Why Should I Care About Personal Finance?
I used to feel that personal finance was a pretty boring game. I thought that if I was smart and conscientious about my personal finances, and willing to put up with potentially un-ideal jobs and a little self-deprivation, I would be able to retire at a respectable age (maybe even as early as 60). Or maybe I could even afford a vacation home someplace interesting or pretty, or to be able to give several thousand a year to charity. Personal finance was just something to be maintained, and none of my potential goals seemed that exciting to me; if I work on something for decades, the best I can get is a few more years of vacation when I am older? Who knows if I am even going to live that long? And why should I get that excited about a vacation home that I will only have time to go to a few times per year? And giving a few thousand to charities is good and all, but is that really the best I can do?
It turns out the answer is no - the possibilities are far greater than I’d ever heard of or considered. Personal finance has a range of discrete goals that map on to and respond to different kinds of values. Having a goal makes personal finance an exciting game worth spending some effort on: once you get a handle on your finances, you can drastically change your lifestyle into one that is more appealing for you. The question “What do I want to do with my life?” stops being theoretical and becomes instead something practical that I can work on every day.
I’ve created the Financial Ladder to illustrate the different levels of wealth. Each rung requires different financial efforts and results in different options and lifestyles. They are in order of wealth from least to most, but NOT in order of worst to best. The lowest levels might be more stressful for the average person to handle than the later levels, but as we discussed in the What is Money? post, the wealthier levels are not ‘better’ than the lower levels - wealth does not a good person make. Instead, the different rungs of the Financial Ladder give you something to shoot for as you align your life goals with your finance goals. Everyone will want to aim for a different goal based on their needs, desires, and what they feel is the right thing to do. You don’t need to get to the higher levels of wealth in order to serve God’s purposes (unless you would be an extremely effective philanthropist). However, it is also important to realize what is possible – learning about optimizing savings and investing could lead you to explore rungs that you never thought possible (financial freedom! financial independence!).
The Financial Ladder
1. The Rung of Bad Times
This stage can be characterized by increasing debt, an inability to pay the bills each month, the use of payday loans or credit card debt ( anything above 0% interest credit card debt, to be precise), or bankruptcy. These financial symptoms can easily become a downward spiral, with initial problems leading to bigger problems. This is a stressful state to be in and should be avoided as much as possible. Although I’m sure no one consciously chooses this step of the Financial Ladder, one should carefully plan one’s finances to avoid being dropped onto this level by one or two unfortunate events.
Suited for: No one! Although transitions to/from education or out of harsh circumstances (divorce, severe illness/injury without health insurance, etc) may mean that temporarily there aren’t any other options.
2. The Rung of Paycheck to Paycheck
On the Rung of Paycheck to Paycheck, expenses are roughly equal to income. In this stage, financial decisions may be driven by the amount of cash available rather than what may be the best choice overall. You might not have the cash to buy groceries in bulk or put a deposit down on a different apartment, even if they are the better deal in the long run. On this rung, your bank account may just have a few hundred dollars left when the next paycheck arrives. Sometimes things can seem fine because all the bills are getting paid, but without savings in the bank you may just be a car issue or a single illness away from having to skip out on essentials or take on credit card debt. In this stage it is also necessary to be somewhat cautious about your job, because an unexpected layoff would easily knock you onto the Rung of Bad Times.
Suited for: Those who are comfortable taking a gamble or are just getting back on their feet. This may be the case if one is just starting a career, and can expect income to soon go up quickly (perhaps due to a spouse finding work or an upcoming promotion). It could also be suitable for those starting a business or nonprofit or those taking advantage of a unique opportunity or need. Maybe you are called to take on very low-paid service work (perhaps as a missionary), or take care of a suddenly sick relative. In most cases it would be better to first climb to the Rung of Stability before undertaking these types of work, but life isn’t always that simple or straightforward.
3. The Rung of Stability
The difference between the Rung of Stability and the Rung of Paycheck to Paycheck is greater savings. Just a few thousand dollars in savings, or a bit of a monthly surplus of income over expenses creates a little space in a budget, eases stress and worry, and creates a feeling of stability and peace. In this stage, it isn’t necessary to worry about how much money is in your bank account at any one point in time, because it is definitely enough to cover any bills. Instead, daily thoughts and worries can be directed towards other interests and pursuits. At this rung, you may also have a solid retirement fund and are able to save up for large purchases, like a house.
Suited for: Those who love their job and career and plan to work for many years or those focusing on other priorities. If you work in a stable field, love your job, and think you want to and should continue working in your field until retirement age, you have no need to go beyond the Rung of Stability. If you love your current lifestyle, and changing your expenses or income would endanger that lifestyle, the Rung of Stability might be for you. Of course, it is quite possible that if you love your job, want to keep working for many years, and have a happy comfortable family, you may still accumulate more wealth than you currently need. In that case you’ll quickly find yourself advancing rungs...
4. The Rung of Flexibility
In the Rung of Flexibility, you have enough savings (and/or a large surplus of income above expenses) that it is possible to make short-term decisions regardless of their impact on finances. In other words, this level allows you the flexibility to quit your job if you get a new, terrible boss; to give friends or family a few thousand dollars if they need help; to invest in a business or charitable opportunity; or to ask for a leave of absence at work to spend time with your family or travel for a couple months. In essence, this level of wealth allows you to consider your life choices around what is most important to you, rather than what is best for making or keeping money. To be on the Rung of Flexibility, savings equivalent to a year or two’s worth of spending and a savings rate above 20% is the minimum.
