Laura and I recently had dinner with a good friend and the topic of finances came up. Our friend is being really smart with her money and doing a lot of the right things to be responsible. However, after Laura and I got home, I got the sense that our friend just wanted someone to tell her what to do with her income, because starting out on a financial plan can seem so daunting and confusing.
I’m here to tell you that it doesn’t have to be either, and if we can do it, you can do it too. It doesn’t matter if you are young or old, rich or poor, savvy or carefree. We don’t have all the answers, but the Dave Ramsey plan works for us. I want to layout some simple steps and good tips to get you to the end goal: debt free living and financial peace.
First thing is first: Envision the end-goal. The best way to attain something well off in the distance is to set goals so that when the slogging gets tough, thinking of the end goal gets us through the valley. Our goal is to be completely debt free, including the mortgage, to never go into debt for anything, and to be financially secure when life happens. Imagine: No payments on anything! When that becomes a reality, think of the wealth one could be building and what could be done with that kind of freedom. If the car burns up, an addition to the house needs to be built, or if a jobless friend could use $10,000 as a free gift to help them out, it’s all okay, because the money is there. By living responsibly, we can be free to be generous and be protected from financial disasters. Think of your friends who live paycheck to paycheck. They have the plasma TV, the new car, the big house and the great clothes, but if one financial problem comes, they are in serious trouble. They will have to run to a credit card with 21% interest to get them out of their jam, or worse.
Don’t be that person!
Don’t be played for a financial fool.
Don’t risk your family’s security by buying things you can’t afford.
Envision the end goal, and before you know it, you’ll be there.
The next steps come from Dave Ramsey. It’s not voodoo or get-rich-quick stuff, it’s simple common sense. He and I promise you that if you follow these simple “life” steps, you’ll truly be set for life. To read more, visit Dave’s 7 Baby Steps:
Step One: Start a $1,000 dollar emergency fund.
Life happens: jobs are lost, cars break down, toilets overflow, and legs break. When this happens, you can go to your emergency fund instead of into more debt.
Step Two: Pay off all debt using the debt snowball.
List your debts in order of smallest to largest, and forget about what the interest rates are. Pay the smallest off first and move on to the next largest until they are all gone. Smallest to largest helps to pay off the small ones quickly, which gives you a small victory to feel proud of. Were I went wrong was to pay on several debts at the same time, so they all went down by a small amount each month, but nothing was being paid off. If you have a $400 loan on a camera, a $1200 loan on some furniture, a $5,000 student loan, and $10,000 car loan, pay the minimum on all the payments but the small camera loan. It will be gone in no time, and then take that camera loan payment and roll it into your payment on the furniture, and so on. The “snowball” effect will grow and quickly make all your debts disappear.
Step Three: Save 6 months of expenses in savings.
To be real safe, we put 6 months worth of paychecks in the bank for when life REALLY happens. Six months of expenses is one thing, but six months worth of paychecks gives us even more of a security blanket. Then, when the car is wrecked or the septic system needs to be replaced, a $15,000 dollar bill is much easier to swallow than if you have zero savings.
A tip here: If you have to dip into your savings to cover life events, then halt all discretionary or extravagant spending until the six month level is back in the savings account. By the way, new wardrobes and plasma TV’s are not emergencies.
Another tip here: Open an online savings account, like this InterstPlus one, to save your six month emergency fund in. Why? That much money just sitting there isn’t gaining any interest in a checking account but can gain as much as 2% (as of this writing) in an online savings account. The account links to your online checking account so that when you need it, it can be easily transferred in a day or two. Also, and more importantly, the money is liquid and accessible, but not too accessible. The separation of the online account to the simple checking account helps cut down the chances that it will be spent frivolously.
Step Four: Invest 15% of household income into Roth IRA’s and pre-tax retirement, like 401(k)’s and other employer plans.
By now you only have payments to the mortgage. Don’t fall into the trap of entering retirement with no mortgage, but also no retirement savings! Plan for the future right now. As Dave says, only people who want to eat Alpo don’t save for retirement. Many employers match a certain percentage of your payment to a 401(k). The rule of thumb is to contribute up to the match percentage to the 401(k) and then max out a Roth contribution. As of 2010, the cap on Roth contributions is $5,000 per year, per wage earner. Laura and I both max out a Roth in each of our names, so that makes $10,000 a year in contributions. The great thing about Roth money is that it is already taxed when it goes in (after tax money) so when it is withdrawn at retirement, it is tax free income. Need advice, call any investment company like Fidelity or Franklin Templeton — they will be happy to assist you (and take your money). Or, call these guys as they come highly recommended.
Step Five: Start saving for your kids’ college fund.
Kids already grown? Skip this (duh). Don’t have kids yet or single? Many 529 savings plans will let you put money into them with your name listed as the beneficiary, then when you have a child, you can switch the beneficiary to them. ESA’s and 529’s are really the only way to go. Google them for more info or follow the links.
