t even like coffee.
I know, I’m picking on coffee. Coffee is an easy target, but it’s just one example.
Maybe coffee is not your problem. Let’s say that you’ve cut out family vacations.
Family vacations can be expensive. There’s no doubt about it.
But instead of eliminating vacations, what if you could find a way to earn an extra $5,000? That could turn into a really nice family vacation.
For some people, this is a no-brainer. They find a way to earn more money.
Other people will simply skip the family vacation because it’s too expensive.
At this stage in my life, I’m not willing to do that. I have three young kids. I already feel like they’re growing up too fast.
A year ago, my daughter wouldn’t let go of my hand when I walked her to school. Now, she’s “too cool” to waive goodbye to Daddy.
The idea of skipping out on family vacations does not appeal to me at all. I know that there will come a day when I would really regret that choice.
Instead of eliminating family vacations, I would rather find a way to make more money.
You can have anything you want; you just can’t have everything.
Warren Buffett famously told his kids that they could have anything they wanted. They just couldn’t have everything.
That sums up my approaching to spending. If there’s something I truly want that doesn’t currently fit in my budget, I would prefer to earn more instead of giving up on having that thing or experience.
I might get there through a side hustle. I might get there through investing. If it’s something I value enough, I will get there one way or the other.
If you focus on your income, not just cutting expenses, you can continue your journey to financial independence without giving up these things that make life special.
Or, you can cut out the coffee and vacations, if that’s your preference.
I’d rather challenge myself to make more money so I don’t have to make those sacrifices.
Do you think financial independence is only for people willing to aggressively cut their spending?
Or, do you agree that financial independence is for anybody willing to work for it?
“I’m worried about today. I’ll deal with tomorrow later.”
“If I cut out vacations and saving for retirement, I can make it work.”
Have you ever heard money excuses like this before?
I recently had a couple of great talks that got me thinking about comments like this. These talks led me to think about common money mindsets we sometimes have when we’re worried about paying for things today.
For many of us, the natural inclination when money is tight is to ignore the future and focus on today.
The pattern goes something like this:
Go to work, pay the bills, keep food on the table.
Wake up and do it all over again tomorrow.
Dream about life-enriching experiences and retirement later.
The problem with this money mindset: how are you ever going to break the cycle?
How are you ever going to progress towards financial independence so your life is not stuck on auto-pilot?
My challenge to you?
When money is tight, think long and hard about the future. Think about what comes next.
Use a challenging period in your life as motivation to do things differently.
It helps to picture yourself 10 years from now. Imagine you don’t do anything differently.
Same Job. Same bills. The cycle continues.
Do you like what you see?
If you do, no need to read any further. Keep doing what you’re doing.
If you don’t like what you see, let me share another perspective with you.
Let’s use the future as motivation to make the hard decisions today.
That way, you can spend your money (and time) on the things and experiences that bring you happiness in life.
Some dollars will be used to pay your ordinary life expenses, some dollars will be used for all the things in life you love, and some dollars will go to your financial goals.
That’s all there is to it.
When it comes to budgeting, I divide my money into three primary categories:
Now Money
Life Money
Later Money
Now Money
Now Money is what you need to pay for basic life expenses.
These are expenses that you can’t avoid and should be relatively fixed each month. If you have expenses for kids, pets, and other fixed life expenses, be sure to include them in your Now Money category.
Life Money is what you are going to spend every month on things and experiences in life that you love.
This bucket includes dining out, concerts, vacations, subscriptions, gifts, and anything else that brings you joy.
We can’t be afraid to spend this money. This bucket is usually what makes life fun and exciting. The key is to think and talk so you are spending this money consistently on things that matter to you.
Later Money
Later Money is what you are saving, investing, or using to pay off debt.
This bucket includes long term goals, such as retirement plan contributions (like a 401k or Roth IRA), college savings for your kids (like a 529 plan), emergency savings and paying off student loan or credit card debt.
This bucket also includes any shorter term goals, like saving for a wedding or a downpayment for a house.
Most fun of all, this bucket includes any investments you make to more quickly grow your wealth, like investing in real estate or the stock market.
Later Money is the key category that fuels your ultimate life goals, like financial independence. The more you fuel this category, the faster you can reach your goals.
