Tuesday, February 1, 2011

7 Baby Steps: the RTRSBM Version

13 months ago, Marjie and I pinky-swore to change everything we did money-related and commit to a new direction and way of life.  Today, that bond is stronger than ever and thriving.  This post is intended to give a basic understanding of the plan we are following, things we've done, things that we've altered, and the future that we are looking forward to.

A couple of foundation points:
The 7 Baby Steps are the logistical steps to follow with the ultimate goal to be 100% debt free with the ability to give and live "like no one else."  The most common phrase when hearing about Dave Ramsey is "Living like no one else today so that tomorrow, you can live like no one else."  Unfortunately, many tie that first part to living on nothing and suffering.  Today's post should prove at least one thing to you...that is extremely far from the truth.  Quite the opposite, actually.

This is the foundation.  You've got to have it in savings to prevent you from running to credit at the first sign of an emergency as you work through the plan.  If you hit it mid-plan, you simply pause and replenish it.  Have a large emergency fund already but also have debt outside of the mortgage, you bring it down to the $1000 level and put the rest straight on debt.  Tough, I know, but consider it more of a driving force to get out of debt faster.

As part of building this emergency fund, you must realize that the cornerstone of your financial life and most powerful tool is your income.  It is your weapon you take to battle to make it all work.  You need to maximize it and there are multiple ways to do so without actually getting a raise and you need to do these things as part of kicking off your plan:
  • Adjust your withholdings: how much of a tax return do you get each year?  Much more than a few hundred dollars?  If so, you need to stop loaning Uncle Sam your money interest free and put it in your pocket, your budget, and against your debt.  Let's say you get $5000 back, on average and get paid every other week, ie: 26 times per year.  That means that you are loaning Uncle Sam about $192 PER CHECK, interest free.  Wouldn't that be better in your hands so you decide what to do with it?  Forget the worksheet on your W-4...it's based on an outdated system.  You need to start increasing your withholdings until you put this money in your pocket.  You'll probably have to make a few changes to your W-4 as you fine tune this adjustment as you cut off Uncle Sam.
  • Stop investing.  What?!?!  Yes...stop.  We stopped our 529 Plans (kids' college savings), idled Marjie's deferred comp at work, and initially stopped my 401K contribution.  Now, Dave Ramsey's plan calls for stopping the 401K even if given a match.  In all honesty and transparency, we did that, but re-started the matched amount only two months later.  Giving away free money for retirement was something I simply disagree with.  It's a minor, minor change, but one WE decided to do.  Everything else remains idled until later.  If we were contributing to an IRA, we would've idled that, too.
  • Can you sell anything?  Another common phrase in "Ramsey Land" is "Sell so much that your kids think they're next!"  Garage sales are awesome for this.  Don't look anything over in your house.  Open boxes, dig out the closets, clean out the garage...sell, sell, SELL!
  • Term Only: as a prior financial advisor, I used to believe in whole life insurance.  Whole (vs. Term) gains cash value over time and eventually pays for itself.  Typically, whole life is far more expensive than term because of that.  Term, on the other hand, gains no cash value but is worth much more.  Whole is a horrible "investment" and the better option would be to "self-insure" yourself later on to achieve the same ultimate goals of having that insurance.  So, we cashed in our whole life and kick-started our debt snowball.  On the flip side, we have maximized our term life coverage...typical goal is 10 times your annual income in term coverage...for each of you.  If you are a relative healthy, non-smoker, term is CHEAP!  You are being irresponsible if you are not protecting your family with term insurance.  Period.
Next, write out your debts, build your budget, and build your self-escrow plan: now you are going to face head on the numbers, the big "not talked about in public" numbers.  You can buy budgeting software, etc. but for me, I'm a big fan of Google Docs.  Word docs, Excel spreadsheets, etc. are all available for free and are accessible from anywhere.  No files to e-mail around and wonder which one is current, etc.  With my travel, I can access my budget and debt snowball from work, from my iPhone, or from the other side of the world, and Marjie can be viewing it with me in real time.  Awesome, simple, free tool.
  • First Tab on your Google Doc: Across the top, list your debts smallest to largest, including your mortgage.  One column per debt: ie: Kohl's card, Mastercard, school loan, car #1 loan, equity loan, mortgage.  On the left, list the months starting with the current month and list them month by month for the next two years.  Column A should all be months.  Now you have the framework built.  Next, log in to all your accounts and type in the current balance...remember, smallest to largest, left to right, ignoring any interest rates.  Don't skip anything.  List everything!!!  As you work through your plan, you will come back to this tab on the 1st of each month and type in the balance.  As you zero out a debt, you will close that account and stop recording the zeroes.  Can you picture the ladder forming on your spreadsheet?  That simple graphic will help keep you moving as you achieve your short-term goals.
  • Next tab: your budget.  For over 17 years of marriage, we had no budget.  We lived paycheck to paycheck.  It didn't matter what we made.  More, less, it didn't matter!  We just spent what we had and prayed nothing bounced.  It never did and we were proud of a great FICO score!  We could buy anything!!!   ON DEBT!!!  WOOT!!  That's so normal today but so wrong...but we as a nation have been brainwashed that it is normal...which it is.  Normal IS wrong.  Debt Free is right and weird.  Yes, your goal here is to be WEIRD!  Anyway, your budget: for us, we get paid weekly so our budget is built on a weekly basis.  Yours may be different.  The top is the take home income followed by the necessities.  Here are some pillars of our budget:
    • Groceries: cash amount each week withdrawn from ATM.  Cash only.
    • Allowance: we each get one weekly and if we want something, we save for it.
    • Gas: you should have an idea how much you need to make it to the next budget
    • Self-Escrow Account: see later in this post for this.
    • Mortgage (we break our mortgage into weekly amounts and sweep that into savings each week but make the payment once a month)
    • Monthly bills as they become due
    • Tithe for church
    • Entertainment Fund (what we use to do extras like restaurants)
    • Vacation Fund (weekly amount to save for vacation or Christmas)
  • Self Escrow Account: OK, this is my own creation but let me tell you, it is a "work of art"!  You know how you have those bills like the sewer, water, and trash bills that perhaps come everything 2 or 3 months?  For us, our taxes are not part of our mortgage and that monster bill comes every six months.  We also have our security monitoring, lawn care, timeshare maintenance fee (timeshare is owned free and clear and deeded for life), and a few other items.  These bills, depending on when they show up, can be the "perfect storm" and derail your forward momentum.  What we do is "self escrow" an amount every single week.  That amount is found this way: we convert all the bills into a yearly amount.  For example, let's say the trash bill is $45 and it comes every 3 months.  That's $15 a month and $180 a year.  Take $180 and divide that by 52 weeks.  That is the amount for that bill that needs "swept" into savings each week.  Using simple formulas on the Excel spreadsheet, you do this for every bill and determine the amount needed in total to sweep to savings.  When those bills show up, you simple write the check.  Zero emotion, zero worry.  The money is there and makes no impact on your debt snowball.  For us, this is a major and critical component to our budget.
You are ready!  Your plan at each payday is to go right down your spreadsheet and knock each thing out...immediately.  Give every cent a name and tell it where to go, not the other way around.  YOU take control of your most powerful resource, your income.  Your goal each payday is to zero out the bottom.  Always, the bottom line is "Debt Payment."  Whatever is next, from smallest to largest on your debt tab, gets that amount in full.  Nearly all people who build this budget start finding money they swore didn't exist nearly immediately.  When you budget and tell your money where to go, you find more of it.  Hard to believe until you see it happen before your eyes.  KEY POINT: you must zero that budget out quickly or you'll find yourself adding line items to your budget as supposed "must-haves" appear in your daily life, thus killing your debt payment.  If it's not budgeted, it doesn't happen!  Period!  Remember, you pinky-sweared to your spouse (if married) that you'd adhere to the budget and be fully accountable to each other, right?  Right.  As you attack and pay off each debt, you'll free up more cash and can put more towards the next debt, hence the reason for the term "snowball."

