Seeking to Understand

Almost a month ago now a coworker introduced me to a fellow named Dave Ramsey. He’s a talk-radio personality that focuses on money and how to manage it. Dave is also a bestselling author about the subject and has written several books - the most popular of which is probably The Total Money Makeover. He’s quite popular all over the country and has developed a loyal following by dispensing what amounts to mostly common-sense money advice. If there has been any common patterns in my life, one of the most established has probably been my utter lack of money management skills. That may be changing…

Melody and I trekked to the book store and bought The Total Money Makeover a day or so after I was made aware of its existence. Before buying the book I had done some googling on Dave and discovered that a lot of people seemed to love the guy. His advice and plan was pretty simple and I wasn’t even sure we really needed to buy the book - descriptions of pretty much everything he has to say is online for free if you look around. But hey, I figured it’d be nice to have it and I could read through it and see if there were any tricks or secrets or something like that.

Turns out there are no tricks and I was just being stupid with money. Shocker there, right?

After reading the book I became pretty well convinced of my lackluster money management skills. The thing is, I already knew I sucked at it and I just figured I’d always be living hand-to-mouth unless I got lucky and won the lotto (that I don’t play) or inherited a bunch of money (seems unlikely) or invented a better mousetrap (not gonna happen unless I have an engineering degree I don’t know about) or something equally unlikely.

Given Dave’s popularity, I wouldn’t be surprised if some of you have heard of him and, perhaps, written him off as just another celebrity “expert.” Or perhaps you didn’t like the fact that he’s an outspoken Christian and occasionally uses a bible quote or two to back up his positions and moral stance. (And honestly, if that’s the case… grow up!) If you have a lot of debt, and you’re not really feeling like you’re getting anywhere, then I’d suggest that, perhaps, you open your mind a bit and consider the possibility that you’re doing something wrong and maybe could use some advice.

All right… the simple core of the plan Dave pushes is: debt is bad, mmmkay? This should be a no-brainer, really, but for some reason it always seems more complicated. After all, debt helps your credit score, right? And debt lets you get neat stuff NOW that you can surely afford because the payment seems reasonable and, ya know, why put off getting today what you can have right now?!

The truth, though, is that if you need credit to buy it, you can’t afford it. If you’re worried about building or fixing your credit score - forget it! You don’t need a credit score if you don’t borrow money. Who cares if its bad or good?

What makes Dave’s stuff work for me is that he presents a simple plan with easy steps and gives good, simple, logical reasons for doing them in the order specified. Since virtually every other blog posting I’ve read about Dave Ramsey (even the posts that hate him or think he’s horribly wrong or misguided) have listed the basic steps involved, why should I feel a need to break with tradition?

Step 0: Get current. If you’re behind on anything, get caught up. Pay minimums. Call and make deals. Whatever it takes.

Step 1: Make starter emergency fund of $1000. Put that money somewhere safe. Like, literally, in a safe. As cash. Or tucked away in a secret drawer or something. It needs to be accessible but just difficult enough to get to that it’s hard to impulse spend it. This $1000 fund is for unforeseen emergencies like car repairs, a sudden hospital visit, etc.

Step 2: Debt snowball and budgeting. This is the core of the plan. The heart of what makes it fun and difficult at the same time. First you build a budget. An actual, honest budget. You write down your rent/mortgage, estimated utilities payments, estimated food costs, maybe gas, and then minimum payments on any loans you have in a given month. Add this all up. Then work out how much you make in a month. Make sure that number is bigger than the budget total. If it isn’t.. uhh… you need to change something…

After the budget, you put together a list of all debts you have. Credit cards, cars, that $20 you borrowed from uncle Joe, etc. (Ignore the mortgage or rent payments.) Then you sort them from smallest to biggest. You have already budgeted enough money each month to pay the minimums on each bill - now add any money you have left over in your monthly income to the smallest debt. This will help pay off the debt faster than normal. The month after you kill off the smallest debt, you take what you’d normally have sent to that debt and send it all to the next smallest debt. Repeat this until there’s no more debt beside your house (if any).

This takes awhile. Sometimes it takes people years. It depends on how much you want to sacrifice and how hard you want to work and how much in debt you are. (Don’t be afraid to sell something if you have to!)

Step 3: Full emergency fund. This is where you save up 3-6 months worth of expenses in cash. Not 3-6 months of income - just expenses. Once you have no debts (aside from the house), this isn’t as hard as it might feel right now. Imagine all those monthly payments you are making now… they could be all added together and turned into savings. It adds up quickly.

Once the emergency fund is ready to go, you hide that away in some different bank account. Someplace that you can get to if you need it, but make sure it’s hard to actually dip into it. It is only to be used in emergencies - not to buy a new car or whatever.

Step 4: Invest 15%. This is pretty simple. Now you have no debt and a nice safety fund set up. Now it is time to think of retirement. Invest it into mutual funds and other good things. Set up an IRA, etc. Invest 15% of your income each month.

Step 5: College funding. If you have kids, this is where you finally start to set aside some money for them in a college fund of some kind so that it has time to grow and maybe allow them to go to school without ever having to experience the horrors of student loans.

Step 6: Pay off your mortgage. This is pretty obvious. Push everything you can to the mortgage payments and try to pay that sucker off way ahead of time. You can save thousands doing that.

Step 7: Build wealth. This is the part where, mostly, you just sit back and relax and let your money work for you. Now that the house is paid for, the kids are pretty much set up for life and such, you just invest like crazy. Give money away. Have fun, etc. Whatever - as long as you buy everything using cash. This is the final goal.

Note 1: Steps #4, 5 and 6 can generally start to be executed in parallel. The steps before those are required to be serial (done in order). Once you are past step #3, any extra money you have each month can be forwarded down the list of steps until it runs out.

Note 2: If an emergency happens and you have to tap into your emergency fund, then you immediately rebuild that fund before proceeding with any other action. So if you’re on step 2 and something bad happens, you need to go to step 1 again. If you are step 4 and something bad happens, you stop investing and go back to step 3 until it’s finished. Then you get to move back to step 4+.

Ok. That’s the whole thing right there. It’s not magic and it’s not rocket science, either. What it is, though, is a plan laid out there clear as day, easy to see, easy to reason about, and actually not that hard to do. Probably the single most difficult step for most people is #2 because it takes forever if you have a lot of debt.

The most dangerous step is around #3. After paying off your debts I imagine it’d be easy to be tempted to fall back into old habits since it would suddenly seem like there’s a lot of money around. Danger!

For me, the real value of this plan isn’t so much that there’s any magic to it (there’s not), just that it is so clearly specified and makes so much sense once you see it laid out in a clean manner.

It’s not even the most mathematically optimal plan since it ignores interest rates. Some experts advise people to always pay off the bills with the highest rates. True that’d save some money, but most people need the mental boost of a few quick wins. A lot of people have a few debts sitting around that could be killed off easily in a month or two if they just made them a priority. That’s what this plan does. It’s a simple human behavior hack. (I’ve seen many people do the math on this and Dave’s method usually costs a little bit more than an optimal interest rate-based plan, but the psychological benefits outweigh the small added financial cost.)

This might all seem blindingly obvious to some people, but it is one thing to know a “truth” and quite another to act on it. Dave Ramsey has somehow managed to write and talk about this topic in such a way that it finally motived Melody and I to take action rather than just sit back and assume it’d all go away somehow.

This entry was posted on Tuesday, April 10th, 2007 at 12:58 am and is filed under Life. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.