What to do with your gap

You’ve created a gap between your income and expenditure! YAY. That alone can be a big task. We are proud of you.

Now you have got a gap, what the heck do you do with it?

This is where Katie and I got stuck for a long time, we let it build up in a savings account, we paid off the mortgage, basically we did a bunch of sub-optimal things before we worked out what to do with our gap.

There are some simple steps that we followed that we think will help you as well. Let’s get to it!

Step 1: Build an emergency fund

Build an emergency fund of £1000 (or the equivalent in your currency). The emergency protects you if shit goes wrong. The washing machine breaks, the car blows up or something happens.

Instead of having to borrow on a credit card (the norm for a lot of people) you can use your emergency fund to protect you and deal with the problems.

The fun thing is that once you have build your emergency fund things start to stop feeling like emergencies are are far easier to deal with.

Step 2: Pay off expensive debt

Debt is a huge drag on your financial progress. Asset compound and make money for you, debt compounds against you and drags you bag down. This has to go.

We say pay off expensive debt because there are types of debt that aren’t too bad. You can live with them. For example the mortgage on your house. Maybe you have fixed in at a super low interest rate or less than 3%; there is no need to pay this off quickly. It is far better mathematically to invest and leave the mortgage set to minimum payments.

However if you have a credit card at 25% interest or a overdraft at 40% interest that stuff is killing you financially. This needs to be paid off, destroyed, got rid of quickly.

Step 2: Pay off expensive debt (anything over 5% interest). For example credit cards, store cards, loans as quickly as possible.

Step 3: Expand your emergency fund

£1000 / $1000 is a brilliant start for an emergency fund but let’s be honest. It won’t cover the bigger stuff, what if you loose your job, what if the car blows up. We need a bigger reserve to be fully protected from these things.

The next step is to build up a fully funded emergency fund that is 3-6 months of living expenses. This is NOT income, this is expenses. If you spend £2000 a month then you would need an emergency fund of between £6000 (3 months * £2000) to £12,000 (6 months * £2000)

Why the range? Some of you have super safe jobs, you work for organisations where it is hard to get fired and you have a very secure income. You don’t need as big of an emergency fund. On the other hand some of you work for companies that are more ruthless or in industries where turnover is fast. If you are more likely to have a change in income then you need a bigger emergency fund to protect you.

This is where it is down to you. The one caveat here is the more you hold in cash, the bigger your emergency fund the bigger the drag is against inflation. i.e. that cash is just sat there and being erode by inflation each year. So a smaller emergency fund and getting on to the next step is better financially but leaves you open to more risk.

Step 3: Expand your emergency fund to 3-6 months living expenses. Read this article for more details about emergency funds.

Step 4: Invest in assets

After fully funding your emergency fund you take your gap and start using it to buy assets. This is a HUGE step and where you start to get ahead. The more assets you buy the more then make money for you whilst you are sleeping. Eventually the aim is to buy enough assets that they produce more income on their own than you need to live! This is financial freedom, this is financial independence.

You might be a long way off that right now and just starting on this step after creating your fully funded emergency fund but that is ok. Now you are here, compounding is going to start to work for you and it gets quicker and easier as you go.

However this is the step Katie and I got stuck on for years. We wanted to buy assets. We knew we need to buy assets to get ahead but where? How? It is not as if there is an asset shop next to the Greggs on every high street. This one step was so challenging for u to over come. We want to share with you everything we have learnt over the years buying assets that didn’t work for us, investing in property and then discovering index investing.

This is a HUGE topic.

The journey

The four steps above might sound easy but they can take years to move through. You might build up the initial emergency fund quickly but then it may take a year of two to get out of debt. Then you build up your fully funded emergency fund and start investing. It takes time, but this is a journey that will change your life for ever.

One things that makes the journey easier is community. Having people around you to work with, chat to, that understand where you are in the journey and are supporting you.

We build the Rebel Finance School Facebook community to be that home and community to support us all. Feel free to join us there. inside you will find the amazing Rebel Ninjas and some super smart, kind and generous people that want you to win.