Baby Step 1 - $1,000 Emergency Fund
An emergency fund is for those unexpected events that are not regularly planned for happening in life - you lose your job, there's an unexpected pregnancy, the car's transmission goes out, or, or, or. Something like this WILL happen. Money magazine says that 78% of us will have a major negative event happen in any given 10-year period of time. So get a rainy-day fund, an umbrella.
This beginning emergency fund will keep life’s little Murphies from turning into new debt while you work off the old debt. If a real emergency happens, you can handle it with your emergency fund.
It's also the perfect time to get in the great habit of budgeting. John Maxwell says, "A budget is telling your money where to go, instead of wondering where it went." You don't have to start a household budget with a perfect month. Start where you are. Write down what you have today. Income and expenses. From then on, spend all your income on paper with purpose before the month begins.
No more borrowing! It’s time to break the cycle of debt!
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Baby Step 2 - Pay off all debt using the Debt Snowball
The math seems to lean more toward paying the highest interest debts first, but what I have learned is that personal finance is 20% head knowledge and 80% behavior. The principle is to stop everything except minimum payments and focus on one thing at a time. Otherwise, nothing gets accomplished because all your effort is diluted.
You need some quick wins in order to stay pumped enough to get out of debt completely. When you start knocking off the easier debts, you will start to see results and you will start to win in debt reduction.
So list your debts in order with the smallest payoff or balance first (excluding the house). Do not be concerned with interest rates or terms unless two debts have similar payoffs, then list the higher interest rate debt first.
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Baby Step 3 - 3 to 6 Months of Expenses in Savings
Congrats! Now that you’ve completed the first two Baby Steps, you have momentum! But wait… don’t start throwing all your “extra” money into investments quite yet.
It’s time to build up your full emergency fund.
Ask yourself, “Self, what would it take for you to live for 3 to 6 months if you lost your income?” Your answer to that question is how much you should save.
An emergency is something you had no way of knowing it was coming, something that has a major impact on you and your family if you don’t cover it. A great place to keep this money is in a money market account.
Remember, this stash of money is NOT an investment; it is insurance you’re paying to yourself, a buffer between you and life.
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Baby Step 4 - Invest 15% of Household Income into Roth IRAs and Pre-Tax Retirement
If you’ve reached this step, you have no payments (but the house) and have saved 3 to 6 months of your living expenses.
It’s finally time to get serious about building wealth.
I don’t suggest investing more than 15% because the extra money will help you complete the next two steps – college savings and paying off your home early.
Well, why not less than 15%? Some people want to invest less or none so they can get a child through school or pay off the home super-fast. I hate to tell you, but the kids’ degrees won’t feed you at retirement, and if you throw all your money into your house, you’ll end up having to sell it to eat and buy the book 72 Ways to Prepare Alpo and Love It. Bad plan.
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Baby Step 5 - College Funding for Children
Whether you are saving to go college or you’re saving for your child to go, the important principle is to start NOW! You should have already started Baby Step 4 – investing 15% of your income – before saving for college.
In order to have enough money saved for college, you must aim at something. Your assignment is to determine how much per month you should be saving at 12% interest in order to have enough for college. If you save at 12% and inflation is at 4%, then you are moving ahead of inflation at a net of 8% per year!
NEVER save for college using:
- Insurance
- Savings bonds (only 5-6% growth)
- Zero-coupon bonds. (only 6-8% growth)
- Pre-paid college tuition (only 7% inflation rate)
Remember, college IS possible without loans!
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Baby Step 6 - Pay Off Your House Early
Can you imagine what life would be like if you had absolutely no payments – not even a house payment?!
You’re not too far from making that a reality! You’ve come this far in the Baby Steps; now it’s time to throw all that “extra” money into the largest investment you’ve probably ever made: real estate.
As you attack this last debt, you will gain momentum much like you did back in Baby Step 2 with the Debt Snowball. Remember, having ABSOLUTELY NO PAYMENTS is totally within your reach!
Remember:
- When selling a home, think like a retailer.
- When buying a home, think like an investor.
- Never get more than a 15-year fixed mortgage.
- Don't tie up more than 25% of your income in house payments.
Baby Step 7 - Build Wealth and GIVE!
You can’t shake hands with a clenched fist. - Golda Meir
HOORAY! You are now debt free, house and all! Doesn't it feel... weird?
"What am I going to do now that all this money isn't tied up in debt and house payments?" you may be asking yourself.
Build wealth and give like never before. Continue to work toward leaving an inheritance for generations to come. Bless others now with your excess. It's really the only way to live!
Vow to never have a fistful of dollars held so tightly that those precious dollars never get away. Some people think if they clutch those dollars tightly enough, never giving, they are on the path to wealth. The real world teaches that the opposite is true.
Just try it. Let me know if it doesn't work.
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thank you for posting this. I am copying it and printing it out as a reminder. I have his book but so much is going on I haven't been able to read it. I am so glad you guys are working on this within your first year. Dave and I don't have a lot of debt but now almost 6 years in and almost 3 kids, we haven't managed money well.
ReplyDeleteI hoped it would encourage some one! :) Seems like a whole lot of freedom is associated with being debt free. But the important thing to remember - "If you want to have financial peace you must first surrender yourself to the Prince of Peace" ...or something like that, as Dave says. Love you Kami!!!
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