Suited for: Many young folks. This is a great place to be in if you don’t mind spending most of your time working and don’t have many people relying on you. With the confidence of a nice savings account, you can afford to take risks and do what is best for you or what is morally right (which hopefully is the same!). For example, our fellow bloggers at www.pretendtobepoor.com are using their position on the rung of flexibility to have a stay-at-home parent, give to charity, and limit job options to the area they want to live all while feeling financially secure.
5. The Rung of Freedom
The Rung of Freedom is similar to the Rung of Flexibility, but the possibilities are bigger or longer-term. Instead of taking a leave of absence to spend time with your family, you could quit your job to be a full-time caregiver for your children or elderly relatives. Instead of just being able to quit your job to avoid a terrible boss, you could quit your job to get out of a terrible career path and spend a year or two retraining yourself and making new contacts before entering a completely different field. Essentially, you have enough savings and investments that you don’t need a job for 10-15 years. This step is ‘Freedom’ because it allows you the freedom to not care about money for a while. Although you will still have to make more money eventually, essentially you can do whatever you want or think is important now and worry about money later if need be.
Suited for: Many people! Many people are suited for paid work, and the Rung of Freedom allows them to undertake this work in the most favorable conditions possible. Work is good, but the Rung of Freedom takes the power in the working relationship from the employer and gives it back to the worker. Instead of working primarily for money, you can work for your personal fulfillment or for God’s kingdom. This could be different from working for money because you have the option to switch to a lower-paid but more useful and/or pleasant career, because you have the courage to stand up for changes at your workplace that cause both employees and customers to be treated with greater dignity, or because you can continue in the technical role you are best suited for rather than taking a lucrative but unpleasant job in management. In addition, the Rung of Freedom allows you to pause paid employment when appropriate: perhaps at the birth of your child, to help run a local charity, or to take a year-long trip around the world with your parents.
6. The Rung of Independence
When you reach the Rung of Independence, you likely will never need to work for money again. The conventional wisdom defines this as the point where your annual spending is less than 4% of your total investments. Although I think you should do calculations for your own personal situation before retiring for good, the 4% rule is a good goal to aim for when getting started. Instead of your time being dictated by the priorities of the economy in general and your boss in particular, you can spend the rest of your life pursuing activities without regard to money. Maybe you will focus on mentoring the kids in your neighborhood. Or living as a missionary in a foreign country. Or living as a missionary in your hometown. Or serving as a volunteer National Park guide to share the wonders of nature with others. Or taking care of your parents, grandparents, children, and neighbors while still having the time and emotional capacity to appreciate all the blessings in your life. The possibilities are endless.
Suited for: Those whose passions and interests aren’t paid or aren’t paid much. In addition to the examples in the above paragraph, foster parents, some types of artists, small-time bakers, and outdoor enthusiasts also come to mind.
7. The Rung of Surplus
The Rung of Surplus is having more money than you could reasonably spend on yourself ever in your lifetime. At this rung, you can do everything you could do with the Rung of Independence, but you could also fund priorities by yourself. Does your church want to start a homeless ministry? You can fund it. Do you want to help research a cure to a rare disease? You can hire the scientist and pay her salary. Do you think that abandoned property in the poor neighborhood should be turned into a park? You can work with the city council and offer to pay some of the expenses of making that transformation happen.
Suited for: Those who are best suited for paid work, enjoy a frugal lifestyle, and are interested in philanthropy. If you enjoy and are great at teaching, software development, financial analysis, project management, or surgery, you should probably keep doing that. If you live carefully with your finances and continue working in any of these fields for a few decades (or much shorter, depending on the field) than you will eventually end up on this rung whether you planned for it or not. At the Rung of Surplus, your wealth brings you power, and as we all know with great power comes great responsibility (thanks Spiderman). So if you see that your trajectory will end up landing you here, you best start thinking about where your money can do the most good.
As I said above, the higher levels of wealth are not inherently better. They do, however, grant you more freedom to spend your values. If you can already spend your money and time in line with your values without years of savings at your back, great. You probably don’t need to save more or change much in your life. But if you aren’t sure that how you spend your time or your money is in line with your values - well, the world is full of opportunities to change that.
Mainstream personal finance gurus typically encourage people to aim for the Rung of Stability, or perhaps the Rung of Flexibility, but this may be limiting for some people. Conventional wisdom doesn't normally encourage people to challenge themselves financially, even though many people may have the means and the inclination to embrace a more financially creative life (such as saving 50% of their income in order to fund a local homeless shelter). I have heard people dismiss their dreams as ‘not practical’, with ‘not practical’ as code words for ‘not possible or sustainable due to lack of money’. But practicality is dependent on one’s location on the Financial Ladder. What isn’t practical when I am living paycheck to paycheck may be very reasonable and practical on the Rung of Freedom or the Rung of Independence. Essentially, the possibilities at the top levels of the Financial Ladder mean that most people have the option not to work a typical 9-5 job if they don’t believe it is the best use of their time. It might not be possible immediately, but with planning and careful financial choices we all have much more control over how to spend our time than most people realize.
I hope you understand why I now find personal finance to be a pretty exciting and worthwhile game to play: it creates a life with endless possibilities. If you are at all similar to me, however, you will be reading this with a skeptical eye. Sure this sounds great, but how do I get to those wealthier stages of the Financial Ladder where I can do what I want? Well the short answer to that can be found in this post, and the long answer to that can be found throughout the future of this blog (and other blogs and books as well, which we will reference for you).
Are you content with the rung you are currently on? Which rung seems ideal for your future self? Do you want to make changes in your life that are 'not practical' or are you happy with your financial goals?