Got debt? Join the Club

[- Femme -]

Dave Ramsey, financial author and host of a nationwide radio show, has created the following "Baby Steps" for getting yourself out of debt and putting your financial house on solid footing.

 

Honestly, there are a lot of methods for trying to dig yourself out of financial problems, and this may not necessarily be the best one for you. (I preferred, for example, to pay off my debts according to their interest rates, from largest to smallest. But I guess I'm just a loner — a rebel — that way.) The "Baby Steps" are, however, a very workable plan for most folks. They're simple, straightforward, and just crazy enough to work.

 

"The bottom line?" asks Ramsey. "It's easy to become wealthy if you don't have any payments."

 

The best and most-detailed version available of these Baby Steps can be found in Ramsey's 2003 book The Total Money Makeover. I've reviewed Total Money Makeover, and recommend it highly if you are serious about following this plan, as the book addresses many intricacies which space here restricts me from covering. If you'd like to see another online write-up of these same guidelines, you can find it on the MSN Money message boards.

 

 

1. Make minimum payments on all your bills. Squeeze your budget until you've accumulated $1,000 cash. This is your beginner emergency fund.

 

You'll never make headway in your quest to get out of debt if you don't have at least a little something to fall back on. That "little something" is called an Emergency Fund, and that's what this first $1,000 is for (or $500, if you make less than $20,000 per year). Put everything else on hold. Make only minimum payments on all your debts; take on a second job if necessary; forego retirement-plan contributions (temporarily) if you can. Get your emergency fund together first. Get it together fast.

 

If you already have more than $1,000 in savings, and in anything other than a retirement account, withdraw everything except the $1,000. Use these proceeds for Baby Step #2, regardless of penalty (if the money were in CDs, for instance, there would like be a penalty for early withdrawal).

 

Once you have accumulated the $1,000 (or $500), keep it someplace where you cannot easily get at it. It must be available, but not easily available, and not easily spendable.

 

"Sometimes," Ramsey instructs, "you have to protect yourself from you."

 

2. Pay off your debts, smallest to largest. "Snowball" the payments.

 

Write down all your debts except your home. (If you're into spreadsheets, something like my DebtTracker spreadsheet will come in really handy here!) Arrange them in order from smallest balance to largest. Do everything you can to pay off the smallest debt listed (take on a second job, or sell stuff if you have to!) while making minimum payments on everything else. Once that first debt is paid and gone, then "snowball" that monthly payment money over and apply it to the next-smallest debt (in addition to that debt's normal payment). When that one is paid off, then take that monthly payment amount and start applying it toward your next debt. Get the picture? The more debts you clear off, the more your "snowballed" payments are increasing, and the more headway you'll make — faster — on your larger balances.

 

Ramsey writes: "The reason we list the debts from smallest balance to largest is to have some quick wins. This is where behavior modification is more important than math."

 

One important caveat: If you're working on this second Baby Step and some emergency arises which forces you to spend any part of your emergency fund, immediately stop this step and return to Baby Step #1 until you've refunded your emergency fund in full.

 

Check my "Debt Snowball" page for a more thorough discussion of this part of the Baby Steps.

 

3. Create a full-fledged emergency fund containing 3 to 6 months' worth of expenses.

 

Bad luck and rainy days are a part of life. Expect them. Prepare for them.

 

If you'll keep three to six months' worth of bills and living expenses in a savings or money-market account, then you'll have gone a long way toward erasing the "what if" stress from your life. The emergency fund allows your family to always be ready for whatever life hurls at you. Sure, that Murphy guy might still stop by your residence every so often, but he won't be able to run roughshod over your financial life the way he used to. Ramsey takes the analogy a step further: "Don't forget that the emergency fund actually acts as Murphy repellant."

 

You must also flip a mental switch regarding your e-fund: It is there for bonafide emergencies. Nothing else.

 

Ramsey elaborates: "Beware not to rationalize the use of your emergency fund for something that you should save for and purchase. Something on sale that you 'need' is NOT an emergency. Prom dresses and college tuition are NOT emergencies," he says. [Aside: This, of course, is where Mary Hunt's Freedom Account concept enters the picture.]

 

In any event, get your full e-fund together, and you'll be in a financially-elite class. You won't need your credit cards any longer ... even for emergencies. And the next time your car's alternator detonates?

 

"What used to be a huge, life-altering event," Ramsey says, "will now become a mere inconvenience."

 

4. Fully fund 15% into pre-tax retirement plans and Roth IRA, if eligible.

 

Now it's time to get your retirement funds in shape. Contribute the maximum amount you can, your target being contributions of a full 15 percent of your household's gross (pre-tax) income. If you have tax-advantaged plans (401k or Roth IRA, for example) available to you, then exploit them to their fullest extent. If your company matches any part of your contributions, do not consider this as part of your 15 percent. Additionally, do not include expected Social Security benefits in your retirement calculations. "I don't count on an inept government for my dignity at retirement, and you shouldn't either," Ramsey says.