Your budget is really just about finding fuel for the best things in life.
This is where we circle back to the importance of having a clear understanding of what we want out of our money.
“Is your current spending aligned with how you want to use your money to fuel your goals and ambitions?”
If not, you can make incremental adjustments as you progress towards your ideal spending alignment.
The idea is to continuously add more fuel to our Life Money and Later Money. Why?
These are the buckets that represent the things we love the most (Life Money) and our most important life goals (Later Money).
When money is tight, resist the urge to cut these expenses from your budget. These are the expenditures that oftentimes give meaning to life and allow us to build a future on our terms.
Instead, focus on the Now Money bucket as much as possible.
You can make small adjustments, which are usually easier and faster to put in place. These adjustments might include dining out a bit less, cutting out a concert, or cancelling a gym membership or subscription you don’t use.
You can also make big adjustments, like moving to a cheaper part of town or getting rid of you car.
Small or big, the key is that when you make these adjustments, you repurpose that money in a thoughtful and intentional way. You’re now starting to align your budget with your money motivations.
These adjustments will give you options in the future.
With each thoughtful decision, you’re progressing towards your best money life. Most importantly, you’re learning about yourself and developing lasting habits. You won’t get discouraged and give up on budgeting.
Creating a Budget After Thinking is really all about one question:
What do you really want out of life?
When you prioritize Life Money (experiences) and Later Money (financial freedom), each dollar you spend or invest brings you one step closer to that ideal life.
If you are totally consumed with Now Money, you’ll struggle to build the life that you really want.
By that point in my life, I had paid off my student loan debt and was about to get married.
My soon-to-be wife and I had good money coming in, but I never truly thought about what I wanted in life. Sure, I had thought about things like having a family and being able to take vacations.
But, I never carved out time to purposefully think hard about what I actually wanted. I had never asked myself what truly motivates me.
I never allowed myself to dream about financial freedom.
The truth is, I don’t think I had ever visualized a life that wasn’t dominated by a full-time job.
Up to that point, my whole life had revolved around getting an education and then getting a job. I never pictured a world where I might not need a full-time job to provide for myself and eventually my family.
I had read about the concept of being financially free, but it always seemed like a possibility for other people, not me.
Writing this years later, I feel sad for that version of myself for having such limiting beliefs.
Whenever someone tells me she doesn’t make enough money to dream about the future, I think about those same limiting beliefs I used to have.
That’s the cycle I’m hoping to help people break.
When money is tight, think about the future.
When it comes to spending choices, resist the urge to cut the things from your budget that make life what it is. That might mean money spent today on memorable experiences, like vacations.
Or, it might mean money saved and invested to provide yourself more options down the road.
The key is to break the thoughtless spending cycle that can make your life feel like it’s stuck in place.
Create a Budget After Thinking that prioritizes what you truly value.
Money might still be tight, but you’ll know you’re spending on things that matter.
You’ll know that you’ll have options in the future.
By investing in an index fund that tracks the S&P 500, like I do in my 401(k), I have a pretty good chance of earning consistent returns in the long run.
Sure, there may be ups and downs. And, there are no guarantees the S&P 500 will continue performing at 10%.
But, check this out:
Since 1996, the S&P 500 has ended the year in positive territory 23 times and negative territory only 7 times.
In other words, the S&P 500 has generated positive returns three times more frequently than it generates negative returns.
And even with those 7 negative years, with the exception of 2000-2002, the S&P 500 returned to positive territory the following year.
What this all means is that while the S&P 500 will drop occasionally, the down periods are historically short-lived.
Because of this historical consistency, I feel comfortable using 10% as a baseline to compare other investments with.
Note that predictable returns does not mean guaranteed returns.
There are no guarantees in the stock market or with any other asset class.
To recap: the S&P 500 has historically provided an average annual return of 10%.
While not guaranteed to continue in the future, 10% average annual returns represents a safe projection for our calculations.
That means we can use 10% as a baseline investment return to compare other potential investments to.
With this baseline in mind, we can now move to our two real estate metrics.
The first step in evaluating any real estate deal is to calculate the expected cash flow.
