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The Most Valuable Financial Asset You Will Ever Have | Importance of Financial Literacy/Intelligence - YouTube
Channel: Next Level Life
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Financial literacy is one of the most important
skills to learn in today's world.
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However, it's not one that's always thoroughly
talked about in schools, though we are slowly
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but surely improving on that front as time
goes on.
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However that's not going to be of much help
to those of us who have already left school.
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Thankfully the proliferation of blogs, podcasts,
YouTube channels, and other outlets have given
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people easy ways to learn more about finance
outside of the traditional education system.
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Today I'm going to show you why that is so
important.
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Let's talk about just how big a difference
becoming financially literate can be for your
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life.
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So what is financial literacy?
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The dictionary definition would define financial
literacy as the possession of the set of skills
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and knowledge that allows an individual to
make informed and effective decisions with
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all of their financial resources.
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In more plain English, it is the ability to
figure out what financial decisions are likely
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to lead you to achieving your financial goals
and having the ability to act on that knowledge.
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So how do we become financially literate?
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Assuming that you did not get enough financial
education in school you will need to take
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things into your own hands.
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You do this by exposing yourself to new ideas
from as many different people and perspectives
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as you possibly can.
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Read books, take classes, watch videos or
look at blogs related to money just like you
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are now.
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Any of these can have very positive effects
on your financial situation both in the present
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and future.
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They can introduce you to new ideas that you
may not have come across on your own.
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These may lead to you saving or making more
money or even finding new passions.
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These outlets can reassure you during uncertain
times that the world isn't coming to an end
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and this too shall pass.
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This can be particularly helpful during less
than ideal times.
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They can give you encouragement when things
are going well and help keep you motivated
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to continue working towards your goals.
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And perhaps most importantly (especially if
you're just starting out and didn't get much
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financial education when you were growing
up) they can introduce you to so many new
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possibilities that get you excited about researching
finance.
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That'll get you thinking about what you can
accomplish in your own life with your own
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resources.
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Before we get into an example showing how
big of a difference even a moderate level
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of financial literacy can make let’s discuss
some statistics relating to the average American
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budget.
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Some light rounding has been done, but this
should give us a general idea of what the
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typical American spends money on.
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According to data gathered by the Bureau of
Labor Statistics’ Consumer Expenditure surveys,
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the average American household spends almost
$20,000 a year on housing costs.
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These costs include mortgage or rent payments,
utilities, maintenance and repairs, property
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taxes, and other related fees.
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The median price of a home is approximately
$300,000.
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The average rent for a 1 bedroom apartment
nationwide is $950.
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2-bedroom apartments will run close to $1,200
a month.
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Transportation is the next largest category
and it costs the average American about $9,000
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annually.
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These costs include fuel, maintenance, repairs,
public transit, plane tickets, and other related
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transportation expenses.
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Food costs about $4,000 and dining out costs
about $3,150.
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Healthcare costs about $4,600 a year.
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That includes health insurance as well as
prescription medication, doctors visits, and
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other health-related expenses.
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We spend around $2,500 a year on personal
care and clothing.
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The clothing portion of that cost also includes
related services such as tailoring and dry
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cleaning.
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We also spend almost $3,000 a year on various
forms of entertainment like cable, concerts,
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movies, and subscription services.
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Insurance costs can vary widely depending
on your level of coverage and what type of
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insurance you’re looking for, but here are
some rough averages.
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Renter’s insurance will run you about $180-$200
a year.
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Homeowners insurance averages between $1,000-$1,100
a year.
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Term life insurance averages around $2,000
a year and whole life policies can be upwards
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of $5,000 annually.
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However, like I said those can vary quite
a bit depending on what you’re going for.
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Finally, giving and miscellaneous expenses
amount to around $2,000 and $1,000 a year
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respectively.
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The reason I bring these statistics up is
its what we’re going to be basing most of
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the expenses of our first couple on.
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In this example, we’re going to be looking
at two couples who have just graduated high
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school and are looking to start college at
the end of the summer.
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They will both start with no debt to speak
of and will be able to work all summer before
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starting college.
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They will both earn the same amount of money
from their jobs before, during and after school.
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In both cases, they will be earning $12/hr
from their summer and school jobs and will
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have $60,000 a year in household income from
salary after graduation.
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As for other expenses, they will each be getting
new cars once every 7 years.
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Our first couple will be buying new cars while
our second couple will get their cars used.
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Both couples will be getting homes, but our
first couple will be lucky enough to receive
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a full down payment as a gift from their parents
while our second couple will have to save
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for the down payment themselves.
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Where saving money is concerned both couples
will try to have enough money on hand to purchase
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their next cars outright.
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However, as you’ll see this won’t be possible
all the time.
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The down payment money will also go into savings
for our second couple.
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The money that is put into savings will earn
2.5% in interest.
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The rest of the money that doesn’t need
to be spent or saved will be invested.
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Money invested will be earning 8% in interest.
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There will also be a dollar-for-dollar match
for the first $1,800 invested each year.
