And maybe you’re truly interested in making a change but all of the financial jargon out there makes your head swim. How do you get started? What are the basics?
According to Johnson, people would be well served to realize that debt extinguishment should be a priority.
“To quote Albert Einstein, ‘Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.’
Johnson added, “People can put their financial house in order by reducing debt and acquiring assets that grow in value over time.”
He said the fastest way to improve your net worth is to obtain more assets that compound in value (e.g., stocks and CDs) and reduce your debts and interest payments.
“Typically, one should pay down the highest interest rate debt first,” he said. “And that is generally high interest rate credit card debt.”
“Not all debt is bad,” Johnson said. “Some experts would contend that student loans are bad debt, but I disagree. I would categorize modest student loan debt as being good debt.”
In his opinion, student loans get a bad rap.
“There is no doubt that the system has been abused and that some students have accumulated a mountain of debt and have earned degrees that simply won’t provide the earning power to pay that debt back.”
But, used judiciously — and to earn degrees that truly build your human capital and earning power — Johnson said student loans can be essential bridges to career success.
Mortgage debt also can be considered good debt. Johnson cautioned against comparing mortgage interest against investment interest, because mortgage interest is tax deductible.
He offered up a formula to determine whether it makes more sense to pay down the mortgage or invest. To get the after-tax cost of debt, subtract your tax rate from 1 and multiply it by the interest rate. Johnson’s example: “If the mortgage rate is 6%, and an individual is in the 30% marginal tax bracket, the after-tax cost of mortgage debt is 6%*(1-0.30) = 4.2%.”
If you can earn more than 4.2% on invested capital in this example, Johnson said, you would be better off investing your money over trying to pay off the mortgage early.
Budget Wisely
The key to putting your financial house in order is to budget realistically, Johnson said. “Specifically, one should not simply budget and track expenses, but one should budget for savings.”
He added, “Berkshire Hathaway chairman and CEO Warren Buffett is quoted as saying, ‘If you want to make saving a priority, take a look at how you budget. Do not save what is left after spending; instead, spend what is left after saving.'”
“It should be a line item on your budget,” Johnson said. “You don’t successfully build wealth by simply taking what you have left after all your expenses. We accomplish what we prioritize. Prioritize savings and invest those savings.”
He said not everyone values the same goods and experiences equally, so you should not “feel guilty about spending money in a manner that some might consider frivolous.”
Don’t Simply Save, but Invest for Retirement
According to Johnson, achieving true financial security and wealth is done both by saving and investing.
“Because of compounding, time is the greatest advantage of investing,” he said.
Too often, he said, people say they will begin saving when they make more money; but, as their salary increases, so does their spending.
Developing the discipline to save is extremely important and, Johnson said, “It is also important that people embrace investing and not simply saving.”
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