For a detailed explanation on how to analyze real estate deals and calculate cash flow, check out my post here.
To keep in simple, cash Flow is whatever money you have left over after paying all expenses. Think of it as your monthly profit.
Today, we’ll use an example of a hypothetical property that is listed for $1,000,000.
Here’s a quick snapshot of how you might calculate the cash flow on this property:
Asking Price: $1,000,000
Monthly Rent: $9,000
Mortgage Payment (Principal and Interest)
$4,500
Taxes
$900
Insurance
$300
Utility Bills
$300
Property Upkeep
$200
Preventative Maintenance
$200
Vacancy Rate (5%)
$300
Unexpected Repairs (5%)
$300
Property Improvements (5%)
$300
Total Monthly Cost
$7,300
Cash Flow = Income – Expenses
$1,700 = $9,000 – $7,300
This hypothetical property has a monthly cash flow of $1,700.
That means it has annual cash flow of $20,400, a number that we’ll need for our next calculation.
So, is this property a good deal?
That brings us to our first metric, Cash-on-Cash Return on Investment.
What is Cash-on-Cash Return on Investment (CoCROI)?
Cash-on-Cash Return on Investment (CoCROI) measures how much cash flow a property earns in one year relative to how much money was initially invested.
The formula looks like this:
CoCROI = Annual Cash Flow / Total Cash Invested
With this simple metric, we can compare the return of a potential rental property to the returns of any other investment, like an S&P 500 index fund.
Then, we’ll have some useful information to decide if this is a good deal.
Keep in mind that CoCROI does not factor in appreciation, debt pay-down, or tax benefits. That analysis comes with our next metric.
To continue our example above, we know the annual cash flow on this property is $20,400.
Let’s assume our down payment is 20% of the purchase price, or $200,000.
In addition to the down payment, we paid $10,000 in closing costs and invested another $5,000 to clean up the property before renting it out.
In total, our initial investment is $215,000.
Let’s plug those numbers into the CoCROI equation:
CoCROI = Annual Cash Flow / Total Cash Invested
.095 = $20,400 / $215,000
The CoCROI on this property is .095 or 9.5%.
Does a 9.5% CoCROI automatically mean this is a bad deal?
Back to the important question: is an initial investment of $215,000 to earn $20,400 in annual cash flow a good idea?
What does the math tell us?
We now know that the return on this property in the first year falls just short of the S&P 500’s 10% annual return.
Does a 9.5% CoCROI automatically mean this is a bad deal?
Not at all.
The answer will depend on what your preferences and goals are as an investor.
Keep in mind that CoCROI is a projection tool designed to measure the expected return on this rental property in just the first year.
Because of all of the variables at play, use CoCROI to help you compare investments. But, don’t make your investment choices based solely on the CoCROI.
Also keep in mind that CoCROI is a quick and easy way to compare the initial investment on one rental property to another rental property.
If you’re evaluating a lot of properties, you can quickly see which ones give you the best initial return on your money.
To recap, CoCROI is a great way to quickly compare the returns on different investments in the first year.
However, what if we wanted to evaluate the long-term investment potential on a property?
For example, what if we plan to hold a property for 10 years?
By holding a property for 10 years, we’ll ideally profit through appreciation and debt pay-down, not just through cash flow.
Let’s learn how to factor in those profits by calculating our overall Return on Investment (ROI).
Return on Investment (ROI) factors in cash flow, appreciation, and debt pay-down. It also factors in the sales expenses associated with selling a property after a defined holding period.
Put it all together and ROI is a great way to project the overall returns on an investment over time.
The ROI formula looks like this:
ROI = (Total Profit / Total Investment) / Years
Let’s continue our example to calculate the ROI on this property over a 10-year period.
The first step in calculating ROI is to total up the cash flow.
We already know that this property will earn $20,400 in annual cash flow.
Over 10 years, that means we will earn $204,000 in total cash flow.
Remember, cash flow is only part of our total profits.
Next, we need to calculate the equity we will earn through appreciation and debt pay-down on this property.
Next, figure out the expected appreciation and debt pay-down.
To calculate the rest of our total profits, let’s start with some basic assumptions.
First, let’s assume that this property will appreciate at 3% annually.