 

At this point, if you haven't already done so, it is time to begin seriously educating yourself about mutual funds, stocks, and the financial markets.

 

"Getting older is going to happen," Ramsey says. "You must invest now if you want to spend your golden years in dignity."

 

5. Take care of college funding.

 

If you have kids, then you'll have college to worry about. The earlier you start, and the more attention and funding you're able to give to it, the better off you and your kids will be. Since college tuition inflation averages around 7 to 8 percent per year, your investments will need to (hopefully) do better than that. Always use tax-advantaged accounts (such as 529 plans or Education Savings Accounts) to their fullest extent to assist with this. These plans do have certain income limits and other restrictions and/or fees, so be sure to check the fine print before diving in.

 

6. Pay off your home . . . early.

 

For most people, the mortgage payment is the single largest monthly payment they will ever have. Just imagine what you can do with that money when you've paid it off. Imagine how you'll feel when you make that last payment. Round up every spare dollar you can find and put it toward your mortgage, regardless of all the oft-quoted benefits of mortgage-interest tax deductibility. (How wise is it to continually pay, say, $5,000 in interest to a bank each year, just so that you won't have to pay $1,500 in taxes to the government? The small minority of folks who own their homes debt-free probably don't mind paying that $1,500 a bit.)

 

For more comments regarding home, home loans, and their affordability, you might refer to my "Home, Expensive Home" article from Aug. 30, 2002.

 

7. Build wealth (mutual funds / real estate) and give!

 

With every bit of your debt zeroed-out and your savings tanks on the full mark, you can finally reach for the "pinnacle" — that point where your money works harder than you do. Invest more so that you can continue to grow your wealth. Give more so that you can continue to grow your self.

 

Source

[- Femme -]

Every dollar you spend has consequences elsewhere in your life. Remembering that will change the ways you spend and save.

 

By Dana Dratch, Bankrate.com

 

Can you remember life before $100 sneakers and $5 coffee, when people actually lived on what they earned and still had a little something socked away for a rainy day?

 

"People moan and groan about why they can't make do," says Michelle Singletary, author of "Seven Money Mantras for a Richer Life." "But if you look at your lifestyle, there's almost always a way to trim (costs) and make do with less."

 

Singletary and her four brothers and sisters were raised by their grandmother, who earned a modest salary but owned her home and car and accumulated a nice savings and pension while providing well for her family.

 

Cutting costs was more than a handful of tips, says Singletary. "It was a way of life."

 

Her grandmother looked at potential purchases in terms of "what you could spend that money on that would put you in a position of not having to struggle," says Singletary. Like a fast-food meal out vs. allocating that money for the phone bill. "And I actually do that now myself," she says. "I ask, 'What are the consequences of spending this money?'"

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Track what goes out

That approach, save automatically and spend selectively, is exactly what money experts and consumer advocates advise. To accomplish that, here are 13 strategies for living well on less:

 

# Analyze your spending. Look closely at what you've spent for the last three to six months, says Ed Moore, CFP and president of Edelman Financial Services. "And look for spending (you) might regret." As you examine your expenditures, ask yourself, "What dollars satisfied a need, what dollars satisfied a want and which expenditures might not have satisfied either?"

 

David Bach, author of "The Automatic Millionaire," says not to forget even your smallest purchases: Where do you spend small amounts of money on a daily basis? For many, it's something as seemingly insignificant as a few bucks for a cup of gourmet coffee, but it adds up. That doesn't mean you necessarily have to give up your java break. Bach says you do, however, need to change your thinking. Notice exactly now much you are spending and where.

 

# Make a budget. "Without exception you have to do a written plan, called a budget," says Dave Ramsey, author of "The Total Money Makeover." Listeners to his national call-in radio show tell him once they make a budget, "they feel like they got a raise." The reason, he says, is "managed money works harder."

 

But there's no one-size-fits-all budget. "It varies from month to month," Ramsey says. So sit down and plot how each dollar will be spent "on paper, on purpose before the month begins." (For more on budgeting basics, read "A simpler way to save: the 60% solution.")

 

# Never pay retail. "Everything's negotiable," says Bach, who learned this money lesson from his grandmother. "Almost everywhere she went, she could talk the price down," he says. And that's still perfectly acceptable in many retail situations, he says.

 

Also know when to shop. For example, buy clothing in season. That's when the retailers consider it past the season and put it on sale, says Clark Howard, co-author of "Clark's Big Book of Bargains."

