Episode 327 - On this week's podcast I reveal the steps to take in order to achieve financial freedom/independence. I also explain what black box thinking is and why you should apply it to your finances. Finally, we discuss the apps that can help you overpay your mortgage without making a dent in your finances.
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The steps to achieve financial independence, Black box thinking & apps to clear your mortgage
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Abridged transcript - Episode 327
Below is an abridged transcript of this podcast episode that also includes timestamps. The people featured in this episode are Damien Fahy and Andy Leeks.
Steps to achieve financial freedom
Damien Fahy 5:25
Step 1 - Build a spending plan
Or in other words, build a budget. So how are you going to spend your money? Where is it going to go? How's it going to be divided? What are you going to spend your money on? How much discretionary spending have you got? There is a range of apps out there that can help you, such as Money Dashboard. In the 'resources' section below I provide links to an article detailing the best budgeting apps out there.
Step 2 - Remove your reliance on credit
So if you are reliant on credit (i.e. you're always having to use it in order to survive and you're finding yourself not being able to clear your debt) then you need to seek help from stepchange.org.uk. You ultimately need to be able to afford the minimum monthly payments on your debts before you can move to step 3.
Step 3 - Build a small emergency fund
Now you want to start to build a small emergency fund worth approximately one to three months of your outgoings. Go back and listen to podcast episode 270 where I talk about emergency funds and how you can build one easily. An emergency fund will give you a nice buffer against the things that could go wrong in life
Step 4 - Auto-enrol in your workplace pension scheme
Your employer is legally obliged to pay into a pension for you as long as you pay in too. This is free money plus you get tax relief on any personal contributions made.
Step 5 - Start clearing any high-interest debt that you have
Step 2 was just focused on removing your reliance on debt, but now you need to get rid of it. Focus on unsecured debt with an interest rate of 5% or more (but not your mortgage). The 'resources section below contains an article on the 5 simple steps to clear debt.
Step 6 - Extend your cash buffer to cover 6-12 months expenses
It is up to you whether you choose to have 6-12 months of living expenses covered or 6-12 months net pay (which should be slightly higher).
Step 7- Fund your shorter-term goals
You're getting to the point where you can now save for your shorter-term goals that are less than five years away. This largely going to mean putting money aside into savings. Because your timeframe is less than five years then you don't really want to invest this spare money because if, for example, the stock market crashed then your funds won’t have time to recover before you need to access them. Focus on using savings accounts, your savings allowance and also cash ISAs
Step 8 - Invest for your long term goals
Your longer-term goals are those more than five years away in the future. At this stage you can start taking investment risks, which means investing in things like shares and bonds. But if your long term goal is beyond the age of 55, then consider investing via your pension and make sure you claim the tax relief that you're entitled to on your contributions, especially if you're 40% taxpayer,
If you have longer-term goals that are occurring before you're able to access your pension (currently age 55), then don't forget, you can use your stocks and shares ISA allowance. If you are a first-time buyer then consider a Lifetime ISA if you are under the age of 40. Don’t forget that the different types of ISA can all invest in the same underlying assets as a pension. They're just tax wrappers.
So that gives you a broad framework of how to achieve financial freedom or financial independence. So work out which step you are at then work out what you need to do to go to the next step.
An alternative approach
The US financial journalist, Dave Ramsey, has a similar methodology as set out below. However, there is an additional step involving paying off your mortgage early.
- Baby step 1 - Save $1,000 for your starter emergency fund
- Baby step 2 - Pay off all debt (except your mortgage) using the debt snowball
- Baby step 3 - 3 to 6 months expenses in a fully-funded emergency fund
- Baby step 4 - Invest 15% of your household income for retirement
- Baby step 5 - Save for your kid's college fund
- Baby step 6 - Clear your mortgage early
- Baby step 7 - Build wealth and give away
Black box thinking & money
Andy Leeks 15:57
Okay, so moving on to the next piece of the podcast, then black box thinking and embracing your mistakes. What's this about?
Damien Fahy 16:04
I read a lot of books and one of them that I've been reading is called Black Box Thinking by Matthew Syed. A link can be found in the 'resources' section below.