Using an online calculator like this one, we learn that our property will be worth $1,343,916 in 10 years.
In other words, since we bought the property for $1,000,000, we have earned $343,916 in appreciation over those 10 years.
Next, we need to calculate how much our loan balance has decreased over those 10 years. This is known as loan amortization.
Recall that our initial loan was for $800,000 because the property cost $1,000,000 and we put 20% down.
Again, we can use a simple amortization calculator like this one to do the math for us.
Assuming a 6.5% interest rate and a 30-year loan, we will have $678,209 remaining on our balance after 10 years.
Since our loan balance started at $800,000, this means that we have earned $121,791 in debt pay-down over those 10 years.
By adding the appreciation and debt pay-down together, we learn that our total equity in this property after 10 years is $465,707.
If we add up our total cash flow, appreciation, and debt pay-down, we see that our total income on this property is $669,707.
Don’t forget to factor in the costs of selling the property.
When we sell this property, we will incur some costs that we don’t want to ignore in our analysis.
Let’s assume that we will pay 6% to real estate agents, 2% in closing costs, and another $15,000 to fix up the property before selling.
In total, that adds up to $107,513 in costs associated with selling this property.
When we subtract the sales expenses from our total income, we see that our total profits on this property after 10 years are $562,194.
Now that we know our total profits, we can calculate the ROI.
How to Calculate ROI.
We now have all of the pieces we need to calculate the ROI on this property.
As we added up above, our total cash flow, appreciation, and debt pay-down, combine for a total income on this property of $669,707.
When we subtract the sales expenses from our total income, we see that our total profits on this property after 10 years are $562,194.
We also saw above that we made a total investment of $215,000 (our down payment plus closing costs) to acquire this property.
Now, we can plug this information into the ROI formula.
ROI = (Total Profit / Total Investment) / Years
.261 = ($562,194 / $215,000) / 10
ROI or Total Return: 26.1%
In the end, this property generates a total annual return of 26.1%.
So, what should you do with your $200,000?
Is this property a good deal?
Would you be better off investing in an S&P 500 index fund and earning 10%?
Using CoCROI and ROI can help you make that decision.
As an investor, you may be thrilled with a 9.5% CoCROI or 26.1% ROI.
On the other hand, you may not be interested in doing the work and taking on the risk involved with owning that rental property.
Remember, we are making projections based on a number of variables. Nobody can predict exactly how an investment will perform.
In the end, only you can answer this question based on your personal preferences.
The point in doing the math is to provide additional data points so you can make the best decision possible.
Let’s say that you have $200,000 that you want to invest.
Up to this point, all of your investments are in the stock market, mostly through tax-advantaged retirement accounts like a 401(k).
However, you’ve recently started thinking about buying your first rental property.
You have an important question to sort through:
Should you buy your first rental property or just keep investing in the stock market?
This is a common dilemma for all real estate investors, not just people thinking about buying their first rental property. Personally, I’ve been thinking about this question quite a bit lately.
The way I see it?
Why not do both?
Why not build your overall investment portfolio to include both stocks and at least one rental property?
It’s no secret that real estate is my favorite asset class. Without my four rental properties, my journey to financial freedom would look much different.
I’m confident that real estate will remain a powerful asset class moving forward.
That’s because no matter how much the world changes with AI, quantum computing or any other new technology, I know one thing will always be true:
People will always need a place to live.
At this point in my life, I know that I’ll never become a brilliant coder or software engineer solving the world’s hardest problems.
But, I can provide the geniuses a place to live.
That’s why I’m comfortable with the majority of my net worth being in real estate right now.
By investing in rental properties, I can make money in four different ways:
With cash flow, you can cover your immediate life expenses. For anybody hoping to reach financial freedom, it is essential to have income to pay for your present day life expenses.
For my money, cash flow from rental properties is the best way to pay for those immediate expenses.
If your present day expenses are already covered, you can use your cash flow to fund additional investments.
That might mean buying another rental property or investing in another asset class, like stocks.
Appreciation simply refers to the gradual increase in a property’s value over time.
While cash flow can provide for my immediate expenses, appreciation is all about the long-term benefits.
