Financial Planning

The Radical Budget of John Wesley

John Wesley was an Anglican pastor in the 1700's. He is credited with starting and initially leading the Methodist movement.

First off, this post is not to give a biography of the life and teachings of John Wesley. Nor is it to weigh the theological teachings of Wesley and the Methodist movement compared to those of others (particularly Calvinism). This post is merely to highlight an exceptional aspect of the life of an extraordinary man.

What can an Anglican pastor from the 18th century teach us about personal finance?

First, A Little Background on John Wesley

As a young child, Wesley was no stranger to poverty. His father, Samuel Wesley, was a priest. His mother, Susanna, taught their children at home. Samuel and Susanna had a total of 19 children together, 9 of which tragically died during childbirth (John Telford, The Life of John Wesley, Ch 2.). Between Samuel's meager earnings and the burden of raising 10 children, the Wesleys were in a constant state of financial turmoil. Their finances were so poor that Samuel was twice placed in prison for his large debts.

John Wesley was determined not to be of the same poor financial stature as his parents. He later went on to teach at Oxford University and later be elected as a fellow of Lincoln College. Initially, John seemed to splurge his newfound wealth, spending his money on card games, tobacco, and brandy.

One day at Oxford, an event happened that changed his perspective on money. Charles Edward White describes it this way:

[Wesley] had just finished paying for some pictures for his room when one of the chambermaids came to his door. It was a cold winter day, and he noticed that she had nothing to protect her except a thin linen gown. He reached into his pocket to give her some money to buy a coat but found he had too little left. Immediately the thought struck him that the Lord was not pleased with the way he had spent his money. He asked himself, Will thy Master say, "Well done, good and faithful steward"? Thou hast adorned thy walls with the money which might have screened this poor creature from the cold! O justice! O mercy! Are not these pictures the blood of this poor maid? - White, "What Wesley Practiced and Preached About Money"

What Wesley Did Next

Soon after this incident, whether solely caused by it or not, John Wesley's views on budgeting and spending changed for the remainder of his life. He began to reduce his expenses so that he would have more money to give away. His first year at Oxford, his income was 30 pounds a year (enough for a comfortable living for a single individual). Through budgeting, he found that he could live on 28, and gave away 2. In his second year, his income doubled to 60 pounds, but he kept his expenses the same, and thus gave away 32 pounds (more than he kept for himself). This process continued, even as his income vastly grew. Below is a table of what the generosity of John Wesley looked like as he progressed in life:

 Year Income Living Expenses To the Poor
First Year: 30 pounds 28 pounds (93%) 2 pounds (7%)
Second Year: 60 pounds 28 pounds (47%) 32 pounds (53%)
Third Year: 90 pounds 28 pounds (31%) 62 pounds (69%)
Fourth Year: 120 pounds 28 pounds (23%) 92 pounds (77%)
Eventually: over 1,400 pounds 30 pounds (2%) over 1,400 pounds (98%)

Source: The Accountability Connection by Matt Friedman, Victor Books,  1992, p. 12.

When I first read this story and looked at the numbers above, I had several different reactions.

I felt ashamed. I was extremely humbled to discover a man that lived so radically in generosity with his finances. I was able to see that greed is more than the mere desire for more wealth, but that it also lies in the fear of loss -  The debilitating fear of poverty that precludes us from parting with our precious pennies. Generosity in Christianity today seems to be all about "How much do I have to give to be 'good' with God?"  The conversation about charity and tithing is too often about math and percentages than it is about the heart.

I felt inspired. I used to think my childhood dog was big until I learned about cows; I used to think cows were big until I learned about elephants. I used to think my giving was sufficient until I learned about truly generous people. Not rich people, but regular, ordinary, often poor, people. Wealth is never a prerequisite for generosity.

I felt excited. Our storybooks are filled with themes of someone small accomplishing something big. It's amazing how much my meager generosity can accomplish as soon as it leaves my clenched fist.

The Takeaway

Now, I admit that I am far from being Wesley-esque in my giving. I am not saying that you should feel bad if you don't give away over 98% of your income. I hope that you are encouraged and inspired by the story of John Wesley, and not discouraged and ashamed, as I was at first. Our giving should not be a mere mathematical formula that we filter our income through like we do when we fill out our taxes. Our generosity should be fueled by faith, obedience, and surrender to God. A person's money is intimately intertwined with their heart. Your money will follow your heart, and with enough time, your heart will ultimately follow your money.

