Ever since last September our (or arguably before then) our economy has been in a downturn.  Big companies, small lenders and consumers all engaged in irresponsible behaviors that resulted in the failure of  businesses, and necessitated the bailouts of many others.  People are being laid off left and right,  and things are extremely tight!  So what’s a person to do when times are so hard?  Give up and wait for things to get better?  Wait for the government to give them a job?

How about this:

• Don’t participate in all the doom and gloom.
• Don’t wait for the government to create a program to pull you out of the muck and the mire.
• Don’t participate in the recession.

Instead, create your own mini economic boom!

• Have some hope and be ready to accept your own future that’s bigger and brighter than anything you can imagine.
• Realize that things aren’t necessarily as bad as they’re made out to be because you’re in charge of your own destiny.
• Create your own economic plan, set up a budget, and start saving an emergency fund in case you’re hit with a setback.
• Be ready to seize opportunities as they arise – even in hard times opportunities to succeed abound!
• Get an extra job or create your own side income.
• Have hope!

Have hope.  When you have hope, it’s just a matter of time before things turn themselves around.   Decide that you’re not going to participate in the recession, and that you’re going to have the best year you’ve ever had! Remember, God loves you, and you are important to him – so you will have the things you need:

Indeed, the very hairs of your head are all numbered. Do not fear; you are more valuable than many sparrows. Luke 12:7

Dave Ramsey is hosting an event in April called “Town Hall For Hope“.  The event, which will be streamed live to thousands of churches and other locations across the country will be a time to get together, talk about the economy, strategize and figure out ways to improve your situation.  From the site:

Connect with families across the nation for a truly radical message: HOPE.

Tired of hearing the fear, doom and gloom that’s filling the airwaves? Join Dave Ramsey for a nationwide town hall meeting and discover what’s happening with the economy, how we got here, and where we’re going.  Plus, Dave will answer your questions live throughout the event!

Join with me in attending the Town Hall For Hope event on April 23rd at a location near  you, and have hope! Click the banner below to go to the website.

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Are You Participating In All The Doom And Gloom? Don’t! Have Hope.

When we were taking Dave Ramsey’s personal finance course, “Financial Peace University” last year, one of the things he stresses in his course is the need to have someone in your life who can keep you accountable for your financial goals.   For single people it might be a close friend, a mentor or a parent.  For those of us who are married, it’s usually going to be our spouse.

photo credit: Sami Keinänen

I hadn’t really thought about how important it was to have someone there to help keep you in line, until after we had taken the class. Since then I’ve seen time and again how much my wife (and accountability partner) actually does keep me in line.

Keeping Each Other Accountable

For example, this year the bug has bitten me to get that new 50″ Plasma TV.  We love watching TV and movies at our house, and I have been able to rationalize getting a new big screen TV as being something “we need”.   After all – the digital transition is happening this year!  Never mind the fact that we already have a TV in almost every room, and the fact that our basement entertainment room already has a nice big 37″ LCD in it!

My wife has reminded me how we really don’t need to get the TV, and how we should just put it off so that we  can focus on our other goals.

On the other hand my wife likes to buy souvenirs of all sorts when we’re on vacation. Whether it’s the little replica of the leaning tower of Pisa, or the $75 piece of Venetian glass, she likes to buy things to commemorate our trips and remember them through the years. I am there to help keep her accountable though, and to make sure that we stay within our allocated souvenir budget. If she starts buying too much or wants to get something that’s too expensive, I’ll step in and remind her that we’re spending on a budget.

Two Is Better Than One

Here’s a verse that speaks to how important it is to have someone who will be there for you, and help keep you accountable:

Two are better than one because they have a good return for their labor. For if either of them falls, the one will lift up his companion. But woe to the one who falls when there is not another to lift him up. Ecclesiastes 4:9-10

When either of us fails and is ready to give in to the temptation, the other is there to lift the other up and give good advice.  If I were on my own I know I would have failed many times, and probably would have 3 50″ TVs scattered throughout the house.  Instead we’ve been spending our money  much more wisely, and building towards our future because we are keeping each other accountable.

Tips For Better Accountability

There are a few things you need to do in order to make sure that you will have a successful relationship with your accountability partner.

1. Set Up A Plan, And Give Your Accountability Partner A Copy:  Write out a budget for your household, set goals for saving, investing and/or debt reduction.   Go over your plan with your accountability partner, and get their input and advice.  If they make good suggestions for changes to the budget, make them!
2. Set Up Regular Meeting Times To Talk:   Have a regular budget meeting if you’re talking with a spouse, or a lunch date if your accountability partner isn’t your spouse.  Talk to them about how you’re doing with your budget, temptations you may be having in the financial area, and even go over a set of accountability questions to make sure you’re doing ok.  Keep track of your spending and purchases, and allow them to go over them with you, pointing out places where you might be able to cut things out.
3. Allow Your Accountability Partner To Be Brutally Honest:  If the person keeping you accountable sees things that are concerning in your budget, allow them the latitude to be completely and bluntly honest with you.  If they are able to really be open with you, you’ll stand a much better chance of getting good advice.

Are you working with an accountability partner in the area of your finances?  Has it helped you on your path towards financial success? Let us know about it in the comments!

Copyright © Bible Money Matters - please visit biblemoneymatters.com for more great content.


Accountability: Sometimes You Need Someone To Slap You On The Back Of Your Head

This is a guest post from Philip over at http://www.weakonomics.com.    Please check out his blog where he writes about personal finance in an edgy, yet entertaining way. You can subscribe to his RSS feed here. I may not agree with everything he’s writing here,  but I think it’s important to get more than one viewpoint.  So here it is, take it away Philip!

We’ve all been following Pete’s series on Dave Ramsey’s baby steps program with the utmost interest. As someone that has never struggled with debt, the need for the program has never presented itself to me. However I discovered his radio show in college, and really like the call-ins from listeners with financial problems. The show was successful in inspiring me to proceed through life with a debt-averse attitude.

But between listening to Dave on the radio and listening to financial planners and my finance professors, a general consensus emerged that Dave may not be doing what is best for someone looking to get their financial house in order.