Like investing in stocks over the long run, real estate tends to go up in value. The key is to hold a property long enough to benefit from that appreciation.
To benefit from appreciation, all I really need to do is make my monthly mortgage payments, keep my property in decent condition, and let the market do the rest.
When I buy a rental property, I take out a mortgage and agree to pay the bank each month until that mortgage is paid off. At all times, I remain responsible for paying back that debt.
However, I do not pay that debt back with my own money.
Instead, I rent out the property to tenants. I do my best to provide my tenants with a nice place to live in exchange for monthly rent payments.
I then use those rent payments to pay back the loan.
As my loan balance shrinks, my equity in the property increases. Equity is just another way of saying ownership interest.
When my equity in a property increases, my net worth increases.
When you earn rental income, you must report this income on your tax return. Rental income is treated the same as ordinary income.
However, the major difference between rental income and W-2 income is that there are a number of completely legal ways to deduct certain expenses from your rental income.
Common rental property expenses may include mortgage interest, property tax, operating expenses, depreciation, and repairs. We’ll touch on a few of these deductions below.
With all of these available deductions, the end result is that most savvy real estate investors pay little, or nothing, in taxes on their rental income each year.
Yes, you read that right.
I’ll say it again, just to be clear:
Most savvy real estate investors legally pay nothing in taxes on their rental income each year.
Even though I love owning rental properties, I still invest in the stock market.
While there are certainly real estate investors out there who are 100% committed to real estate, I’m not one of them.
Even with my passion for rental property investing, I have a significant portion of my net worth in the stock market.
For one reason, I enjoy having some totally passive income streams. Compared to being a landlord, there is essentially zero work involved in being a passive stock investor.
For another reason, I see the value in having multiple, diverse streams of income to help protect me against life’s uncertainties.
Plus, like many of you, my investing journey began with my employer-sponsored 401(k) plan.
401(k) investing is easy and relatively straightforward. With automatic contributions from my paychecks, I don’t even need to think about funding my account.
As a W-2 employee since 2009, without even thinking about it, I’ve invested regularly in the stock market and enjoyed the benefits of compound interest.
As my career progressed and my family grew, I added investment accounts to my portfolio.
Besides my 401(k), my favorite investment accounts include a Roth IRA, 529 college savings accounts for my three kids, and a Health Savings Account.
In conjunction with my rental properties, I view each of these different investments as part of my overall strategy to reach financial independence.
Combined, I refer to these different investment and income streams as Parachute Money.
Parachute Money is one of my favorite concepts in all of personal finance.
Pretend your life is like flying on an airplane.
For whatever reason, you decide you need to get off this airplane. You decide to take control and make a change. You’re ready to jump.
All you need is a parachute.
You have a choice between the only two parachutes on the plane.
The first parachute has only one string (or line) connecting the canopy to the harness . You think to yourself, “This doesn’t seem very safe. What if that one string breaks? That would end very badly for me.”
Then, you look at the second parachute.
The second parachute has 10 strings. You say to yourself, “OK, this one looks much safer. If one string breaks, the parachute still has nine other strings to keep me safe. Even if something goes wrong with one or two strings, I would glide safely to the ground.”
It’s obvious which one of these parachutes to choose, right?
Why is having Parachute Money important?
The central idea of Parachute Money is to create multiple sources of income so you are not beholden to any one source.
Picture each source of income as a string on your parachute. The more strings on the parachute, the stronger it is.
With Parachute Money, if one of your sources of income dries up, you are more than covered with your other sources.
Likewise, the more sources of income you have, the stronger your personal finances are.
Parachute Money includes your primary job, any side hustles, any income generating assets, and your emergency savings account. It also includes the income of your significant other, if you share finances.
The key to Parachute Money: protect yourself with as many investment and income sources as you can.
That’s why I own stocks and own rental properties.
Should I buy a rental property or stick with the stock market?
Lately, I’ve been asking myself this very same question, “Should I look into buying a fifth rental property? Or, should I invest that money in the stock market?”
There are certainly lifestyle considerations that go into this question beyond just the strength of the investment on paper.
For example, owning rental properties means taking on a job. On the other hand, investing in the stock market is mostly passive.
If you’re not ready for the job of being a landlord, then you should stick with investing in stocks.