Not Normal

Keep in mind that radical giving is completely contrary to the motives of the world around us. It always has been and always will be. Even in John Wesley's time, the English Tax Commissioners were so flummoxed with Wesley's generosity that they investigated him in 1776, insisting that for a man of his income he must have "silver dishes" that he was not paying tax on. He wrote them saying, "I have two silver spoons at London and two at Bristol. This is all the plate I have at present, and I shall not buy any more while so many round me want bread" (Toward the Tithe and Beyond, John Piper).

Now this I say, he who sows sparingly shall also reap sparingly; and he who sows bountifully shall also reap bountifully. Let each one do just as he has purposed in his heart; not grudgingly or under compulsion; for God loves a cheerful giver. And God is able to make all grace abound to you, that always having all sufficiency in everything, you may have an abundance for every good deed. - 2 Corinthians 9:6-8

 

 

Resources:

John Wesley, Methodical pietist

An Account of the Life of John Wesley

What Wesley Practiced and Preached About Money

Toward the Tithe and Beyond

How to Determine Which Debt to Pay Off First

The average American household has $98,315 in debt. If you remove all of the people who are debt free, the average household with debt has $132,086 in debt (Nerd Wallet).

How does your debt rank with the average American? Does it make you feel better? Worse?

Before we get into specific debt repayment strategies we need to understand the basic process of paying off debts in general. The basic steps to approach paying off your debt are:

  1. Pay the minimum payment on all your debts. This one is not optional. Not paying at least the minimum payment on all your debts equals much more trouble down the road. This is where you can consider debt consolidation and other forms of restructuring if need be.
  2. Track your spending. Know where your money is going each and every month. Here is a list of 12 free apps to help (I use Mint).
  3. Cut your spending. If you've successfully tracked your spending, it's inevitable that you'll find something that appalls you. When my wife and I tracked our spending for the first time we couldn't believe how much we were spending each month on eating out. Find these areas and cut back.
  4. Budget. Now that you know where your money has been going, it's time to plan for where it should be going. Here's some info on how to get started. In doing your budget, determine how much you can allocate to debt repayment above the minimum payments.
  5. Choose a payoff strategy and allocate accordingly. This is where the jury seems to be out on what to do. Many people have multiple sources of debt and have to decide the best way to pay them all off. There are many strategies paying off debt from various sources, but three strategies consistently rise to the top in terms of people implementing them.

So what are the three methods, and which is right for you?

Strategy 1: The Balance Method (Debt Snowball)

This strategy was made popular by Dave Ramsey and has garnered multitudes of followers that are loyal to Dave and his sage wisdom for the masses. This method is defined by ranking all of your debt by the size of the debt. From there you still pay the minimum payment on all your debts, but you allocate everything else that you can towards paying off the smallest balance first. Then moving on to the next smallest, and so on.

Trent Hamm wrote a great article on his thoughts on the Dave Ramsey snowball approach, and you can find it here. Like Hamm, I greatly respect and admire what Dave Ramsey has done for many, many people, but you have to keep in mind that he is speaking to a very broad audience and has to make some generalizations.

The snowball method is deeply rooted in psychology. It uses the feeling of accomplishment that comes with having a debt eliminated from your plate entirely to fuel your motivation to eliminate the rest. The reason this method is called the "snowball effect" is that when you eliminate one debt, you allocate all your money that you were paying towards eliminating that debt towards the next debt in line, increasing the amount you are paying on each successive debt balance.

Strategy 2: The Interest Rate Method

In this method, you still pay the minimum payment on each debt, but the difference is that you rank each debt by the interest rate, rather than balance, associated with it. In this method, you still "snowball" the amount you had been paying on prior debts, but the process doesn't always happen as quickly since the lowest balance debt is not always prioritized first.

Logically and mathematically speaking, this method is proven to lead to the least amount paid over the life of all your debts of any approach.

