Debt sucks! It really, really sucks. I’ve been there (over $40,000 in the hole, with nothing to show for it) and it’s depressing as hell! It truly is a suffocating feeling… But, with patience and a few smart practices, it can be overcome.
I just finished Dave Ramsey’s book – The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness. I really enjoyed Dave’s no nonsense, simple approach. Below I have outlined his 7 steps to a total money makeover. They are extremely simple, but the catch – it will require time and patience. Dave repeatedly states that you shouldn’t expect to get out of debt overnight with some debt consolidation scheme. Stay away from those! Getting out of debt really requires you to budget, spend wisely, and make consistent payments. I think it goes without saying (but I’ll say it anyways), you should have a written budget. Sit down and write out your expenses and figure out where you can cut costs. Keep your receipts for a month to see where you are spending and wasting money. Once you start analyzing where you are spending your money, you may be surprised. Additionally, only use cash when making purchases. It’s much harder to spend cash when it’s in your hand because it is tangible, whereas putting it on a credit card isn’t very tangible.
Without further ado, here are the 7 very, very simple steps:
Step 1 – Save $1,000 – This is your initial emergency fund. This is your cushion (provides comfort and that warm feeling of a little financial security) and it’s for emergencies that pop-up so you don’t have to put more on a credit card. Putting more on your credit card while you’re trying hard to get out of debt will only discourage you. Just remember, your car breaking down is an emergency… needing a new pair of shoes is not! If you have defined a budget for the household and cut costs where needed, it shouldn’t take long to save this.
Step 2 – Pay off all of your debt, except the house (if you have one Download Ola Taxi App). Start with the smallest balance. You may think that paying the debt with the largest APR is the best choice (fiscally it is), but it’s not the best way to go when you factor in the psychological factor. When you start with the smallest debt first, you see progress fast. This small feat gives you momentum and as you pay one off, you can take that extra money and put it towards the next debt. Once you pay the second one off, you start this domino effect and you’re moving at full speed as you focus on each debt one by one (using extra money from previous dues towards the debt you’re working on paying off). By the time you get to the last one you have so much momentum that you can crush it in no time. Once you’re out of debt, which may take a year or two (or more), do not get anymore debt! Debt is not a tool. You don’t need a credit card, believe it or not! Don’t buy things you can’t afford. Live below your means. It’s pretty simple.
Step 3 – Save 3 to 6 months of expenses in savings (about $10,000 on average). This is your full emergency fund. This should be enough to cover all of your expenses for 3-6 months (house, utilities, food, etc.). You shouldn’t have any debts at this point. No car payment, no credit card payments, nothing. Now when something unexpected happens (like losing your job), you will be able to pay for it without going into debt. What a nice feeling! Make this money liquid (easy to get to). A money market is a good spot for it.
Step 4 – Now it’s time to start thinking about your future. Invest 15% of household income into retirement. Think 401K, Roth IRA, and traditional IRA. The average American household earns about $40,000. Investing 15% per month ($500) into a low-cost index fund for 30 years will yield just over 1 million dollars… and the total deposits are equal to $180,000. With time and compound interest, you can turn $180,000 into 1 million dollars. Pretty nice return if you ask me!
Step 5 – Start a college fund for your children (if you have them). Saving in a 529 college savings fund or an ESA (education savings account) will give you certain tax breaks. There is no reason to go into debt for a college degree. If your child is going to start college soon, look into grants and scholarships. There are thousands and thousands of grants and scholarships young adults can apply for and many of these go unclaimed each year. Do not take a huge student loan! If your child is young enough, invest $167 dollars per month for 18 years and your child will be able to go to any college they want.
Step 6 – At this point, you are debt free, have a nice emergency cushion, are saving at least $500 per month for retirement, and saving $167 per month for your child’s college fund. Next, if you have a home, pay it off early. Apply all of your extra money towards your home. Paying it off early will allow you to save tens of thousands of dollars.
Step 7 – Finally, build wealth and give. Once you have done steps 1-6, it’s time to start giving back as well as continuing to building your wealth. If you want to keep it simple, just stick to a low cost index fund, like the S&P 500. Make your monthly contributions and sit back and watch the magic of compound interest go to work. Give back in a way you find fulfilling. You should be doing this from step 1 because I believe when you give, you receive. It’s strange how it works, but once I started giving and donating more, I also started getting out of debt quicker. It seems counter intuitive, but it works…. Universal karma I suppose!
There you have it. 7 quick and simple steps to get out of debt, stay out of debt, and start building wealth. It seems too simple and easy, but you know what? It actually works. Dave Ramsey has been criticized in the past because his methods are so simple, but they truly are effective. If you are having financial difficulties and want more details for each step outlined above, I highly recommend you take a look at his book. The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness