This is an updated posts the original post can be found here.
On our path to developing a strong financial foundation, it is important to keep increasing our financial literacy and knowledge. One way to do that is to read literature from different financial experts, via blog posts, articles, and books. While telling people about my blog posts and my passion to educate others in personal finance the author of today’s source material kept coming up. After, the third time, I took the hint and decided to look into his work and read one of his books.
The author is non-other than Dave Ramsey, a financial maestro, whose approach differs because of its practicality and simplicity. Ramsey offers no quick fix but requires a commitment from participants of his, Total Money Makeover, (the same name as his book) which promises financial independence when carried out to the T. Dave is a no non-sense, no fluff author who is an unapologetic Christian and its depicted in his writing. Christian or not, I recommend a quick read through his, Total Money Makeover, for its valuable information and encouragement. The book is filled with testimonials from practitioners from all different lifestyles and careers who used the seven-step system themselves. I personally, skipped over most testimonials because I wanted to finish the book and start applying the steps to my own life. In this blog post, I will layout the seven-step system (summarized, shorten form, not really giving the complete details and recommend reading the book yourself) and give my opinions on some steps.
The Total Money Makeover Steps
(Prior to step one Ramsey mentions the importance of getting all bills current and to setup a budget.)
Step 1) Save $1,000 Fast: The first step is to set up an emergency fund. This 1,000 is for those unexpected events such as car problems, medical bills, job loss, home repair etc. that requires preparation. This $1k is not a lot but it deters us from going for those credit cards once a problem arrives. Ramsey wants readers to do whatever it takes legally to get that $1k as soon as possible. For example, work overtime, get a second job, sale possessions and get the creative juices flowing.
Step 2) The Debt Snowball: This technique utilizes (according to Ramsey) your most powerful wealth-building tool, your income. Imagine how much money you would have if you have no debt payments. To utilize the debt snowball technique: first list your debts from smallest to largest, next put any extra income to pay off the smallest debt while you pay the minimum due on the rest. Once the first one is paid off, take the money you used to pay it off and use it on the next debt until that is paid off. Repeat the snowball until you are debt free. Here is a link to the worksheet with instructions here. I had an issue with this step at first because he mentioned not contributing to your 401(k) and using that money to pay off the debt. I objected because the company match is free money and you'll miss out on the compound interest. However, I see losing compound interest as a motivator to get us to hurry up and pay off the debt so we can start accumulating it again.
Step 3) Finish the Emergency Fund: You are now debt free except for your mortgage and are ready to stuff that emergency fund. A full-grown emergency fund (E-fund) is three to six months of salary. How many months you save depends on your personal situation and how much padding you need in case of job loss/income. Ramsey defines an emergency as, “things you had no way of knowing was coming…[it] has a major impact on you and your family if you don’t cover it”(Ramsey 136). For example, the deductible on medical, homeowner, car insurance after an accident and a job loss are emergencies. Emergencies are NOT, something on sale, fixing the boat (unless its home), I want to start my own business, college tuition and vacations (Ramsey 136). Your budget should have room for those items. Lastly, the E-fund should be easy to access with no penalties; Ramsey suggests Money Market accounts with no penalties and full check-writing privileges.
Step 4) Maximize Retirement Investing: Now you are debt free except the mortgage, you have a fully funded emergency fund and you are ready to set yourself up for retirement. Ramsey promotes investing 15% of your income in retirement. Do not do more than 15% because you need other funds for the next steps in the plan. Whatever percent your employer matches in the 401(k) max it and deduct it from the 15%. For example, if your employer matches 6% match it and take the remaining 9% to invest yourself. Ramsey advocates splitting your investment into four types of growth stock mutual funds. In his plan, 25% would go to growth and income funds (aka Large Cap and Blue Chips), 25% to growth funds (aka Mid Cap, Equity Funds or S&P Index Funds), 25% international funds (aka Foreign or Oversea funds) and 25% to aggressive growth (aka Small Cap or Emerging Market Funds). I suggest meeting with a financial expert and discussing how you want to diversify.
Step 5) College Funding: In this chapter, Ramsey expressed the importance that college does not ensure success and that it only teaches knowledge. I really liked that point because it is a myth that needs to be debunked. Ramsey rules for college are, first pay cash, second if you have the cash or scholarships go and lastly student loans are a cancer you cannot get rid of. Ramsey advocates the use of Educational Savings Accounts (ESAs aka Educational IRAs) funded in a growth stock mutual fund. They grow tax-free. Use ESAs only if you start it fully funded and your child is under eight years old. For children over eight, Ramsey recommends 529 Flexible plans (Flexible Only). The 529 Flexible plans are for those whose income disqualifies them from ESAs and if your child has extra schooling in their future like medical school.
Step 6) Pay off the Mortgage (This chapter was very information rich and requires personal study): By this step, you are debt free except your mortgage, have a fully loaded E-fund, got a retirement plan working for you and you are saving for the kids’ college. Now you are ready to pay off the mortgage. Ramsey advocates, 15 year, mortgages because you will pay less interest over time and it will keep you motivated. Ramsey mentioned, that people who take out 30 year mortgages and tell themselves they will pay it off early rarely do. The 15 year mortgage on the other hand will get paid off because you are motivated to do whatever it takes to make that mortgage payment. In addition, Ramsey recommends never having a payment over 25% of your take home pay.
Step 7) Build Wealth Like Crazy: You made it to the final step. You are debt free, have a fully funded E-fund, retirement is set, kids college is set, and you own your home. Now is the time to use that money of yours to build wealth. It is time for your money to make money, even when you are not working, even while you are sleeping. Ramsey recommends, putting together a wealth building team of experts (you can afford it) but making the final decisions yourself. No one cares more about your wealth than you do. This team of experts should include an estate-planning attorney, a CPA or tax expert, insurance pro, an investment pro and a good realtor. In addition, he recommends the use of simple mutual funds and debt-free real estate. I recommend studying millionaires for ideas of how they accumulate wealth and have their money work hard for them so you can to emulate them.
As you can see, these concepts are nothing new and have been around for years. Ramsey offers no get rich quick or easy way out. His plan requires work, grit, discipline and communication with your spouse and children. They need to know your financial goals and understand the sacrifices the family has to make in order to obtain them. Family sacrifices such as, longer nights at work due to overtime, second jobs, each spouse working if possible, living on a budget, staycations, and not caring about keeping up with the Jones. Personally, I like the practicality of Ramsey’s approach. After reading his book, I committed to the, Total Money Makeover, and started driving for Lyft for a short period as a way to make extra money to get the snowball rolling. As a result, I was able to pay off one of my student loan that was close to being paid in full. Next, I will take the amount I paid on that loan and divert it to the second loan on the hierarchy. I recommend Ramsey’s book for a concrete plan, inspiration, and to increase your financial literacy. I want to highlight the importance of a balanced life. Having a plan and seeing it work for you is great, but I advise you to make time for the important things in life.
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Reference and Useful Tools
Ramsey, Dave. The Total Money Makeover: A Proven Plan for Financial Fitness, Classic Edition. Nelson Books, 2003