Wealth is Good
Cash Flow Is Better

Reduce Your Biggest Early Cash Flow Drag and Put the Extra Savings to Good Use

If you’re in your 20s you’re probably facing a number of unique economic challenges.   Through no fault of your own you’ve been hit with the proverbial double-whammy: a deep recession that just won’t quit AND a major restructuring of the U.S. economy as we try to adjust to an increasingly competitive world.   As a result, good jobs are in short supply.  And wages are low.  Oh yes, and benefits are shrinking as companies exploit every opportunity to cut costs.

To make matters worse, with a projected average of 11 job changes by age 42,* job security appears to be a thing of the past.   As are defined benefit pension programs.  So unfortunately, when it comes to financial security you (and the next generation or two) just have to fend for yourselves.

As if that weren’t enough, if you have education debt (the average is now $25,000) you face years of sacrifice just to get back to break-even.

Okay, now that you’re sufficiently depressed, what can you do about it?  Fight back, that’s what.  You can still overcome these challenges – by working not just harder but SMARTER.

Start by keeping in mind your longer term goal: financial independence.   You want to get there as soon as possible – and you can…maybe even as early as your 40s or 50s.  But doing so requires squeezing out as much monthly savings as possible, especially when you’re young.  How?  This is where doing things smarter comes in.

Don’t accept the norm, challenge it

Alright, you want to maximize your savings.  You can do that by increasing your income or reducing your expenses (or both).  For now let’s focus on the expenses.

A common savings approach involves micromanaging every expense.  That can work, but it isn’t the most efficient use of your time and effort because it doesn’t establish any priorities.  Alternatively, you can employ the “80/20 rule” to identify the relatively few expenses that inflict the greatest cash flow damage, and explore some creative ways to slash them significantly.   That’s the smart way to go.

What’s the biggest of the big? Housing.

Whether you rent or buy a home,

your cash outlay in just 5 years

can be as much as $60,000 to $100,000 –

unless you outsmart the system

Option 1:  Rent

If you rent an apartment or house at, say, $800 per month plus another $200 for utilities, after 5 years your total cash outlay will be a whopping $60,000.  Ouch!   And not a penny goes towards building wealth.  Talk about a double-whammy…a massive negative cash flow together with zero wealth accumulation.

Wealth Outcome: $0 (no asset acquired)

Cash Flow Outcome: $1,000 per month negative cash flow; $60,000 total 5-year outlay

Option 2: Buy a house

Alternatively, you could buy a house.  Let’s see what that does to your wealth and cash flow.  A $150,000 house would set you back $30,000 for the down payment.  Hmm…where’s that coming from?

In addition to the down payment you need to make monthly housing payments.  Assuming a 4.4% 30-year mortgage ($600 per month) plus $400 per month for property taxes and $100 per month for insurance, then your monthly housing cost will be $1,100.  The 5-year total cash outlay?   $101,000 ($35,000 down payment + $66,000 mortgage/taxes/insurance).

That’s a substantially larger cash flow loss – $41,000 larger – than renting, but at least you’d be accumulating some wealth in the form of equity (partial ownership of the real estate asset).  This is why a house is only a “2^nd Best” asset; it appreciates in value over time but it also generates negative cash flow, and lots of it.  Because of the large negative cash flow, Option 2 is still far from an ideal solution.

Wealth Outcome: $35,000 equity in home

Cash Flow Outcome: $1,200 per month negative cash flow; $107,000 total 5-year outlay

But you still need a place to live.  So how can you do so while minimizing the cash flow drain?  Answer:  Share.

Option 3: Share a rental

A 2-bedroom apartment will be a little costlier than a 1-bedroom – let’s say $1,200 per month vs. $1,000.  But if you share the apartment and split the cost down the middle you’re monthly rent falls to only $600.  That savings can really add up over time.  (And into savings is exactly where the money should go, by the way.)

Wealth Outcome: $0 (no asset acquired)

Cash Flow Outcome: $600 per month negative cash flow; $36,000 total 5-year outlay

Sharing a rental still yields a negative cash flow, but compared to the other options it is clearly the least negative.

But what about wealth creation?  Be patient, you’re working on it.  Here’s how:  Over 5 years you will have accumulated $24,000 in savings.  That’s almost enough for a down payment on a house.  (See our “Get Ahead of Vehicle Debt by Staggering Purchases” article for savings ideas to get you all the way there.)  Your wealth will come from a house, but not just any house — one that also creates a positive cash flow opportunity.

Your next step: Leverage housing to build both wealth and cash flow

In Part 2 we’ll discuss how you can get even farther ahead on the path to financial independence by increasing your housing wealth while also moving your cash flow from negative to positive.

*  Source: U.S. Bureau of Labor Statistics

Keith Whelan is Cashflownavigator's founder and author of the "Wealth is Good, Cash Flow is Better" e-booklet. He is a graduate of Columbia University Business School, teaches at Rutgers University, and has over 30 years experience in the banking and financial services industry. Keith, his wife Cindy, and their two sons live in New Jersey.