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This equates to roughly 3% of our couples
salaries.
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The net worth of each couple will be determined
by how much they have saved and invested.
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It will not include the value of their home,
but I will mention those at the end separately.
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With that out of the way, let’s get into
the example and see just how big of a difference
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financial literacy can make on our lives.
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Bill and Mary have just graduated from high
school and are looking to go to college.
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As I mentioned, they will work the summer
after graduating from high school and during
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college for $12/hr.
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During summers they work full time and during
the school year, they work 20-hours per week.
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Therefore Bill and Mary make about $10,000
the summer before college and $31,200 a year
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combined while going to school.
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Once Bill and Mary graduate they will get
new jobs that each pays $30,000 a year for
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a total household income of $60,000 annually.
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Bill and Mary attend 4-year universities in
state which cost them about $25,000 per year
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to attend.
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These numbers are based on averages gathered
by valuepenguin.com.
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The $25,000 per year includes all tuition,
fees, books, and other expenses relating to
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their education.
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Between food, transportation, and the occasional
fun night out Bill and Mary spend an additional
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$850 a month.
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Therefore in total, they spend just over $60,000
a year while in school.
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Four years go by and unfortunately for Bill
and Mary they racked up a lot of student debt.
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All told, they will graduate with over $100,000
in student loans.
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Assuming 4.5% interest their student loan
payments will be over $1,000 a month!
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After graduating from college, Bill and Mary’s
budget looks similar to the average American
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budget in most respects.
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They spend around $20,000 in housing costs,
$9,000 on transportation, $4,600 on healthcare,
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$2,500 for clothing and personal care, a little
over $7,000 for food and dining out, and about
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$1,000 for miscellaneous expenses.
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In total, they spend everything they make.
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However, there are still a few things worth
noting.
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First is their insurance bill.
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They will spend about $6,000 a year for all
their insurance.
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This is because they have a whole life insurance
policy (which is generally more expensive
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dollar for dollar than term life), pay homeowners
insurance (which is generally more expensive
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than renter’s insurance since there’s
more to cover), and have two cars to insure.
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Another thing to notice is that they aren’t
doing any charitable giving, saving, or investing
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because they can’t afford to with their
other expenses.
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Lastly, their entertainment budget is essentially
zero.
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They had to cut that in order to make their
debt payments each month.
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Unless they were to find some other source
of income or slash their current expenses
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somehow, this is likely to be how they live
for the next several years.
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At the age of 33 Bill and Mary’s student
loans are finally paid off.
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As a result, their expenses drop to about
$50,500 a year.
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This also means that they can finally increase
their entertainment budget.
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I’m going to assume that from this point
forward they spend right about the average
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of $3,000 a year on entertainment.
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20 years later at the age of 53, their home
is paid off which drops their housing cost
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significantly.
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Based on their $240,000 mortgage and assuming
a 3.85% interest rate (which is right about
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average as of the time of this writing) for
a 30-year loan, Bill and Mary's annual expenses
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will fall to about $39,750 a year.
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40 years after graduating high school Bill
& Mary will have a paid-for home.
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They will no longer be financing their cars
and will have a net worth of $75,000.
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Additionally, they bought their home for $300,000
with the help of their parents 34 years ago.
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They haven’t moved since, which is pretty
unusual but it certainly has helped them financially.
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Assuming the value of their home grew by 3%
per year their home would be worth $820,000
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today.
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So between their savings, investments, and
home, they are worth a whopping $895,000!
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That’s pretty good considering they carried
so much debt that they couldn’t save for
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the first several years of their careers.
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But how much better could they have done if
they played their cards a little differently?
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Let's find out by comparing them to John and
Jane.
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John and Jane may not have all the answers
but they have researched personal finance
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and investing.
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They have learned enough to make some different
choices than Bill & Mary did.
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The first difference comes in the form of
where they go to school.
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Bill and Mary graduated high school and went
straight to a 4-year University.
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John and Jane decide to get their first two-years
done at a local community college.
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As it turns out this is a lot cheaper.
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According to data from valuepenguin, the average
cost of a community college is $4,800 per
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year.
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Therefore, John and Jane will be spending
$9,600 per year between the two for their
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first two years of college.
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They will then transfer to a 4-year university
to complete their bachelor’s degree just
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like Bill and Mary.
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This will cost them the same $25,000 per year,
per person like it did for Bill and Mary.
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In total, their college education will set
them back almost $120,000.
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That’s certainly a lot, but it’s far more
manageable than the $200,000 than Bill and
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Mary spent on their education.
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Assuming their non-education expenses and
incomes were the same as Bill and Mary, John
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and Jane would graduate with about $20,000
in student loans.
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However, this is where we see the second difference
between the path Bill & Mary took and the
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one John and Jane are taking.
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John and Jane noticed that their salaries
weren’t going to be able to pay for their
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college in full so they decided to start researching
how to make money outside of a job.
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They learned about side hustles and eventually
started one where they flip items on places
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like the Facebook marketplace for a profit.