 

# Try store brands. "Every time somebody goes to the supermarket, I want them to try one more store brand," which Howard notes costs up to 40% less. "To get people to change everything isn't possible. But to get them to change one item at a time is less difficult." (You'll find other ways to save in "20 ways to slash your grocery bill.")

 

# Buy used. New is nice, but for the best buy, think pre-owned. Bach points to the classic example of a used car. After two years of depreciation, you can get a good, high-quality car at virtually half price, says Bach. "And if you ever do buy a new one, plan on keeping it five to 10 years," he says.

 

Whatever you're buying used, Ramsey says to focus on high-quality merchandise, "not torn up, junky or dirty."

 

Secondhand shopping isn't just for those who have to watch their pennies, either. Ramsey recalls a millionaire friend who picked up a $38,000 Rolex for $18,000 from a reputable jeweler. "That's how he got to be a millionaire," Ramsey says. (M.P. Dunleavey has more thoughts on buying used in "Why first-class folks love second-hand stuff.")

 

# Pay cash. "When you spend cash, it hurts," says Ramsey. "And you spend less."

 

Ramsey recalls a study several years ago that showed when shoppers spend cash, "you spend 12% to 18% less than when you spend plastic because of the emotional pain."

 

Plus, he says, you can get a better deal when you use cash as a negotiating tool.

 

# Pick your credit card wisely. If you must use a credit card, make sure it's one that gives you something. Look for a no-fee card with a rewards program. Mark Oleson, director of the Financial Counseling Clinic at Iowa State University, recently signed up for a AAA-branded no-fee card that rebates 5% of all gas purchases. The credits are applied automatically to his account every month. Now he's getting $2 gallon gas for $1.90 without changing his buying behavior. (For an easy way to compare card rates and perks, try MSN Money's Credit Card Analyzer. )

 

# Shop around for auto insurance. You want your car protected, but make sure you get the most cost-effective coverage you can. Howard recounts one ecstatic caller to his radio show who compared rates and sliced his annual premium by $1,433. "That's the easiest money for someone to grab," he says. Anecdotally, Howard says, the typical savings by shopping around for better auto insurance rates is around $1,000.

 

While you're at it, look at your coverage and deductibles on an annual or semiannual basis, says Oleson. Can you afford to raise the deductible to lower your premium? Are there any overlaps in your coverage that could be eliminated? (Learn more at our car insurance Decision Center.)

 

# Dial up phone savings. Your cell phone certainly comes in handy, but is your plan really worth what you pay? "There are lots of people who sign up for calling plans for cell phones who don't need them," says Howard. He says a more economic choice might be a prepaid plan.

 

Do you travel with your cell phone? Be sure you don't face roaming charges. A better telephone-travel move might be a discount calling card. "I'm a big believer," says Howard, who finds that the average per-minute price on the cards runs about 2.9 cents per minute, a far cry from regular or in-room long-distance charges.

 

# Change your mortgage payment method. Make biweekly payments instead of monthly house payments. You don't change the amount; simply send in half a payment every two weeks. That means, says Bach, you make an extra payment every year and can slice nearly seven years off the average mortgage.

 

# Use family and community resources. This is something that a lot of new parents discover when faced with the cost of expensive baby goods that their child soon will outgrow. "Rather than going out and buying a new crib, this and that, there's a lot of sharing," says Chris Farrell, author of "Right on the Money!"

 

You can also do the same thing at other stages of life with furniture, appliances, electronics and clothing. Farrell employed the strategy to get rid of a fairly recent desktop computer when he switched to a laptop. "A lot of us are in situations where we spend money on something we wanted, but it's outgrown its usefulness," he says. "And someone else could get pleasure out of it."

 

# Pay yourself first. Automatically transfer part of each paycheck to a retirement account before you get your take-home pay. "Learn from the government, which figured out years ago (people) can't budget," says Bach. His rule of thumb: Save one hour a day of your income each week.

 

In addition to the longer-term retirement account, also save for short-term emergencies. How much? "I think (a salary contribution equal to) 30 minutes a day is a good start," says Bach.

 

And while the goals of the two accounts are different, the savings method is the same: Pay yourself first.

 

# Exercise restraint. Finally, call upon your willpower when it comes to spending. Want to save money on your phone bill? Hang up. Want to use less gas? Stay home. Do you really need a bread maker when you have an oven?

 

Sometimes cutting costs really is just a matter of saying enough is enough.

 

"As long as I can remember (growing up), I never ate out at fast food (places)," says Singletary. Why? Because her grandmother's motto was, "I have good food at home."

 

That attitude helped Singletary's family flourish. And by using at least some of these strategies, you too could find that it really is possible to live well for less. (You'll find more perspectives on spending less in "How small cuts become huge savings.")