You can think of financial freedom like a video game. You have to overcome 7 levels to reach financial freedom. In this post, I will describe more about Tier I – Addressing All Bad Debt. First, let’s distinguish what makes debt good or bad.
Good debt is debt that currently or potentially helps you produce more. Student debt will apparently help you generate more income in your career, therefore it is considered good debt. Corporate debt that helps you grow the business is good debt. Even mortgage debt is considered good debt because it stabilizes your second biggest expense, the mortgage, and allows you to own real estate. Most good debts have advantageous treatment in the tax code (meaning that interest on good debt is generally tax deductible). So what is bad debt?
Bad debt usually comes from consumption. It’s credit card debt. It is a self-loan debt. This debt is not helping you produce more; Everything is based on consumption. If you’re not building to produce more income or potential capital appreciation, then it’s bad debt. And, generally, bad debt does not have favorable tax treatment (it is not tax deductible).
The most important aspect of Level I of the game to gain financial freedom has three main lessons to learn. One is being able to budget. You have to be able to create a budget and stick to it. If you can’t do that, it’s hard to get ahead in other parts of the game. Two is that you pay yourself first. Too often, when some expenses go over budget, everyone else gets paid but you. The store is paid, the rent is paid, the credit card is paid, but somehow you have no money to pay yourself. Learning to pay yourself first, before you pay rent or anything else, is a fundamental life lesson to learn in Level I. Three, the last lesson to learn is to be able to produce more than what is needed. consume. You can do this by limiting spending or by producing more income. It is with the additional production capacity that you will pay off all your bad debts.
I would say that you are generally ahead of the game if you can pay off all your bad debts in your 20s. It’s tough because your big production years won’t come until your 40s and 50s. But, if you learn the three big lessons of Tier I while not making a ton, that will help you even more when you’re at Tier II and beyond.
Next is earning Tier II: start a retirement account and add 10 percent per year. More to come in the next article.