Examples? Okey dokey. Let’s start with the simpler things and work our way up.

Say you’re in step 2, making that debt snowball. You’ve got $1,000 credit card balance at 12% and a $1,500 credit card with a 15% rate.  Since Dave wants you to start with the smallest debt, he is asking you to pay off the credit card paying at a lower interest rate! If you wanted to save a little on interest payments,  start with the $1,500 credit card charging you 15%, otherwise Dave is just telling you to throw money away. You’ve heard that one before I’m sure; Pete even covered it.

But now say you’ve got a $2,000 balance on a HELOC at 6%, and a $10,000 car loan at 5.5%. Well by your rules and mine it makes sense to pay down the HELOC. Wrong again. HELOC interest is tax deductible, plus the minimum payments are often very small. Use the HELOC to pay off the car, and now you have $12,000 in tax deductible debt and the advantage of smaller payments in case money gets tight. As a bonus, sell the car and get a “beater,” using the proceeds to pay down debt.

Interest rates are fine and all, but Dave isn’t just about abolishing debt, he wants you to invest too. Dave tells you to invest 15% of your income, and that you can expect a 10-12% return. As a 20-something just starting out in my career, this may be appropriate. But as a 30-something, if you’re just starting to invest for retirement, 15% will not be enough. If you’re clearing your debt at age 40, you’d be lucky to get decent retirement before you hit the ¾ century mark. Why? Because the median family income in this country is $50,233. Less than 16% of families make more than $100,000 a year so your chances are slim. If you’re 30 and making $50,233 a year and invest 15% of your income, you will not have enough to retire on in 35 years.

Another problem with Dave’s investment advice is risk tolerance. Dave suggests you diversify your investments into four categories:

• Growth
• Growth & Income
• Aggressive Growth
• International

Every one of these categories is more risky than the S&P 500. This makes for a larger potential payoff, but you need only to look at sub-prime loans to see how the risk/reward relationship works. A proper balance should include bonds, value stocks, and index funds. As you get nearer to retirement, you will want to move closer into bonds. Their fixed income will reduce your potential return, but increase your chances of preserving what you’ve made. As someone who understands the risks of investing better than most, I would laugh at someone who thought they were diversified with a any portfolio balance of just the 4 categories above.

And what about that 10-12% return I spoke about earlier? If there is a mutual fund out there that has averaged 12% for 30 years please point me to it; because I haven’t found it. A common error made by Dave Ramsey and anyone else out there that talks about investments is the fees in mutual funds. Vanguard, the prince of cheap funds, has expense ratios of about 0.15% for it’s index funds. But Ramsey’s recommendations aren’t index funds, they are managed money funds. Managed money funds range from 0.5% to 2% or more in fees! So even if you find that wonderful 12% returning mutual fund, take a look at how much of your 12% is eaten by fees. A much more realistic expectation is 8-10% in true returns.

Okay, so I’ve established that there are some mathematical flaws in the Dave Ramsey plan. Wow, I’m probably the first person to do that, ever. But I’m not here to tell you Dave’s plan is a failure. I actually believe that no one out there can help you get your finances in order better than Dave Ramsey. Yes after wasting all your time above, I’m now telling you how great he is. Money is 75% mental, and Dave knows that better than anyone else. He designed a plan that helps you get your mind in order first. No one can motivate you better, no one has the powerful support structure, and no one has as many success stories as Dave Ramsey. If you are looking to get debt free, Dave is the way to go.

The caveat to this comes after Baby Step 3. When you’re on Baby Step 4 and setting up your investments, make sure you do due diligence. Read, research, regurgitate. That is to say absorb investment books and read finance blogs, then conduct your own research about investments, finally go and talk to an investment councilor. As Dave says, “find someone with the heart of a teacher”, but also find someone who is not paid on commission.

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Where Dave Ramsey and I Part Ways

Over the past couple of weeks we’ve been doing an in depth look at Dave Ramsey’s Baby Steps plan for getting out of debt, building wealth and giving.   The plan really is a pretty simple one, some might say it’s common sense,  but it brings home a lot of concepts that a lot of us don’t normally think about.

I thought it might be helpful to go over the baby steps one more time before we close out the series to take one last look at them, and how they can help you.

Dave Ramsey’s 7 Baby Steps

Here are the steps – one through seven.  If you want a more in-depth look at one of the steps, just click on the link below to go to the page with the full explanation of that step.

• Step 1 – $1,000 to start an Emergency Fund
• Step 2 – Pay off all debt using the Debt Snowball
• Step 3 – 3 to 6 months of expenses in savings
• Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement
• Step 5 - College funding for children
• Step 6 – Pay off home early
• Step 7 – Build wealth and give!

7 Baby Steps, so where does it all start?

Baby Step 0: Getting Started, Making A Decision To Change

Before getting started on the Baby Steps plan you may not have ever thought about working on your finances before. You just kind of let your money happen to you.  To get started on this plan you have to make a conscious decision to care about where your money is going, and to live responsibly and within a budget.  For many of us, this will be a quite the shift.

For some people they won’t want to make a change until they’ve hit rock bottom, facing a foreclosure or bankruptcy.  Hopefully you’re getting started before reaching that point.  Whatever point you’re at, just remember that you’re not alone, and you’re making this change to make your family’s lives better.  It won’t be easy, but nothing worth having ever is!

Commit yourself to living within a budget, and to creating no more consumer debt!  As long as you’re creating new debt, none of this plan will work!  Once you’ve made the decision to make a change, cut up the credit cards, get on the same page with your significant other (if you have one), and move on to step 1!

Baby Step 1: Save A $1,000 Baby Emergency Fund

Baby step one is where you start building up an emergency fund for your family to cover any incidental and emergency expenses that might come up while you’re paying off all the debt you’ve created.

Some people don’t feel secure with only $1,000, and depending upon your circumstances, you may need slightly more.    But $1,000 is a good starting point, and for most families will be more than adequate to cover the little expenses that come up for every family.