Setting lifestyle considerations aside, we all have limited dollars available to invest. And, we work hard for those dollars.
When we choose to put those hard-earned dollars to work for us, we want to make sure we’re getting a good return on our investment.
It’s hard enough deciding where to invest your money once you’ve decided on the asset class. Take real estate, for example.
Even if you know you want to buy a rental property in a specific area, there might be hundreds of potential properties available.
Picking the right property is not easy and requires some careful analysis.
How much more difficult does the decision become when you’re not even sure if you should invest in real estate or invest in the stock market?
Deciding between various asset classes can feel overwhelming.
With so many investment choices out there, it can be difficult to choose where to invest your money. That’s why it’s useful to have a way to compare one type of asset class to another.
Then, you can consider investment opportunities in different assets classes and make informed choices on where to invest.
Fortunately, we can use two simple metrics to help with this analysis:
Cash on Cash Return on Investment (CoCROI)
Return on Investment (ROI)
Real estate investors have long used these two metrics to decide if a potential property is a good deal compared to investing in the stock market.
In our next post, we’ll take a close look at each of these metrics. We’ll learn how each of these metrics can help you compare a rental property investment to typical stock market returns.
Don’t worry if math is not your favorite thing.
These two numbers are easy to calculate with an online calculator. The key is to make sure you understand the underlying principles and variables that go into the calculations.
Are you comfortable investing in rental properties and the stock market?
I like to invest in rental properties and the stock market to protect myself from economic and life uncertainties.
I don’t want to be all-in on only one asset class.
So, I view my rental properties and my stock investments as parachute strings working together to protect me should my airplane start going down.
Because I’m comfortable investing in both rental properties and the stock market, I need a way to help choose between options across those asset classes.
In our next post, we’ll learn how to do just that.
Do you invest in the stock market and in rental properties?
Which asset class did you invest in first?
Is part of your reasoning for investing in both asset classes to add layers of protection to your overall finances?
Most lawyers and professionals have a complicated relationship with their careers. That’s a topic for another day. Suffice it to say, the relationship evolves over time.
In the beginning, we’re mostly satisfied to have a decent job. We’re proud of what we’ve accomplished to get this far. We can put our skills to use and start living like adults.
This phase typically lasts until we develop confidence and realize that we’re pretty good at our jobs. We know that we can take on more responsibility and perform more challenging work.
At this point, we begin to work harder than ever. Oftentimes (but not always), we make more money.
We tell ourselves that we’re doing important work. We even start to earn recognition and receive awards from professional groups.
The thing is: we haven’t ever questioned why we’re doing it and what we’re chasing.
Somewhere along the way, our work becomes our identities.
Is your job the most important thing in your life?
How would your spouse or kids answer that question about you?
When your job is the top priority in your life, your health, relationships, and personal interests all take a back seat.
Many of us prioritize our jobs above all else until we get around to retiring in our sixties or seventies.
We never stop to think about whether there’s another way. We’re stuck on autopilot.
Earn a paycheck, buy nice things, save for retirement.
It’s that last part that we oftentimes use as justification for working so much: saving for retirement.
Part of the problem is that we’ve been programmed to think that saving enough for retirement is a never-ending challenge.
We’ve been brainwashed to think that unless you save 10-20% of your paycheck for the rest of your life, you’ll never comfortably retire.
These fears are strong enough to push us to chase more money. To save endlessly for retirement.
Because if you don’t save enough, so we’re told, you’ll never get that lake house in Wisconsin you’ve always dreamed about. Instead, you’ll be living in your kid’s basement.
Now, don’t get me wrong. Saving for retirement is extremely important. It’s one of the bedrocks of personal finance.
But, saving enough for retirement is not an impossible goal. It is most definitely an achievable goal.
For many of us, it’s achievable earlier in life than we ever thought possible.
Once you accept the fact that you actually can save enough for retirement, you give yourself permission to ask, “When is enough is enough?”
This is where Coast FIRE comes in.
With the money mindset hack of Coast FIRE, you can tell yourself, “I have saved enough for retirement. Cross that major goal off of the list.”
Enough is enough.
With retirement taken care of, you can think about what else to do with your time and money.