Step Six: Pay off the mortgage early.
You are getting close now — let the debt snowball save you hundreds of thousands in interest and get to a place of no payments on anything. Paying just a little more than the monthly payment on a mortgage will save you thousands in interest and years on your payment. If you can afford it, pay double payments each month and watch a 30 year mortgage get paid off in a quarter of the time and save huge amounts of interest payments.
Step Seven: Build wealth and give.
Roll in the dough! Leave money for your future generations and give it away. You’ll have fun doing both. With no payments or debt, you have the freedom to be generous, and the ability to really build wealth. When Laura and I get to this stage (hopefully in the next three years) we will continue to save and invest so that our next house can either be paid for outright, or at the most, with a 15 year mortgage that gets paid off early.
Don’t be a miser.
Keep saving.
Give a lot away to truly enjoy your money.
Have fun!
Here are a few other tips I’ve learned from trying to live out the Dave Ramsey model:
One: Get serious about getting rid of the credit cards. If you have more than one, keep your favorite rewards card to save money on things like gas and groceries and then cancel all the others. Why have more than one? I’m trying to cut my addiction to credit cards because even though I get money back for using them and even though they are very convenient, I end up spending more money because of the convenience. On average, people who use credit over debit cards spend 12-15% more, so it negates any cash-back rewards program. Debit cards have the same protections that credit cards have, and are accepted nearly anywhere a credit card is. Also, you have to have the money in the bank to spend it with a debit card, whereas overspending and paying later is easy to do with a credit card. If you are a big credit user like me, ween yourself off by going down to one card, and then dump it when you are ready. Lastly, an emergency fund is critical: the worst time to put money on a credit card is during financial strife. Don’t keep the cards around “incase of an emergency” — that’s the last time you want to be using a credit card!
Two: Make a budget. You have to do this. Laura and I tried to spend less and be responsible without the roadmap and guidance from a budget, and it just doesn’t work. We would spend money, forget about it, and then wonder where it all went and never had much left over for savings. Budgets are easy to do and only take about five minutes a week to manage. Sorry, but if you don’t have twenty minutes a month to check on your money, there isn’t much hope for your financial future. The hard part is setting it up, but maintaining it is easy. Create a spreadsheet in Excel that shows the amount of each bill you have and what you spend your money on. You may forget a few items, but after a few months of tinkering, you’ll have most of what you spend your money on listed. At the top, we wrote in what we make each month. At the bottom is a total of all the places we spend our money. The bottom number simply needs to be equal to the top number. Then, commit to staying within the budget. If $100 is what can be spent on eating out, then don’t spend more than that.
Three: Make the online savings account work for you. We pay our property tax, income tax, home and car insurance, and other things either once or twice a year. So, we divide the total of those bills by 12 and make sure we are putting that much in the savings each month. Then, when a tax bill comes, no sweat, it’s in the bank, except it’s earned interest. We’ve found the best thing to do is find out how much money needs to go to savings or be spent each month. Two Roth’s is $X, mortgage is $X, insurance is $X, to our savings is $X, tithing is $X, and so forth, each month. Add that all up and say it comes to $3,000. If you are bringing in $4,000 a month, put aside 3K right away, so that all that is left is the 1K for groceries, eating out, etc. If you don’t put that money away first, it will get spent. If it is set aside first, instead of last, you can more easily stay on track with your budget and ensure you have enough money at the end of the month or year.
Four: Be as frugal as you can, especially while paying off debt. Here are some ideas to get you started. Off brand food doesn’t bite. Plan your weekly menu prior to grocery shopping. Never buy food while you are hungry. Cancel the digital cable and go with the basic plan. Lower the minutes on your mobile plan. Run a fan instead of the a/c. Have a garage sale. Have a second one. Don’t be afraid to negotiate a better deal (especially with the cable provider). Pack a lunch. Get water when eating out. Coast up to stop signs and drive slower. Don’t buy the latest gadgets — it makes you look like a goober. Don’t sample new and trendy things like iPhones or Plasma TV’s — they become a luxury you can’t live without, yet still can’t afford. Pay a little more for energy efficient windows and appliances. Add insulation to your attic. “Save a flush” in the middle of the night. Buy used cars. Always. Let some other dunce take the hit on the new car premium. We buy one year old cars with less than 10,000 miles, and have saved over $13,000 in two purchases by doing so. Someone else paid that 13K for us! Don’t buy premium gas. Always check the coupon pages. Utilize Craig’sList and UPillar. Don’t rent. Don’t have kids you can’t afford. Never buy on credit. Buy high quality items once, instead of cheap items over and over (like lawnmowers, computers — don’t waste your money on windows, power tools, etc). If you have more ideas, post them below.
These are some things that have worked for us, and Dave’s baby steps are definitely the way to go. Good luck, have fun, and invite me to your mortgage-burning party! Got a financial tip? Share it with all of us below.