Get “gazelle intense” about saving that first $1,000.  Most people will get it saved in the first 1-2 months of the plan.

Baby Step 2: Pay Off All Debt Using The Debt Snowball

In baby step 2 the family starts their debt reduction portion of the plan.   This is often the hardest part of the plan for most families, especially if a large amount of debt has been created.

To get rid of the debts Ramsey has put together what he calls the “Debt Snowball”.  In this plan you setup a debt repayment plan where you pay your necessities first (food, clothing, shelter, transportation), and then you pay the minimums on all of your debts.  Once the minimums are paid, you pay as much extra as you can on the smallest debt.  You continue doing that every month until the smallest debt is paid off.  Once that debt is paid you “snowball” all the extra money created by paying that debt off into the next smallest debt.   You continue doing that until all of your debts are paid off.

Some people can get the debt paid off within a few months, where others can take a few years.  In either case it will sometimes be helpful to get part time jobs, sell stuff and do other things to temporarily create extra income to help pay off the debts.     Once the debts are paid off you can quit those part time jobs because you’re debt free except the house!

Baby Step 3: 3-6 Months of Expenses In Savings

In baby step 3 you continue building that emergency fund that you started in baby step 1.  Starting from the baby emergency fund of $1,000 you build your reserves until you have 3-6 months of expenses saved in an easily accessible savings account.    Depending upon your family’s expenses, the amount you’re saving up will be different, and some people will prefer to build up more than 6 months of expenses depending on their desired level of risk, and what they feel comfortable with.

Remember, you’re saving up this money to help eliminate much of the risk that comes from the “little murphies” or life’s unexpected events that just seem to pop up.  Things like car troubles, medical expenses and job losses.  When you have the emergency fund buffer, it makes these life events seem more like bumps in the road instead of horrible car wrecks.

Baby Step 4: Invest 15% Of Income in Roth IRAs And Other Pre-Tax Investments

After you’ve saved up your 3-6 months of expenses it’s time to get cracking on investing and saving for your retirement.    Dave Ramsey suggests saving at least 15% towards retirement, and saving it in a Roth IRA or other pre-tax investment.  The order he suggests saving for retirement is this:

• Company 401k or other plan up to the match
• Roth IRA for you and your spouse
• Back to the 401k or other plan

Some people debate on whether 15% is enough to invest, or what types of investments are the best.  For me I believe the key is just to get started investing, and do it now!

Baby Step 5: College Funding For Children

After saving 15% of your income for your retirement, it’s time to save for your child’s education!  Some people think that this step should come before step 4, but Ramsey stresses the point that your child will have other options to help fund their education if they need to including scholarships, grants, working part time and other things.  If you don’t fund your retirement, however, you’ll never be able to get that money back!  Fund retirement first, and then your children’s college.

Some good places to save for your kid’s education include:

• Education Savings Account (ESA):
• 529 Plan

Other options exist as well, but the above options are the best.

Baby Step 6: Pay Off Your Home Early

Once the children’s college is paid for, it’s time to start making extra payments on your house! There are a lot of good reasons to pay off the house, including:

• Less Risk:  With no house payment and a fully funded emergency fund, there aren’t many things that can happen (like a job loss) that can threaten your well being.
• Peace Of Mind:  With no house payment you’ll be free to do a lot of things with your time and money that you might not have been able to otherwise.
• Interest Savings:  By paying off the house early you’ll save thousands in interest.  The earlier in the life that you pay the mortgage off, the better you’ll do!
• Less Stress:  With no worries about losing a house, paying off debt, or small expenses coming up, you can live  a more stress free life!

Paying off your house will free you up to do so many things with your time and money!  It’s like getting a raise since you’ll have all that extra money every month.  With that extra money you can save, give and live like no one else!

Baby Step 7: Build Wealth And Give

The last step of the baby steps is the one that gets me the most excited – building wealth and giving!

When you are debt free and you have no large payments like a mortgage, it frees you up to begin building wealth, and it allows you the freedom to help others with the blessings that you’ve received.

As a Christian I feel called to give to others, and getting to baby step 7 is something I look forward to because it will allow my wife and I the ability to help others out even more than we are now!  We are stewards of everything that God has given us, and God wants us to give because giving to others makes us less selfish people, and better in every aspect of our lives.  Less selfish people are more successful in relationships, business and in life in general.  Plus, we are happiest when we are serving and giving!

Conclusion

Thanks for taking the time to look at Dave Ramsey’s 7 baby steps with me, it has truly been a lot of fun for me.

I really do believe that his plan is a good one, and can help others as it has helped my wife and I.   If you’re looking at your checkbook and accounts and you have a mountain of debt – don’t delay! Get started on getting out of debt today!  Step one is only a decision away!

Live like no one else today so that tomorrow you can live like no one else!

Copyright © Bible Money Matters - please visit biblemoneymatters.com for more great content.


Dave Ramsey’s 7 Baby Steps Review: Get Out Of Debt, Build Wealth And Give.

Last time we looked at Baby Step 6,  paying off your home early.  We talked about how much freedom paying off your house would give you, allowing you to really save for retirement, give and live like no one else!   Today we’ll be closing out the baby steps with a look at building wealth and giving to others.  In my opinion giving to others is of the best reasons to build wealth.  You always get back more than you give!

Dave Ramsey’s 7 Baby Steps

• Step 1 – $1,000 to start an Emergency Fund
• Step 2 – Pay off all debt using the Debt Snowball
• Step 3 – 3 to 6 months of expenses in savings
• Step 4 - Invest 15% of household income into Roth IRAs and pre-tax retirement
• Step 5 - College funding for children
• Step 6 – Pay off home early
• Step 7 – Build wealth and give!

Baby Step 7: Build Wealth And Give

Baby steps 1-6 are all about getting your financial house in order, paying off debt, and then planning for the future.  Step 7 looks at what Dave Ramsey likes to call the “Great Misunderstanding”.    The misunderstanding, in Ramsey’s eyes, is the mistaken belief that many people hold that the way to have more, is to hold on tightly to what they have.  In reality, it doesn’t work that way, generous people tend to be more prosperous.  The reason?  Giving to others makes you less selfish, and less selfish people have more of a tendency to do better in both relationships and in wealth building.