That might mean staying exactly where you are: same job, same house, same vacations. If it ain’t broke, don’t fix it.
If it is broke, you can pivot.
You can start to dissect exactly what it is that you’re chasing in life.
Coast FIRE is a subset of FIRE for people who are not necessarily trying to retire early.
Instead, the idea is to aggressively fund your retirement accounts early on so you have more options as your career progresses.
The reason you’ll have options is because once you hit your projected magic retirement number, you no longer need to fund your retirement accounts.
You can sit back and let compound interest do its thing. Your retirement years are covered.
With retirement covered, you don’t need to earn as much money. You can focus more attention on your present-day self. That might mean working less hours or working the same amount but in a different job.
This is the essence of Coast FIRE: knock out retirement planning early on to create more career flexibility later.
Coast FIRE does not mean complete financial independence.
When you reach Coast FIRE, you are not financially independent because you still need money coming in to fund your current lifestyle.
But, you need less money because you no longer need to save for the important goal of retirement. That means you have earned some financial freedom, but not complete freedom.
That’s OK.
Remember, the part that separates Coast FIRE from traditional FIRE is that early retirement is not the goal.
Instead, Coast FIRE means continuing to work until normal retirement age (like age 65) but having more freedom in what you do for work.
To put a bow on it: the main money mindset benefit of Coast FIRE is that you have options once you’ve already put away enough money for retirement.
With retirement taken care of, you can:
Switch to a lower paying job or lower stress job.
Become a stay-at-home parent and live off of one spouse’s income.
Start a business.
Grow your side hustle.
Take some time off to think about what you want to do next.
With Coast FIRE, each of these options feels safer because you’ve already fully funded your retirement.
Knowing when enough is enough.
Towards the end of 2024, I had a breakthrough moment thinking about when enough is enough.
Earlier that year, we had moved into our “forever home.” I had traded in my 20-year-old car for a new one. My wife and I were expecting our third child.
As it happens, I was reading an excellent book on real estate investing written by Chad “Coach” Carson.
If anything, we’re closer to having too much on our plates. We self-manage our 10 units in Chicago and work closely with a property manager in Colorado.
With our full-time jobs and kids at home, we’ve bitten off as much as we can chew.
Our portfolio generates enough income to help fuel our current goals. If we were to continue expanding, the headaches could end up outweighing the financial benefits.
We want to build a life full of experiences and memories. That means we need more time, not more money. Acquiring and managing more properties right now would take up a lot of time.
What would you do with your time if money was not an obstacle?
Whenever I think of Coast FIRE, I’m reminded of a conversation I had with a friend earlier this year.
We were having lunch at a downtown Chicago lunch spot that’s been serving up epic burgers since the 1970’s. My friend and I are both balancing careers as lawyers in Chicago with young families at home.
In between bites of a massive BBQ-bacon-cheeseburger, I asked him a question I like asking smart people:
“What would you do with your time if money wasn’t an obstacle?”
Without hesitation, he answered that he would work with his hands.
He likes working on projects around the house. He gets immediate satisfaction from completing a repair or making an improvement.
His answer was great and very relatable. My years as a landlord has taught me the same feeling of satisfaction in completing a project.
What stood out to me the most was how quickly he answered the question. He knew exactly what he would do if money was not an obstacle.
This simple question helps illustrate what I mean by Coast FIRE.
When you achieve Coast FIRE, you can afford to take a pay cut. You can choose to work a job that you enjoy for less money.
It’s not an easy goal to accomplish, but I can’t think of a better goal to strive for.
By the way, since having that burger with my friend, he left his old job for one that better fits his life goals. I’m thrilled for him.
Coast FIRE is not about giving up.
Some critics of Coast FIRE argue that it’s just a catch phrase for quitting on your career too early. They say the consequences of having a “bad retirement” are too severe.
The way I see it: having a “bad life” now in hopes of a “good retirement” later is not a worthwhile trade off.
You can certainly prioritize making the most money in life. That might mean continuing to earn and earn so you can invest in the stock market or purchase more rental properties.
But, at some point, you don’t need any more money. At some point, you need to know when enough is enough.
Coast FIRE is about exactly that: knowing when enough is enough.
