The psychology of managing and paying off debt

From: alexhormozi

Being “broke” can be a temporary status, and achieving financial well-being is largely a matter of decision and control [00:02:00]. The average American has a negative net worth, meaning even babies are “richer” because they haven’t accumulated debt [00:00:07]. Even minimum wage employees will earn over a million dollars in their lifetime, and median income earners around $3 million [00:00:16]. This highlights that simply earning money isn’t enough; where it goes matters [00:00:36].

Shifting Your Mindset

To overcome financial struggles, a fundamental shift in mindset is required:

• Decide to be Wealthy You must decide to become wealthy and believe it’s within your control [00:02:00]. This means switching from a victim mentality to one of being the most powerful person in your life regarding money [00:02:04]. Taking responsibility for personal financial situation
• Wealth is a Ratio True wealth is the ratio between what you earn and what you need, not just what you earn [00:01:30]. The number one rule of money is to spend less than you make [00:01:35].
• Be Rich vs. Look Rich Many people prioritize looking rich over being rich, seeking validation (“dabs”) rather than financial security [00:17:45]. The speaker, despite earning millions, lived on less than $15,000 a month because he disliked the feeling of needing money [00:01:20]. This financial mindset of wealthy individuals emphasizes being underestimated for how much money you have [00:17:41].
• Sacrifice for Success Becoming a millionaire often involves elimination, not just addition. This includes getting rid of unnecessary expenses, people who are a bad influence, and the impulse to show off [00:16:41]. If you’re not willing to sacrifice anything, you’ll never achieve your financial goals [00:16:51].

The Problem of Debt

A significant portion of American paychecks, 35%, goes towards paying banks and lenders for debt [00:02:17]. This happens because people often don’t perceive mortgages, car payments, or credit cards as “debt” in the same way [00:02:30].

• Compounding Against You Banks make money off money [00:02:44]. While people aim for 9-10% returns in the stock market, credit cards often charge 24% interest against them [00:02:57]. This is guaranteed negative return [00:03:09]. Compounding interest is often called the “Eighth Wonder of the World” [00:03:16], and fighting against it is a “bad idea” [00:03:23]. Philosophy on debt and financial risk management

Six Steps to Financial Freedom

Here are practical steps, some similar to Dave Ramsey’s “baby steps,” to manage and pay off debt, with a focus on psychological reinforcement: Personal finance habits and strategies Personal finance strategies Smart money management techniques

1. Save for an Emergency Fund (Small Start)

   • Begin by saving $1,000to$5,000 [00:03:45]. The goal is to build the habit of saving and see the amount grow [00:04:17].
   • Unexpected expenses (like a broken AC or car repair) are predictable in their occurrence, even if the specific event isn’t known [00:03:57]. Having this fund prevents new debt when life happens [00:03:51].

2. Pay Off Debt (Psychological Approach)

   • While logic suggests paying off the debt with the highest interest rate first, the psychological approach recommends paying off the smallest debts first [00:08:40].
   • This “debt snowball” method provides quicker “wins” and builds momentum, reinforcing positive habits [00:09:14].
   • Focus primarily on consumer debt and credit cards [00:09:41].

3. Expand Your Emergency Savings

   • After the initial fund, build a larger emergency savings of 3 to 6 months of living expenses [00:11:45].
   • This larger fund, kept in an interest-bearing account, significantly reduces financial anxiety [00:12:00]. It allows you to shift focus from “paycheck to paycheck” to seeing broader opportunities [00:12:10]. This money is for safety, not investment [00:12:21].

4. Eliminate Risky Spending

   • This step involves assessing and eliminating high-cost, depreciating assets or conveniences.
   • Cars: Trade in car leases for a cheaper, owned vehicle (e.g., a $5,000-$10,000 car paid in cash) [00:12:31]. Downgrade to one car if you have multiple [00:13:06]. Paying for convenience, like an extra car, can cost millions in lost investment potential [00:13:58].
   • Lifestyle Creep: Understand your “vice” – whether it’s shoes, clothes, vacations, or living in an expensive neighborhood [00:14:10].
   • Time Cost: Translate your expenses into the time it takes to earn that money. A $600/monthcarlease,ifyouearn$100/day, means working 6 out of 22 workdays just for your car [00:14:55].

5. Invest 15% of Pre-Tax Income

   • Automate investments into assets that grow over time, like the S&P 500 [00:20:21]. Make it “hard to spend, easy to save, easy to invest” by taking money off the top first [00:20:28].
   • Invest in Yourself: Consider allocating another 15% of pre-tax income into education and skill development [00:21:04]. Increasing your earning capacity through self-investment can yield higher returns than passive investments [00:24:22].
   • Daily Financial Check: Regularly check your accounts daily to maintain a “pulse” on your money. This allows you to track inflows and outflows, understanding where you can spend more (on returns) and where to cut [00:21:42]. Tracking finances daily to improve money habits

6. Pay Off Your Mortgage

   • Once consumer debt is handled, focus on paying off your mortgage [00:25:51]. This eliminates major fixed costs [00:25:55].
   • Living in a cash-paid-for house and car dramatically frees up your earning capacity, allowing you to invest more aggressively in your long-term legacy [00:19:53]. If basic expenses are covered, more time and money can be dedicated to investments or personal growth [00:20:00]. Balancing life priorities and financial goals

The Power of Compounding and Active Income

A small, consistent investment of $250amonthcompoundedat9$1 million in 40 years [00:10:16]. Increasing this to $500amonthcanresultin$2.1 million [00:10:37]. An extra $2,500amonthinvestedover55yearscouldyield$52 million [00:23:03]. This illustrates that wealth is a controllable decision [00:23:40].

The money that could be yours is being made by someone through compounding. The choice is whether it belongs to you or the banks and their shareholders [00:25:16].

The “30x12 Working Challenge”

To accelerate wealth building, consider pushing your limits: work 30 days straight, 12 hours a day, without days off [00:26:10]. This isn’t sustainable long-term but demonstrates your capacity to work harder than you thought [00:26:22]. By stopping unnecessary spending and using that time to make money, you double your positive impact by reducing the negative and adding to the positive [00:26:49].