He gives an example to think about the concept – if you take your money, and close your fist around it, you have that money and it’s not going to get away.  On the other hand,  you can’t receive more money in your  hand either, it’s closed up tight.  When you freely give with an open hand, however, your hand is already open and is ready to receive blessings as well as give.

The idea of holding money with an open hand might seem to violate common sense. We feel that if we don’t hold on tightly to our money and our relationships, they will slip away. I’m not saying literally hold your money with an open hand – it represents our attitude toward money. When you give, you open yourself up. You allow the dollars to leave and the freedom to enter.

Giving works because it is in your personal blueprint to be a giver, and you unleash good things in your life that you will never see until you learn the art of unselfish giving. Giving lifts us out of ourselves; we take our eyes off our rights, our problems, and our stuff. The new view gives us renewed vision and hope. Giving is powerful. – Dave Ramsey

So once you’ve reached the point where you have all your debts paid, and you’re blessed enough to be building surplus wealth, do yourself a favor, and start giving to others. You’ll be surprised at how freeing and wonderful it can be!  Not only will you be giving blessings to others, but you’ll be receiving blessings in return (and not always in a monetary sense).

There  are men who gain from their wealth only the fear of losing it. – Antoine Riverolli

Surplus wealth is a sacred trust to be managed for the good of others.  – Andrew Carnegie

Reasons Why We Should Give

When you talk about giving, there are a lot of good reasons why we should do it.  Here are a few:

• As a Christian, I believe that everything is God’s, and as a result, we are only stewards of everything we have.  Psalm 24:1 says “The earth is the Lord’s, and the fullness thereof”.  We need to be good managers of what we’ve been given, using it for the good of others.    The fact that that the money is someone else’s (God)  make’s it easier to give away too, doesn’t it?
• Giving makes us less selfish people.   Giving makes us more Christ-like.
• We are designed in God’s image, and because of that we are happiest when we are serving and giving.    Ever notice how fulfilling it is to serve others?
• Giving can be praise and worship in which we show our gratitude to God for everything he has given us.

Get Creative About Giving!

When you’re giving, you don’t always have to wait until your financially secure because giving doesn’t have to be related to money.    There are a lot of ways you can give of yourself and your time that are just as valuable.   Here are some ways that you can give, both with money, and without!

• Help a single mother buy groceries or pay a couple of bills.
• Volunteer time at your church serving others.
• Give an extra large tip to a waiter or waitress.
• Spend time with people at a local nursing home, talking and listening to them, playing music for them or just playing games with them.
• Pay for someone’s meal behind you in line at the fast food restaurant.
• Serve meals at a local food shelf, and eat with them when you’re done serving.
• Give to a local charity.

Those are just a few ways you can help.   Your own giving is only limited by your creativity.  So get started!

What are some creative ways that you’ve given to others around you. How does giving make you feel?  Let us know in the comments!

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Dave Ramsey’s 7 Baby Steps: Step 7 – Build Wealth And Give!

Last time we looked at Baby Step 5,  college funding for your children.   We talked about how and when you should save for their education.    Today we’ll be looking at taking extra money and paying off your home early.  Before we jump in,  once again, here are the 7 Baby Steps.

Dave Ramsey’s 7 Baby Steps

• Step 1 – $1,000 to start an Emergency Fund
• Step 2 – Pay off all debt using the Debt Snowball
• Step 3 – 3 to 6 months of expenses in savings
• Step 4 - Invest 15% of household income into Roth IRAs and pre-tax retirement
• Step 5 - College funding for children
• Step 6 – Pay off home early
• Step 7 – Build wealth and give!

Baby Step 6: Paying Off Your Home Early

After having saved for your retirement and putting money away for your children’s college expenses, the next thing Dave Ramsey suggest doing is paying extra on your mortgage, and paying off the home early.

To start with Ramsey suggests getting no more than a 15 year fixed rate mortgage, that is no more than 25% of your income.  If you don’t already have a 15 year fixed mortgage, now may be a good time to refinance your home with the “Making Home Affordable Refinance Program“.   A 15 year mortgage may mean higher payments, but it also means you’ll be paying the loan off earlier, and you’ll be paying less in interest.  Pay it quicker that 15 years, and you’ll save even more because most of the interest is paid at the front end of the loan period.

By paying off the mortgage early you’re also going to be giving yourself a huge peace of mind knowing that your house is paid off, and if the worst happens, you’ll be able to get by on a whole lot less. After all, the house is paid for!

Arguments For Paying Off The House

There are a lot of arguments surrounding this baby step, and whether it really is the best thing to do psychologically and financially.    I know I won’t solve that debate here today, but I thought I would look at some of the points in favor and against this plan, so you can make the decision for yourself.

Points in favor of paying off the mortgage early:

• Interest Savings:  You’ll be saving thousands of d0llars in interest payments on the mortgage.   For example, on a 200,000 dollar mortgage over 30 years, with an interest rate of 6%, you’ll end up paying over  250,000 in interest.  Cut that to a 15 year mortgage and you’re only paying 115,000 in interest.  The faster you can pay the mortgage up front (when you’re paying the most interest), the less interest you’ll pay!
• Less Risk:  By prepaying your mortgage you’ll have less risk in your life because you’ll have a paid off house.  When you have a paid off house you have a lot less to worry about because you know you’ll at least have a place to live as long as you cover the few bills you have left.  Plus, trying to beat the the benefit of pre-paying the house by investing the extra money instead means added risk because investing isn’t a sure thing.  (As we’ve seen for sure these past few months.)
• Peace Of Mind: Having a paid off house means having peace of mind.  I don’t think the importance of that can be underestimated.   Having debt of any kind can really be a extra weight on your shoulders, and it can weigh you down.   Don’t underestimate the psychology of personal finance, and that burden is very real.  Remove it and you will feel a lot more free to save, invest, build wealth and give!
• Less Stress:  You’ll have less stress when having to deal with a job change, or wanting to have a spouse stay home to raise the children.   Because you have a paid off house you’ll only have a few small bills to worry about. You’ll have walkaway power – power to walk away from any job you don’t love or enjoy because you only have minimal expenses!
• It’s Like Getting A Raise:  Without having to pay that large bill every month, it’s like getting an instant raise!  You can take the extra money every month -and start investing!

