I speak regularly with people about financial matters. Whether family or friends, employees or associates, most people tend to have similar problems when it comes to personal finance. Typically, when someone is experiencing financial woes, and it’s not from a catastrophic event like losing a job or your house blew away in a tornado, the problems can usually be summed up in two phases. These “phases” create a vicious cycle that causes all kinds of financial problems.
Think of the two phases as the Ying and the Yang of personal finance problems.
First phase, people spend too much, usually taking on debt or spending (what I call) future savings, like NOT putting money into a retirement account. This is when people decide to not live within their means. The “My neighbor just bought a new Benz so I’m going to buy the new Lexus” mentality. This is what Dave Ramsey calls trying to keep up with the Joneses. (Chapter 5)
Secondly, people don’t save nearly enough, no emergency funds (rainy-day funds). They usually live from day to day. Even if the people live within their means if they’re not saving on a regular basis, when that rainy day happens there is no rainy-day fund.
This usually forces people into debt to take care of their emergencies. Then the debt causes people to stop saving or gives them a great excuse never to start (whether for a rainy day or retirement).
People who have fallen in this trap of increasing debt and non-existent savings start to feel like there is no hope, things just keep getting worse. I’m often asked, “what can I do RIGHT NOW to turn my life around?”
I’ve thought about creating a system to help people get out of debt and take back control of their finances. Take that first step, from being completely out of control, to becoming a builder of wealth. Each time I thought about this I always kept coming back to Dave Ramsey’s The Total Money Makeover. For getting out of debt it’s a fantastic system.
This system has three things going for it.
- The book is an easy read, Dave Ramsey describes things in terms that everyone can understand. He shares parts of his personal experiences and mixes in some good, clean humor, making for a very enjoyable reading experience. I’m sure you’ve read some finance books that were a little dry (no matter how great the information was).
- It’s easy to implement right now. Dave Ramsey’s plan needs no special software or years of study and practice in order to implement. The plan contains 7 “Baby Steps” (which I’ll go over in a minute) that guide you through the process step by step. You only need to worry about one step at a time.
- It works 100% of the time. Dave Ramsey has laid out a plan that is fool proof. When someone calls his radio show claiming that the plan didn’t work, Dave can prove pretty quickly that the caller didn’t follow his plan. The plan is so simple to follow everyone should be successful, but you have to follow the plan you can’t start improvising all over the place.
The first 5 chapters I call the mindset chapters. They give you Dave’s take on five different psychological factors that cause financial problems.
Here is a brief summary:
- In Denial
People first have to realize that they have a problem. Most people are in denial when it comes to financial problems until it’s too late. People tend to rationalize their debts and lack of savings. I think it’s human nature. This chapter is your wake-up call!
- Debt Myths
The common myth in America these days is debt is normal. People don’t even think about it, they just accept perpetual car payments, credit card monthly minimum payments and FICO scores being the norm.
- Money Myths
This section deals with the myth that money is NOT the root of all evil, but if managed wisely, can truly benefit you, your family and those around you.
- Financial Ignorance
Dave Ramsey is a champion of the idea that it’s the parent’s role to teach their kids financial responsibility. I really wish they had a program like the Total Money Makeover for students when I was in high school.
- Got to Keep Up with the Joneses
Car payments, huge mortgage payments, maxing out credit cards and paying minimums, let’s all make sure we have all the crap our friends and neighbors have… This material peer pressure gets us in trouble more often than not.
Or as Dave Ramsey puts it: “We buy things we don’t need with money we don’t have to impress people we don’t like.”
The rest of the book contains the 7 “Baby Steps”, if the first chapters dealt with the mindset one needs for a The Total Money Makeover, these seven chapters are the action plan. The physical steps you need to take to become debt free and start building wealth.
Here is a brief summary of the seven “Baby Steps”
Save $1,000 in a Beginner Emergency Fund.
The very first step in your The Total Money Makeover is saving $1,000 in what Dave Ramsey calls a beginner emergency fund (or BEF). To make this happen you need to basically pay minimums on all debt (credit cards, loans…), stop investing in retirement, sell as much crap you have lying around as you can, take on a part-time job if you have to, but get $1,000 saved.
The theory behind the $1,000 is pretty straightforward. 90% of emergencies can be solved or repaired for $1,000 (brakes for your car, replace a window in your house, or fix the oil burner in the middle of winter so you don’t freeze to death.). Then if need to use part of your emergency fund you go back to minimum payments on everything else until you replenish the $1,000.Bottom line is the BEF is there so we don’t use any debt in The Total Money Makeover.
Develop a Debt Snowball.