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They net about $12,000 from this side hustle
and since it doesn’t take much time they
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will continue doing it after graduation.
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John and Jane graduate and get jobs that pay
them a combined $60,000 a year.
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With their side hustle, this makes their household
income $72,000 annually.
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However, the differences between John and
Jane’s working life and that of Bill and
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Mary’s doesn’t stop there.
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John and Jane want to supercharge their finances
while they’re young and able to get the
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most out of compounding interest.
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There’s also something to be said about
spending more of their money on things that
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they care about most.
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As a result, they decide to save on big-ticket
items like housing and transportation.
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John and Jane don’t buy a house right after
graduating from college.
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They make good money but haven’t had a chance
to finish paying off their student loans or
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save up a good down payment yet.
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However, they still want to keep their housing
costs down, so they find some roommates to
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get an apartment with.
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As I said earlier, the average rent for a
2-bedroom apartment nationwide is a little
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under $1,200 a month.
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If we assume John and Jane split the costs
evenly with their roommates and also assume
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that utilities and other apartment related
expenses adds another $400 a month onto the
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total housing costs then John and Jane’s
portion of the costs will be $800 a month.
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$800 a month for housing costs is $9,600 a
year which is about $10,000 less than the
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typical American pays for shelter.
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To save money on transportation, John and
Jane buy one used car for the two of them
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and they buy it with cash.
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This will mean that they have to look for
carpooling options to work, either with coworkers
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or by taking turns dropping each other off,
but for now, that’s okay with them.
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The next time they're shopping for cars they
can get one for each of them.
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This strategy actually accomplishes a couple
things.
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First, they only have one car to repair and
maintain.
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And second, they only have one car to pay
insurance on.
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Statistically speaking, the average American
household has about 2.6 cars.
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So I don’t think it’s beyond belief that
John and Jane could cut their transportation
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costs in half with this strategy.
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With the insurance and transportation savings,
this strategy keeps approximately $5,000 a
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year more in John and Jane pocket when compared
to Bill and Mary.
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The last strategy John and Jane use to save
money is to limit the amount of times that
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they eat out.
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As I said, the average American spends over
$3,000 a year eating out and $4,000 on groceries.
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By limiting their dining out expenses John
and Jane’s total food costs come out to
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about $5,000 a year.
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While most of the money John and Jane saved
with these strategies go toward their investments,
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some will go to savings and other things.
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John and Jane will need to save $20,000 every
7 years to pay for their new cars and will
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need $60,000 for a down payment on their future
$300,000 home.
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The home will be on a 15-year mortgage with
an interest rate of 3.3% (once again the rough
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average for 15-year mortgages as of this writing).
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The monthly payment will be just shy of $1,700.
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We had Bill and Mary get their home right
out of college at the age of 23.
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I will have John and Jane get their house
at the age of 27 since that’s when they
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would’ve saved up enough to make the down
payment.
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They will also rent out their unused rooms
to help offset the cost of housing.
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Their rental income is assumed to be $500
a month.
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John and Jane will be spending $1,700 a year
on entertainment (which is the average amount
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spent on entertainment minus the expense of
cable).
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They will be giving $2,000 to causes they
believe in.
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And they will also be investing $2,000 a year
toward their kids' future college fund starting
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when he or she is born and continuing until
he or she turns 18.
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The investments will be in an ESA for their
son or daughter can withdraw the money for
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college tax-free.
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I’m going to assume that their child is
born the year they move into their new home.
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Everything else will be kept the same as it
was in Bill & Mary’s example.
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Based on this scenario John and Jane would
have their home paid off when by the time
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they’ve turned 43.
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This will lower their annual expenses by about
$20,400 a year.
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Two years later their son or daughter will
graduate high school with over $80,000 sitting
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in his or her college fund.
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This means that John and Jane no longer need
to save money into the ESA which’ll lower
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their annual expenses by an additional $2,000.
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And 40 years after John and Jane graduated
high school they have a paid-off home, a kid
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who has graduated college mostly, if not entirely,
debt-free, and a whopping $4,500,000 to their
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name.
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Their house was originally valued at $300,000
when they bought it 30 years ago.
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Assuming the value of their home grew by 3%
per year their home would be worth $728,000
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today.
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So between their savings, investments, and
home, they are worth a whopping $5,228,000!
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That’s over five times the net worth Bill
and Mary ended up with.
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And John and Jane have set themselves up for
a sweet retirement.
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Based on the 4% rule their $4.5 million dollars
would give them a $180,000 a year income for
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the rest of their life!
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That’s how important becoming financially
literate is.
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And that’s why I and so many others like
me online try to teach it.
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We’re very fortunate here in America that
we can live a pretty comfortable life even
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if our decisions weren’t ideal or if we
got a late start like Bill and Mary did with
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their savings.
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But we also have an amazing opportunity to
set ourselves up for an extraordinary life
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both now and in the future if we take the
time to learn about how money works and how
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we want
to work with money.
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