While reading about the baby steps on another site, I read one story of someone who has paid off their mortgage.  It really emphasized why paying off a mortgage can be a good idea.

A friend of mine is in his mid-thirties and paid his mortgage off completely. This allowed his wife to quit work and stay at home to raise their three children. They have no other debts, and he recently took a lower paying job because it brought him more satisfaction at the end of the day. He wasn’t trapped by an enormous mortgage, or saddled with other debt. Being debt free allowed his family to make these decisions to live the life they want to live, not live the life they are force to live to just to repay debt.

Being debt free brings freedom, and sometimes that’s better than a few extra dollars made through investments.

Arguments Against Paying Off The House

I’ve read a lot of arguments against paying off the house on other blogs. I have to admit that many of them make a good argument against paying off the house.   Some of the better ones:

• Liquidity And Flexibility:  By not prepaying your mortgage and instead investing the money, you are more liquid in your holdings.  Your money is more accessible if it is in investments as opposed to in a house.  This can give you some flexibility if you need the extra money.  Of course, having your 3-6 fully funded emergency fund should preclude needing any large amount of money right away.
• Investing Returns Could Be Higher:  If your expected returns on your investments will be higher than the interest and money saved by pre-paying, investing instead of repaying may be the better choice.
• Inflation Works With You: As inflation goes up by 3-4% annually, by not prepaying you are in essence paying less for the house every year.  You pay the same in 2039 to live in your house as you are in 2009.   So basically you’re getting more for your money as time goes on.
• Lack  Of Diversification:  One could argue that paying off your house first means you’re investing in only one type of asset, and unnecessarily means more risk.  Better to invest in good mutual fund where your holdings are diversified, instead of investing in only one thing, real estate.

The arguments against paying off the house first do have some merit.  It really makes the decision a tougher one.

My Conclusion.

When looking at all of the arguments in favor and against paying off your house early, both sides of the debate make valid points.  That makes the decision on what to do a tough one.

On the one hand, the psychological and peace of mind benefits of paying off the house early are very apparent and powerful to me.  I can’t even imagine how freeing it would be to pay off our house, and to have all that extra money every month to save, invest and give away to those in need.  Complete debt freedom would be amazing!

On the other hand if you look at the numbers logically,  not paying off the house early really does seem to make more financial sense. With a historical stock market return of almost 12% in the long run, there aren’t many cases in which prepaying the mortgage can make more financial sense.  In fact, if you’re looking at a 15 to 20 year window of home ownership, in the past an investment in the S&P 500  index would have been a better investment 100% of the time!

Still, it comes down to weighing the benefits, the risks and balance sheets on both sides of the equation.   For me, after considering both the financial and emotional/psychological sides of the equations, I’m still coming down on the side of pre-paying the mortgage.  It  just seems to me to be such a powerfully motivating goal to have – a debt free life.  I really relate with the story I linked above about not having a house payment, and the freedom that brought to the family – being able to have one spouse stay at home, and having the power to walk away from  a job that wasn’t ideal.

While I realize that some may do better financially by not paying off the house, to me it is more motivating to be living a life without debt and to have the freedom that goes along with that.  The few extra dollars we might make by investing the extra money instead doesn’t matter as much to me.  The answer may be different for you.

Another idea? Do a combination of the two paradigms, pay a little extra, and invest a little extra!

What do you think about paying off the house early?  Do you think it’s a good idea or a bad idea? Which path are you choosing if you’re at that point? Tell us in the comments!

Next Time – Baby Step 7: Build Wealth And Give

Next time we’ll be looking at the last baby step.   Baby step 7 talks about continuing to build wealth and stresses the importance of giving to others.

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Dave Ramsey’s 7 Baby Steps: Step 6 – Pay Off The Home Early!

Last time we looked at Baby Step 4, investing 15% of your gross income into Roth IRAs and other pre-tax retirement accounts.   We looked at the magic of compounding interest, and why it’s in your best interests to start saving earlier rather than later.

Before we jump into step 5, here’s a review of the baby steps.   Haven’t read the others yet? go back by clicking the link below.

Dave Ramsey’s 7 Baby Steps

• Step 1 – $1,000 to start an Emergency Fund
• Step 2 – Pay off all debt using the Debt Snowball
• Step 3 – 3 to 6 months of expenses in savings
• Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement
• Step 5 - College funding for children
• Step 6 – Pay off home early
• Step 7 – Build wealth and give!

Baby Step 5:  College Funding For Children

Now that you’ve got you’re out of debt, and saving 15% towards your future retirement, it is time to start thinking about saving up for your children’s education.  Remember, you don’t have to go into debt for your child to go to college.    Start saving for their education once you’ve finished baby steps 1-4!  Encourage them to get good grades, and help pay for their education through grants, scholarships and other free money.

Here are a few good options of ways you can save for your child’s education:

• Education Savings Account (ESA): You may save $2,000 (after tax) per year, per child that grows tax free!  Beneficiary must be under 18 years old.  Money must be used for education purposes only. Otherwise, a 10% penalty and taxes will apply.  Money must be used or rolled over to a qualifying family member by age 30 or a 10% penalty and taxes will apply.  Singles with an income over $110,000 – or Married couples with an income over $220,000 are not eligible.
• 529 Plan: If you do not meet the income limits for an ESA, or if you want to save money above an ESA, you can use a certain kind of 529 plan. You can save up to $12,000 per year, per child in a 529 plan.  The money must be used for higher education only.  Otherwise, a 10% penalty and taxes will apply to the gains only.
• UTMA/UGMA Plans: UTMA (or UGMA) stands for Uniform Transfer (Gift) to Minors Act.  According to Dave Ramsey, while this is one way to save with reduced taxes, it is not as good as the ESA or 529 plans.