The reason behind this? Your interest rate on your debt is the cost at which the money is borrowed. The longer your highest interest debt stays active, the more and more interest that you accumulate over the life of the loan (and this isn't the good kind of interest like from your investments). By focusing on high-interest rate debt first, you minimize the impact these rates have on how much you end up paying. Compound interest is a powerful thing, either working for or against you.

So if this method is mathematically the best, why doesn't everyone use it?

Psychology. Some people drive home on a route that they know to be slower than other ways, but they enjoy the drive of the slower route more. In the same way, some people may know that they will be paying more for their debt in the long-run, but like the feeling of having one less bill in the mail. Comfort always comes at a cost. In the driving metaphor the cost is time, and in regard to debt, it's usually money (and often time).

 

Comfort always comes at a cost.

 

 Strategy 3: The Credit Limit Method

This strategy is my least favorite out of the three, so I will spend the least amount of focus on it. The difference in this strategy is ranking your debts by their credit limit. Naturally, your credit cards (lower credit limits) usually rise to the top in this method and your debts like your home and student loans (indefinite credit limits) fall to the bottom. This method is geared towards building and protecting your credit by trying to keep your credit utilization rate at the lowest possible. Your utilization rate is the amount of debt that you have compared to your total allowable limit.

The reason that I am not as big of a fan of this method is that it ignores the cost of borrowing money (your interest rates) and focuses on setting you up the best to borrow again in the future. This seems like the equivalent of breaking your arm in a downhill skiing accident and asking the doctor to put a less-than-optimal cast on your arm so you can compete in an even more dangerous event next year. This method may help you to get a better interest rate in the future, but I'm all for debt reduction strategies that get to the root of the problem: unnecessary spending and living beyond your means.

 

Debt reduction is all about living within your means and eliminating habits of uncontrolled spending.

 

So, Which Method Is For Me?

If you want to pay off your debt in the most efficient way possible and have the discipline to pay off your debts with the highest interest rate first, even if they don't have the lowest balance, then the Interest Rate Method is likely the best way for you. This way will lead to you paying the least amount over the life of all your debts and is typically my recommendation to people.

If you are not as disciplined or have a hard time making a plan and sticking to it, then the Snowball (Balance) Method might be the best for you. This way helps you to have some smaller "wins" earlier on that can help motivate you to continue.

If you're concerned with your credit score and really want to focus on keeping it as high as possible, then the Credit Limit Method is the best way for you. The method will lead to the fastest decrease in your credit utilization and should help your credit score most readily.

There is not necessarily a one-size-fits-all answer to this question and it is important to consider your goals and personality before drawing up a debt repayment plan. Feel free to reach out with any questions or help with developing a debt game plan of your own.

 

 

Resources:

American Household Credit Card Debt Statistics: 2015
Should I Consolidate Debt?

In What Order Should I Pay Off My Debts?

The Newlywed Financial Checklist

The Newlywed Financial Checklist

Getting married is a whirlwind. You're down on one knee in one moment, and you're saying "I do" in the next. After the celebratory rice has settled, the stress of the transition often comes into the picture. Many couples don't even know where to start, some think they do, but forget key details, and others put it all off for another day... or year.

5 Steps to a Budget That Lasts

Part of America’s aversion to budgeting may be rooted in language. The word “budget” – much like the word “diet” – has negative connotations. Budgets and diets are viewed as restrictive reminders of things we cannot have. This is linguistic nonsense. A budget and a diet are both tools. If the tools are used properly, they lead to a desired outcome.
— Investopedia Staff

Now, I’m not the first person to compile a guide to budgeting, and my goal is not to claim that I hold the only keys to a successful budget. I only seek to provide a concise, actionable way to implement a meaningful budget that lasts.

This is an issue that is near and dear to my heart. After all, my collegiate thesis was titled “Why Everyone Needs a Budget” (boring title, I know).

Getting Started

For many, this part is the hardest obstacle.  An object at rest is much more difficult to get moving than an object already in motion.  Likewise, a budget becomes easier to manage the more it is used; the real pain can be just starting. It helps to have a process to follow.

 
 

1. Know your income

You should be able to answer the following questions:

  • Do you get paid?
  • How much after taxes?
  • How often?
  • Is it consistent?
  • Is it reliable?

