Saturday, July 10, 2010

Pay Off Your Credit Cards with Simplicity

When I get three emails on the same subject in one week, I know it is time to post a blog response. This week's main topic is paying off the credit card debt. It seems there are lots of discussions going on in a variety of households regarding the proper way to pay off the credit cards. Let me shed some light on the main source of confusion that seems to dominate these conversations. These chats seem to go something like this:

Strategy 1: (rated: not good)

"We want to do the 60/40 principle on our money, but we'll get the debt paid off quicker if we don't put money into savings and instead use it to pay off the credit cards faster!"

Strategy 2: (rated: corrosive)

"We won't do the 60/40 principle exactly, we'll instead pay down our debt faster by using a 70/30 allocation of our money instead!"

Strategy 3: (rated: really toxic!)

"The best thing for us to do in this financial situation is to pull all the money out of our long term savings account (IRA, 401K, etc.), pay off our credit card debt and start over with our finances!"

Those are the three statements I hear over and over and over from households trying to manage their finances. All three of these strategies are doomed to failure. This is why...

Strategy 1 is the most common rationale I hear used when it comes to handling debt. It is also the fastest way to dig yourself into deeper debt. Every single personal finance book I have ever read (last count over 73!) States that you MUST, there is no leniency here, you MUST save money and pay down debt AT THE SAME TIME. Why? Because it is saving money that initiates the process for you to learn to be a wealth accumulator! Paying down your debt must happen, of course, but the more you focus on just paying down your debt and you don't focus on saving is the single biggest mistake a household can make with its finances. That short term savings account is what keeps you from pulling out your credit cards to pile on more debt! Over and over and over again, I have talked with millionaires, financial planners and investors...all of them who are wealthy agree on one thing:

In order to get out of debt you must save money and pay off your credit cards at the same time!

This is a requirement. Do not try to wiggle out of this, do not try to barter with me or any other financial coach. You have to do this. This is a financial law. In order to get out of debt, save your money and pay off your loans at the same time. How do you do this? See my posting on the 60/40 principle. It will get you kick-started in the right direction.

Strategy 2 involves people trying to do too much too fast. Rather than focusing on running the 60/40 principle in its entirety , they begin to customize it, mold it and mutate it to a point that the principle no longer works and they wonder why the results are not forthcoming. If you change the ingredients of a cake too much you'll end up with bread, right? Or a brick of flour and water that would be useful for a stone wall. Don't try messing with the process when you're digging yourself out of debt. Go with the tried and true principles that have helped thousands of people out of the financial hole and have gained them wealth.

Strategy 3 is extremely detrimental to the financial well being of households because this process of pulling money from long term savings vehicles robs you three times of your future wealth. Remember money that is earning compound interest is not a linear form of investing. The curve is logarithmic. (Google Logarithmic curves to get an idea of what we are discussing here or you can review this site.) You can not simply "pay yourself back" by taking money out and putting it back in later and it will "work out in the end." If you pull money out today, you will have to put up to three times the amount in 5 years later and you still may not accumulate enough to get you where you were before you yanked out your savings principle.

Not only does Strategy 3 rob you of your future, it also breaks the flow of money in horrendous ways. It takes households three times longer to get back on their feet and recover when they knowingly use this behavior despite being told the contrary. I have over 15 years of data accumulated from hundreds of households and it is clear...pulling money from long term savings vehicles to pay off credit card debt sets you back more financially then any other bad money behavior.

I can't be soft or kind or gentle with this post. I've seen too many families and households crash, burn and then declare bankruptcy because they refused my council, did it their own way and then hired me a SECOND TIME to pull them out of the DEEPER hole they had made for themselves.

Please, please, do not be like them. Learn from this post and don't follow the large road of debt slavery. Make today the day you take control of your finances and become an active force in your financial life.

Good luck and know that I'm here to help as you walk the path to wealth accumulation.

1 comment:

Dave Drew said...

We pay it off every month. We only use our credit card as a tool and very cautiously. I've actually signed up for a Home Depot credit card for a discount on a huge purchase and then clipped up the card when it came in the mail. It's too bad people are emotional spenders and can't handle credit cards. It's also a shame that our colleges let the credit card companies set up shop during class registration days.

Dave Drew
Money Saving Author
changeforus.com