While the above plans are highlighted as good ways to save for college, Dave Ramsey also lists several ways he would NEVER suggest using to fund your child’s education.  Be wary of these things:

• Insurance
• Savings bonds (only 5-6% growth)
• Zero-coupon bonds. (only 6-8% growth)
• Pre-paid college tuition (only 7% inflation rate)

ESAs, 529 Plans and UTMA/UGMA Plans are the way to go!

Why Other Things Come Before Your Child’s College Fund

photo credit: J-a-x

Many people will get upset at the notion of funding their children’s college fund only when they’ve reached step 5.   They think that by not funding their child’s education until they have all their debt paid off or retirement funded that they’re in some way being selfish or harming their child.

In reality, I would say that you’re doing a lot more harm if you don’t do baby steps 1-4 first.   Your kids can always help pay for their own schooling or get scholarships, grants or loans.   But if you don’t get rid of your debt and start saving for retirement you may never be able to catch back up, and who knows if you’ll be able to rely on social security for anything in your old age.  Better to get your financial house in order first, and then help where you can.

Here are a few reasons why I think that education funding should come only after you’ve gotten out of debt, saved up your emergency fund and invested for retirement:

• Taking the time to make sure you are secure in  your retirement first takes a burden off of your children later on.
• Being responsible in getting rid of debt and saving for retirement sets a good example for your children, helping to lead them down the right path.
• Allowing your children to take on even a part of their school costs helps build character and makes their education mean more.
• Encouraging children to get good grades and participate in helping pay for their own college will help promote responsibility.

Personally I think that even if you are able to pay for your child’s schooling outright, it’s a good idea to have them participate in paying for their own schooling.  They can do that either by saving up for college through after school jobs, getting good grades that lead to grants and scholarships, and by going to in-state schools that cost less.   I talk more about those ideas in this post.

Here’s a funny quote from Dave Barry speaking to the idea of encouraging our children to succeed:

I believe that we parents must encourage our children to become educated so they can get into a good college that we cannot afford.  – Dave Barry

How My Schooling Was Paid For

When i was growing up it was made clear to my brothers and I that my parents wouldn’t be able to pay for all of our college, the money just wasn’t there.   They did have some money saved for us, but the amount was limited.

Because we knew that college wasn’t going to be free, we knew we would have to work hard and go out for grants, scholarships and other financial aid.   It gave us another reason to succeed.

I worked hard and I graduated with honors.  I was able to get quite a bit of my schooling paid for through grants, but the rest was paid for with loans.

The only thing I think I would do different if I could do it again would be to save some of the money I was earning in my part time high school jobs. If I had done that I would have been able to cut short the amount of money I had to borrow, and have paid off those debts a lot sooner than I did.  Thankfully I went to an in-state school which meant my education didn’t cost nearly as much as it could have elsewhere.  I have friends who went to comparable out of state schools who ended up having to pay 4-5 times as much as I did.

Moral of the this article?

• Realize and enforce the value of education even when the children are younger.  Encourage them to succeed to help pay for their own schooling
• Encourage in-state schools, or for some techincal schools (not everyone is going to be a doctor or a rocket scientist!)
• Help where you can by saving in an ESA or 529 plan,  but don’t give a free ride!
• Realize that going to college doesn’t have to mean going into debt.  Save for them, have them to save some on their own, and encourage them to succeed in school.

Next Up: Baby Step 6 – Pay Off The Home Early

Baby step 6 looks at taking extra income and putting it towards paying off your home early. Can you imagine what you could do if you didn’t have a house payment?

What’s your opinion of paying for your kid’s college?  Are you saving for their college funds? Will they have to pay for part of it themselves?  Let us know in the comments.

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Dave Ramsey’s 7 Baby Steps: Step 5 – College Funding For Children

Last time we looked at Baby Step 3, saving up 3-6 months of expenses to prepare for when you have a rainy day.  Everyone will have unplanned for expenses, so it’s best to plan for it, and be ready!

Dave Ramsey’s 7 Baby Steps, and our progress.

Dave Ramsey’s 7 Baby Steps

• Step 1 – $1,000 to start an Emergency Fund
• Step 2 – Pay off all debt using the Debt Snowball
• Step 3 – 3 to 6 months of expenses in savings
• Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement
• Step 5 - College funding for children
• Step 6 – Pay off home early
• Step 7 – Build wealth and give!

Baby Step 4: Invest 15% Of Household Income Into Roth IRAs And Pre-Tax Retirement

For me, Baby step 4 is one of the more exciting steps in the process because it is the step where you really start to save and build wealth for your future!  You’ve finally paid off your debts (except the house) and built up your big emergency fund, and now it’s time to save for your retirement!

Ramsey suggest saving 15% of your household income in good solid long term investments.    No more (for now) and no less.

Why Should I Save 15%?

To give a visual demonstration of why Ramsey suggests that you save 15% for your retirement, I went to his website and used his investment calculator.    I put  some numbers into the calculator based on these factors:

• Making $100,000 a year
• Saving 15%
• Starting at age 30
• Saving for 30 years
• 10% return on the investments

When you put in those numbers above, it comes up with a return of well over 2.8 million dollars by the age of 60.

If you were to keep it going even for 5 more years until the age of 65, the account would grow to over 4.8 million dollars.  That’s not half bad!

So how much money would you really need in order to have a comfortable retirement?  Assuming that you would want 80% of your pre-retirement income to live on as many suggest, and a withdrawal rate of 4% per year and a 30 year retirement,  you would need to have about 2 million dollars.

If you invest 15% of your 100k income, that would allow you to withdraw $112,000 a year for 30 years. (which assumes the money would still continue growing at a rate of at least 8% while you are withdrawing)  That is 12% more than your pre-retirement income!   4.8 million would allow for $192,000 per year!

Now if you were to invest 10% using the same assumptions you’d end up with substantially less money, 1.5 million over 30 years, and 2.4 million over 35 years.   Still not bad, but maybe not as much as you might want to have that comfortable retirement.   At the 30 year point you’d have enough to withdraw 60% of your income, and at 35 years you’d have 96% of your pre-retirement income.