Knowing the amount, frequency, consistency, and reliability of your income can give you a much better picture of how you should approach budgeting. Those who get paid less frequently may need to budget months in advance, rather than monthly. Those with inconsistent income may need to figure out a conservative base amount to base their budgets on. Those with unreliable income may need to build in some extra cushion in their budgets.

Regardless of your income situation, a budget ensures your spending stays below your means.

2. Know your expenses  

The second stage of the process is knowing where that income tends to go. I will present two ways of doing this:

The first way is to use pencil and paper or excel to track all of your expenses for a month to two months by recording and categorizing every purchase. This is very effective and highly customizable, but can also be very hard for someone who is new to the discipline of budgeting. 

The second way would be to use software. Software can be a powerful ally in the budgeting process. Technology such as Mint (from the makers of Turbotax) can help you make the process of tracking your expenses a little easier. Mint can take your spending information from your credit and debit cards and generate a tidy pie chart to give you a glimpse into where your money has been going. 

Even just getting though this step can make a huge impact. Seeing your spending habits laid out in front of you can help you quickly identify problem spending areas. Sometimes just regularly monitoring your expenses can keep you on the right track.

3. Make a list of your values and Goals

 
 

This step may seem like the equivalent of reading a prologue at the beginning of a long novel, but this is the difference in having a budget that is effective, and one that is meaningful.

What's important to you? If someone looked at your spending, could they tell? Maybe you value your faith or certain causes, but not a red cent of your spending goes towards those values. Billy Graham once said, "Give me five minutes with a person’s checkbook, and I will tell you where their heart is."

A budget that isn’t tied to specific, worthwhile goals is like loading cargo on a freight train without any idea where the train is supposed to go.  If a budget doesn’t help you meet your goals, then what utility does it really provide?  A plan that ignores intermediate and long-term goals is foolishly short-sighted, and in the same way, one that ignores short-term obligations and goals is destined to fail.  Goals provide the framework for your budget to last and provide you with the motivation to keep at it.

4. Make a Plan

This is where it all comes together.  Your income, expenses, values, and goals should all be used in unison to create a budget that is truly tailored to you. 

Looking for an app to use for your budgeting?  I could come out here and say that this app is better, or that app is better, but frankly, the best budgeting method is one that you’ll use.  

I don’t care if it’s pencil and paper, an Excel spreadsheet, or even some kind of envelope system, whatever motivates you to consistently track and control your spending is what I recommend. There are multitudes of free apps and resources out there to try, and I would encourage you to try several before landing on one that fits you.

Mint is a great resource, but I actually only use it to track my expenses, and not for my family's actual budget. Mint is so easy it can actually tempt you to forget about it and just watch your money spend itself. I wanted something more interactive and proactive. I use an app called You Need a Budget (YNAB). It's something I've used since college and love it so much that I'm willing to pay for it.

My advice is if you find a free app out there (and there are plenty of them) that you like and that works for you, use it!  Find something that you like, implement it, and keep up with it.  Don’t make the search for software into a “search for the perfect budgeting technology.”  The perfect piece of budgeting software doesn’t exist, and a prolonged “software dating” window will only hinder your progress, not help it.

5. Adjust and Reevaluate

The best advice I can give is this: Don't give up. Your budget will fit you better as time goes on. You'll add categories you forgot, combine categories, adjust your spending, etc. The important thing is to stick with it. You'll be amazed how far you'll come if you just keep at it.

Happy budgeting and feel free to shoot me a message if you have any questions!

The Retirement Savings Order of Operations

There is no shortage of options for saving for retirement. Choices are great, but they can also make things difficult when you have so many of them. The sketch by Carl Richards below perfectly sums up the relationship between the amount of options a person has and the chances of actually getting anything done.

Image Source:  Carl Richards

Image Source: Carl Richards

So, between an employer retirement plan, IRAs, savings accounts, regular investment accounts, and a myriad of other options, where should your retirement dollars be going, and in what order?

Before I get into the specific order in which you should be funding your retirement, I have to mention one factor that trumps everything else: the amount you’re saving. If you are not setting enough money aside on a regular basis for retirement, none of this post matters. The biggest factor, by far, in setting yourself up for a successful retirement is increasing the amount you’re saving. Plain and simple.