Contrary to what other financial experts recommend Dave Ramsey doesn’t get all hung up on interest rates or how much your minimum monthly payments are when it comes to paying down your debt.
You just need to list every debt that you owe (except for the mortgage) from lowest to highest. Then write down the minimum monthly payments next to each debt. Next determine how much you have to spend paying down debt each month, pay the minimums on all but the smallest and pay every other red cent you have on the smallest debt until it’s paid off. Then add the money that you were paying on the smallest debt to the next smallest debt until that one is paid off. Do this over and over until you are debt free (except for the house).
Each time you add the payments from a paid off debt to the minimum of the next debt, your payment on the debt you’re knocking out goes up (like a snowball gets bigger as you keep rolling it in more snow).
For example, if you have three credit card debts ($1,000, $2,000 & $3,000) and the minimum monthly payments are ($10, $20 & $30, respectively) and you have $200 a month to pay down the debt. For your debt snowball, you’d continue paying $20 and $30 minimum payments on the two larger debts and use the remaining $150 to pay down the smallest, $1,000 debt. Then when that debt was paid, you’d roll (like a snowball) the $150 into the $20 and continue paying $170 until the second largest, or $2,000 debt was paid off, then you’d use the full $200 to knock out the last.
Save 3-6 Months of Expenses in an Emergency Fund.
Now that your debt free (except for the house) it’s time to start building the full emergency fund. Dave Ramsey recommends 3-6 months of expenses. So you have to figure out what your annual expenses would be (take a look at this post to see how I recommend you tackle it).
If you calculated your total annual expenses to be $40,000, then put every extra dollar you have each pay period into a savings account until you reach $10,000. (Since we aren’t investing for our retirement at this step, I recommend only saving 3 months now. After you finish your Total Money Makeover try and kick up your emergency fund to one year worth of expenses. I like to feel secure, better to be safe than sorry)
Save 15% of Your Income for Retirement.
Now that you’ve paid off your credit card debt we can start preparing for those golden years. Save 15% of your income for retirement. Now the obvious place to consider would be your company’s 401k plan, but only invest up to your company’s match. (If they match the first 3% then only start with 3% in the 401k)
Then put as much as you can in a Roth IRA (tax free earnings in retirement, you’ll thank me later). Then if you were able to maximize your Roth IRA contributions and still need to invest more to reach the full 15%, now you go back and add to your 401k contributions.
Save for the Kid’s College.
This next step is obviously situational. If you have kids or are thinking of having kids then start saving for their college education.
Let’s take a step back here and notice that the kid’s education comes AFTER your retirement. Remember kids can take loans or even work to pay for school, but you can’t borrow for your retirement.
Having said that, I’m sure parents want to help their kids and that’s a really good thing (I sure wish my parents had this book thirty years ago), just don’t do it at the cost to your own future.
Pay Off Your Mortgage Early.
Next, we come to paying off the mortgage early. This one comes under fire quite often because everyone you talk to thinks you need a mortgage payment for a tax write-off.
That’s a bunch of crap and here’s why.
Let’s say you pay income taxes at a rate of 30%. You also believe that you need a mortgage for the tax write-off. Let’s say for this example the interest you pay on your mortgage in a given year is $6,000 (assuming a $150,000 mortgage at 4%) (I’m just straight-lining it, don’t worry about amortization tables and all that.)
So in this example you are basically paying $500 a month interest to save $150 a month, crazy right? Not to the majority of people out there, who seem to think a mortgage is the greatest tax saving vehicle in the world.
Remember what Dave Ramsey says, “The grass under your feet will feel different when you own your home.”
Invest for Wealth.
Lastly, we start to really build wealth. With no debt, at least 3 month’s expenses saved in an emergency fund, 15% of your earnings going to retirement, saving for your children’s college education and owning a home free and clear, you can really start investing some serious money.
Dave recommends putting money into good growth stock mutual funds with good track records. I think this is solid advice for a basic investing plan. You could write a whole book on investment strategies (there are thousands already written). We’ll cover some of my favorite investing strategies over the coming months.
So, there you have it, a review on The Total Money Makeover.
I think if you carry any debt or know people who do; this book isn’t a recommendation but REQUIRED READING.
This plan works 100% of the time but does require a complete change in your mindset when it comes to money. It goes against what I call “the modern mindset”, your friends, family and work associates will probably think your weird but at the end of the day you’ll be that much closer to financial freedom. That’s total financial peace!
I’ll leave you with one of my favorite Dave Ramsey quotes that sums up The Total Money Makeover:
“If you will live like no one else, later you can live like no one else.”