All of these numbers are of course assuming that you don’t have money coming from social security.   I have my doubts it will last until my own retirement.  That is obviously up for debate, and hopefully the system will be fixed.  But why depend on it if it might not be there?

The point of all this to me is that 15% is usually going to be more than adequate to get you to where you need to be.  10% may not be, depending upon how much of your previous income you want to live on, and how much time you have until retirement.  The longer you have until retirement, the bigger the gains you’ll see through compounding interest!  Play it safe and start saving 15%.  You won’t be sorry!

Another caveat – if you’re older and have less time until retirement you may need to be investing a higher percentage than 15%. You started late, so you have some ground to make up!  Starting earlier?  You might not need to invest all of the 10%.  But why not do it anyway!

Dave Ramsey doesn’t suggest investing more that 15% because the extra money will allow you to complete the next two baby steps – paying for your kids college and paying off your home early.  Stay tuned for those baby steps in upcoming posts.

What Should I Invest In?

Once you’ve decided on how much you want to invest, the next step is to decide on what types of investments you should be holding.   Ramsey suggests:

If you receive a company match in your 401(k), 403(b), or TSP; invest in those plans, up to the match, first.  Once your contribution equals the company match, fully fund a Roth IRA for you and your spouse. If you’ve maxed out your contribution to your Roth IRA and still have money to invest, invest the rest in your 401(k), 403(b), or TSP.

So the order is:

• Company 401k or other plan up to the match
• Roth IRA for you and your spouse
• Back to the 401k or other plan

In your company 401k,  Roth IRA or other investment,  Dave suggests allocating your investments with a good mix of mutual funds.  His preferred plan is to allocate 25% to each of the following types of stocks in your funds:

• Growth
• Growth & Income
• Aggressive Growth
• International

When choosing your funds he says

Always choose A shares (front end load); funds that are at least 5 years old or older with a  solid track record of acceptable returns within fund category.

For a full look at Dave’s investing philosophy, please check out this post.

What do you think about this baby step? Will 15% be enough for your retirement?  Do you think you should save more or less?

Other Helpful Investment Links:

• In Depth Discussion Of Baby Step 4 @ doughroller.net
• Dave Ramsey’s Investment Philosophy @ DaveRamsey.com
• Discussion Of Investments In Financial Peace University @ BibleMoneyMatters.com

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Dave Ramsey’s 7 Baby Steps: Step 4 – Invest 15% Of Household Income

Last time we looked at Baby Step 2, paying off all your debt using the debt snowball.  You take your bills, rank them in order from smallest to largest, and proceed to pay them off with intensity!

To review, here are the 7 Baby Steps.

Dave Ramsey’s 7 Baby Steps

• Step 1 – $1,000 to start an Emergency Fund
• Step 2 – Pay off all debt using the Debt Snowball
• Step 3 – 3 to 6 months of expenses in savings
• Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement
• Step 5 - College funding for children
• Step 6 – Pay off home early
• Step 7 – Build wealth and give!

Baby Step 3: 3 To 6 Months Of Expenses In Savings

Baby step 3 builds upon the baby emergency fund you established in baby step one, and takes it to the next level.  In step 3 you are building a fully funded emergency fund of 3-6 months of living expenses.    The reason for building up this reserve?  With this reserve you’re building your safety net against major life events so that you never have to go into debt again.

When you have your 3-6 months saved there aren’t very many things that can happen that you can’t pay cash for outright.  Lose your job? You’ll be able to cover the mortgage long enough for you to find a new job.  Have to get unplanned surgery? Your emergency fund will cover  your portion of the bill (make sure you have good health insurance!).

Emergency funds help you to get rid of the risk of unplanned for events,  and prepare for the future.

Why Build An Emergency Fund?

Often times people think it’s just a waste to build an emergency fund that is so large.  It just seems to be overkill.  Why not use the money for something else?

Personally I can think of a lot of reasons why it’s a great idea.

• Things Happen:  Unexpected expenses  WILL come up, and it’s better to have planned for it than to stick your head in the sand.  If you don’t plan for those things they’ll end up happening at the worst possible times.  Your heat will go out in the middle of winter, or you’ll end up in the emergency room for an unknown allergy.  I’ve realized more and more over time that emergency funds are necessary because life happens and small unexpected expenses WILL come up.   When you have the money saved these things are an annoyance, but not the end of the world.
• Manage Stress: When you have an emergency fund saved, life is a lot less stressful. You don’t have to worry about what you’ll do if a negative event falls in your lap. You just pay to get it fixed.
• Risk Is Reduced: When you have an emergency fund (along with other things like health insurance, disability insurance and life insurance), you have a lot less risk of having a bad situation turn into a catastrophe.  A medical problem won’t turn into bankruptcy, and a job loss won’t turn  into a foreclosure.  In other words you’re making sound decisions to plan for problems, before they happen.  You manage the risk that comes along with those major negative events, and stop them from turning into life changers.

How Much Is Enough?

The decision of how much money to save in your emergency fund is one your family will need to talk about.  The amount may vary depending upon your living situation, number of children, job stability and other factors.    The baseline that Dave Ramsey speaks of is 3-6 months of expenses.

So if your family has a minimum of $3000 in expenses every month after cutting out all the un-necessary bills, your 3-6 months of expenses would come out to anywhere from $9000-$18,000.

How many months you save will be dependent on your situation.  At our house since we like the peace of mind that comes with the emergency fund,  we want to have at least 6 months saved, if not a little bit more.

• If you’re single and have a relatively low level of needed income every month, you may be able to get by with only 3 months of expenses.
• If you’re the only bread-winner bringing home an income for a family of 5, then you may want to err on the side of caution and keep a buffer of 6 months of expenses (or more).
• If you’re expecting a major life event in the near future (layoffs, surgery), you may want to start stockpiling cash in advance, and save even more than the 6 months if possible.

Where Should I Put My 3-6 Months Of Savings?