Now, How About That Order?

1. Your Employer’s Retirement Plan

The first place you should look to save for retirement is in your employer’s retirement plan. How much? I always recommend that people invest AT LEAST up to the entire match that their employer provides. Why? I’ll give you several reasons:

  1. It is free money. No extra work required.
  2. Would you ever turn down a raise? Of course not. You are essentially turning down a raise if you’re not getting all of your employer’s matching contribution.
  3. 100% IMMEDIATE return on each dollar invested. I can’t think of anywhere else that guarantees an immediate doubling of your investment. Have an employer that does a partial match? I can’t think of anywhere else that guarantees an immediate 50% return either.
  4. It comes straight out of your paycheck. The reason that 401(k)s and plans like it have been such great tools for people over time is not because the investments have always been stellar, nor that the individuals investing in them have been investment gurus. Rather, it is because the 401(k) is a systematic way for people to contribute to retirement without the money ever touching their hands. It forces you to be disciplined in placing a set amount aside each month, regardless of what the market is doing.

Now, there are several factors that can complicate this decision. Your employer may have an extended vesting period that limits your ownership of your employer’s contributions until you have worked there for a certain period (anywhere from 1 to 6 years). However, if you plan on remaining at your job longer than a couple years, I would still contribute.

Another limiting factor could be that your employer doesn’t match at all, or maybe you can’t even contribute to your employer’s plan. You may have what is called a defined benefit plan, or some sort of pension or formulated retirement that is based on your salary and/or years of service. If these are the case, proceed to #2.

2.) High Interest Debt

Compound interest is a powerful thing. It can turn a molehill into a mountain given enough time.

There are two types of compounding returns: Ones that are working for you and ones that are working against you. Just as the compounding returns work for you in your investments, they work against you in your debts.

My rule of thumb is that if you have debt with an interest rate of 7-9% or higher, you are better off paying off your debts before focusing on investing.

Why?

Although the long-term average return of the market is around 10%, many experts feel that future growth will be lower and that 7% is a better forward-looking estimate (Investopedia). In reality, no one knows what the market will look like going forward. All we have is history and projections based off of that; nothing is guaranteed.

If you have a credit card debt at an interest rate of 19.89%, you have no business expecting your investments to outperform that debt. Likewise, if you have student loans at an interest rate of 9%, you can’t expect with reasonable certainty that your investments will outpace that debt.

3.) Roth IRA

The next step after you invest up to your employer’s match and have eliminated hight interest debt is working towards maxing out a Roth IRA if you are eligible. A Roth IRA is similar to a 401(k), but with some key differences. The main differences for the purposes of this article are:

  1. With a Roth IRA, you pay the taxes on your contributions now, as opposed to in retirement like in the 401(k).
  2. The IRS has an income phaseout on who is eligible to contribute to a Roth IRA. These limits are currently $117,000 to $132,000 single and $184,000 to $194,000 married filing jointly for 2016(IRS). There are no income limits in 2016 for 401(k)s.
  3. The IRS places a limit on how much someone can contribute to an IRA. For 2016, this limit is $5,500 per individual per year, $6,500 if you are above age 50 (IRS). This limit is $18,000 per year for 401(k)s.
  4. You have a wider range of investment options available in an IRA, as you are not limited to what is offered in your employer’s plan.

The difference in taxation may seem like a minor difference, but it can have a major impact on future net (after tax) retirement benefits. The question on whether or not your retirement dollars should be placed in a Roth or in your 401(k) or Traditional IRA is all based on one thing: taxes. If you expect your income to increase between now and the time you retire or if you are young, you are likely better off going with the Roth. If you believe that you are at the peak of your lifetime annual income, you may be better off deferring your taxes through contributing to your 401(k).

4.) Where Do Your Retirement Dollars Go From Here?

By now you will have invested up to the employer match at your work, eliminated your high-interest debt, and maxed out a Roth IRA (if you are eligible). From there, it makes sense for most people to focus on placing additional money in their employer retirement plan. After allocating a sufficient amount towards retirement, many with excess cash flow choose to open a regular investment account for intermediate and long-term goals.

There is no blanket answer for every person, but the above process is a prudent method for many to go about saving for retirement.