The book focuses on the concept that your successes come from owning up to your mistakes and learning from them. The term black box is derived from the box that planes have that records all the in-flight information so that when a plane crashes investigators can use it to learn about what happened and prevent a similar incident from happening in the future.
The book provides a fantastic conundrum of why do more people die from mistakes made by doctors in hospitals than they do from traffic accidents? And the reason it occurs is that if a surgeon makes a mistake, and somebody dies on the operating table, then the natural response of most people and the profession is to try to avoid blame. It means that by not acknowledging and owning up to any mistakes then no one learns from them and the medical profession is doomed to repeat the same mistakes over and over again. The only time when lessons are learnt is once legal action is launched by someone affected which therefore requires a full investigation to be made.
Now, the one industry where there is a collective desire to learn the truth/lessons from an incident and not just apportion blame is the aviation industry. The aviation industry uses the information from the black box, once recovered, to inform its thinking. The aviation industry's brilliant safety record is evidence of the success that such an approach can bring.
We need to apply this black box thinking to the rest of our lives because success only happens, according to Matthew Syed, when we confront our mistakes.
So people need to apply black box thinking to their own finances and their relationship with money. So it means that you need to firstly get a progressive attitude to failure. That means that you don't see failure as something negative, instead you see it as a learning opportunity.
You also need to make sure that you don't reframe what happens, to avoid accountability but instead challenge your own beliefs that led to the mistake. So by that, I mean that if something doesn't happen in accordance with how you believed it should, then don’t blame something, someone else or the circumstances.
For example, when I was younger, my failings were related to clearing debt. When I was young, I left university and secured a job that paid me quite well. I then racked up a lot of debt after I got sucked into signing up for a credit card by a salesperson in a shopping centre. I was young, I was naive, and after I signed up I went on a shopping spree. I was like many people, hooked on consumerism buying things that I didn't really need to impress people I didn't really like.
It meant that even though I was earning money I never cleared my credit card bill at the end of each month, despite being able to, and my debt snowballed as a result. The debt eventually became so large that I couldn’t ignore it anymore.
I learned the lesson the hard way.
I initially reframed the evidence that showed my debt was spiralling out of control (and why) and instead focused on the idea that I had less debt than the average person. But, truth be told, I wasn't managing my money half as good as the average person. I also attempted to reframe the situation further by believing everything was fine and that I would soon be able to pay down the debt, it was just a temporary blip. The truth was I was living beyond my means, spending more than I was earning. That was the real problem and it wasn't changing it was actually getting worse. Once I’d accepted my mistake of not budgeting my money, relying on credit to fund a more lavish lifestyle than I could realistically afford, the tide turned. I began budgeting, became more frugal and focused on clearing my debt.
As a parent, or if you're trying to teach your children about money, you should also promote the importance of owning your mistakes. In addition, tell them about your mistakes and the lessons learned too. Help them apply the black box approach to shared knowledge for the greater good.
Apps to help you clear your mortgage more quickly
Andy Leeks 25:35
Okay, so moving on to the final piece in the pub, then we're gonna be talking about apps that can help you overpay your mortgage. Damien, what have we got.
Damien Fahy 25:43
So if you go back to Episode 320 of the podcast, we did a piece with Laura about overpaying your mortgage, so I'm not going to go over exactly how much you can save, but the average person can knock off about five years from their mortgage if they overpay their mortgage by £100 pounds extra a month, There are lots of details which we also covered in that podcast about the pros and cons of overpaying your mortgage as well as what to look out for (such as the early repayment charges). So assuming you've listened to podcast 320, and you like the idea of overpaying your mortgage but you just haven't had the funds to do it, there are apps that can help you overpay your mortgage without it materially impacting your budget/finances.
This part of the podcast was taken from our article in the 'resources' section below titled "Apps to help overpay your mortgage". Read that article for the full list of apps.
How to review your fund portfolio & What to check before overpaying your mortgage - MTTM podcast episode 219
Apps to help you overpay your mortgage - Article by Bronte Carvalho
The best budgeting apps in the UK - Article by Damien Fahy
Big picture budgeting - Article by Damien Fahy
The 5 simple steps to clear your credit card debt - Article by Damien Fahy
How to save for emergencies, pay off debt and build wealth - Dave Ramsay's 7 baby steps
Black Box Thinking - Book by Matthew Syed