Where you save your emergency fund is really up to you.  The only thing I would say about this is to make sure that you put the money somewhere that you can get at it right away if you need to.

My personal preference for a good place to save the money is a good high-yield savings account, like the ones offered by ING. Another option is to keep the money in a good money market account or at a local bank branch. Whatever you’re comfortable with, as long as the money is liquid and available quickly.

Don’t put your emergency savings in things like real estate, investments or other things that could be tied up for a while without you being able to get at the money.   Keep it liquid!

Next Up: Baby Step 4 Invest 15%  Of Household Income

Next time we’ll look at saving 15% of your income once you have a fully funded emergency fund. This is where the fun starts happening – when you’ve paid off your debts and  you start saving for the future and building wealth!

Do you think saving up 3-6 months of expenses is enough?   How much do you have saved in your large emergency fund?

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Dave Ramsey’s 7 Baby Steps: Step 3 – 3 To 6 Months Of Expenses In Savings

Last time we looked at Baby Step 1, saving up an emergency fund of $1000.  You’re saving up that money for a variety of reasons, but mainly because you know you’re going to have little “emergencies” popping up all the time, and the baby emergency fund will help keep you from going further into the hole while you’re on the way to paying down debt.  As a review once again, here are the 7 Baby Steps.

Dave Ramsey’s 7 Baby Steps

• Step 1 – $1,000 to start an Emergency Fund
• Step 2 – Pay off all debt using the Debt Snowball
• Step 3 – 3 to 6 months of expenses in savings
• Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement
• Step 5 - College funding for children
• Step 6 – Pay off home early
• Step 7 – Build wealth and give!

Baby Step 2: Pay Off All Debt Using The Debt Snowball

Now that you’ve got your $1000 emergency fund saved, it’s time to move on to step 2, paying off all your debts using the debt snowball.  This step could easily be one of the longest in your 7 baby steps.  If you’re  dealing with a lot of debt from school loans, car loans, credit card debt and other things you may be in baby step 2 for a couple years or more.  If you only have a few small debts, you can be out of baby step 2 a bit quicker.  Remember, the key here is that you are paying off your debts – because it is the right thing to do. You made those obligations, and you need to stick by them.  Bankruptcy should only be entered into in a worse case scenario – and you’re probably not there.

The wicked borroweth, and payeth not again: but the righteous showeth mercy, and giveth.   Psalm 37:21

So how does the Debt Snowball work?  First things first – if you have done your quickie budget as we talked about last time, you’ll probably have a good idea of where you’re now standing in relation to your income, expenses and debts.    If you haven’t done that yet, take the opportunity to do it now!  Download your quickie budget from Dave Ramsey’s site here.

Once you’ve got all of your income, expenses and debt listed, follow these steps to get rid of your non-mortgage debt. (Mortgage debt is paid off separately in another baby step, so exclude it for now)

The Debt Snowball:

• Put all your debts in order from the smallest balance to the largest.
• After your necessities are paid, pay the minimum payments on all of your debts.
• Put any surplus money towards paying off the smallest debt first.
• Pay off your smallest debt, get a psychological boost from knowing you’re one step closer to being debt free!
• Once the smallest debt is paid off you roll the money you were paying on that debt over to the next largest debt.
• Wash, rinse, repeat until all your debts are paid off!

Pretty simple, right?

Controversy Surrounding The Debt Snowball

Over the past few years there has been quite a bit of controversy surrounding the debt snowball.  The reason?  There are those that say that Dave Ramsey is bad at math and that the debt snowball isn’t the best mathematical way to get out of debt.   They say if you were to do it the BEST way, it would be to list your debts in order from the highest interest, to the lowest interest.   Once they’re in order you pay the minimums, and put any extra money towards the highest interest debt.   Some have called this the debt avalanche.

Mathematically their way IS the best way to get out of debt.  Dave Ramsey has even admitted that the debt snowball isn’t the best  mathematical way to get out of debt.  But he still pushes it as the BEST way to get out of debt. The reason Ramsey believes the debt snowball is still better is because it takes into account the psychology of debt reduction.

His theory is that since you’re paying the smaller debts off first you’re getting a series of “quick wins” that give you that psychological boost  you need in order to keep you motivated and keep you paying down your debts.  The problem with paying the debts another way is that you don’t get that psychological boost from the quick wins.  Too often you’ll end up burning out and giving up on debt reduction.

The debt snowball is more sustainable, and gives you the best chance of succeeding.   You may end up paying a little bit more interest, but they’ve found that you’re more likely to actually succeed in paying off your debts with the debt snowball.

I obviously come down on the side of the debt snowball in most cases.   I know there are those that will still prefer to use the debt avalanche or another similar hybrid debt repayment scheme.  The important part to me is that you take control of your finances and start getting out of debt.  Whether it is the debt snowball, the debt avalanche or some other  method, just get started on getting out of debt.  Whatever works for you!

As Dave Ramsey says, “You can’t go wrong getting out of debt“.

Keys To Not Going Into New Debt, And Paying Off The Old

If your debt snowball is going to be effective, you need to make sure you don’t go into new debt, and continue paying down the old. Here are a few ways you can do that.

1. Quit borrowing more money.  No new debt!
2. Cut up credit cards, and become credit card free.  I know it may feel weird at first, but it’s freeing!
3. Sell stuff. You have more than you need or use, so sell it and put the money towards debt!
4. Get an extra part time job. Take side jobs and earn extra income to accelerate paying off your debts.  You won’t be doing these jobs forever, they can be temporary.

Get serious about paying off your debts, and take any extra money you have coming in, and put it towards your debts. You’ll have them paid off in no time!

Next Up:  Baby Step 3 – 3-6 Months Of Expenses In Savings

Next time we’ll be looking at what you do after getting all your consumer debt paid off.   (Hint: You’ll be saving up for a really rainy day by putting away 3-6 months of expenses!)

What’s your opinion of the debt snowball?  Have you used it – or another system – to get out of debt?  Tell us about it in the comments.

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Dave Ramsey’s 7 Baby Steps: Step 2 – Pay Off All Debt Using The Debt Snowball