What about emergencies?  What if the the washing machine dies?  Remember that baby emergency fund? In the last 13 months, we have replaced our dishwasher, put new brakes on Marjie's 2006 Honda and put 4 new tires on it as well.  Those 3 items were far more than the $1000 but of course, didn't all happen together.  We simply took a pause in our debt payment and paid what needed to be paid.  If we had to touch the $1000, we did so but immediately at the next check, replenished it.  See how we didn't use credit or take a loan to pay for the "emergency?"  That fund keeps you honest and on track and AWAY from borrowing any more money.

What you've been reading above is the machine that makes the snowball roll.  You simply live to the budget, stay accountable to it, and watch it happen.  IT IS REALLY THAT SIMPLE.  Even though we've 'restricted' ourselves to a budget, we honestly feel that we have more money than ever before, tithe (give) more than ever before, and have ZERO stress over money.  Why?  Because we have a plan and there are no surprises.  I can't stress enough how truly easy it is once you "get sick and tired of being sick and tired" and sit down and do it.  Enriched marriage, complete stress removal, and a path to true financial freedom and the ability to give like never before.

As you pay off each debt, celebrate!  Cut up the credit card, take a picture of the payoff notice or you holding the title to your car...celebrate!  At the same time, swear to never return again to that place.  From now on, you will save and pay in cash.  Never be a slave to the lender again!  Don't forget to update your 1st of the month balances, either.  This is a great motivational tool to propel yourselves forward.

When you arrive here (we're not quite there yet), you will have NOTHING left but the mortgage.  That includes an equity loan if you have one...that's part of the debt snowball in Step #2.  Now, you build up 3 to 6 months of living expenses and store it in savings.  This should be easy at this point because you've been living on a budget and it's all written down in front of you.  You just need to add it up.  Plus, you have far less bills to pay, too. :-)  For us, we're going to go for 6 months but it's a case-by-case basis.  We plan to store it in a money market fund that doesn't earn a whole lot but is very accessible if necessary to access it.  Once done, move on to Step #4!

Time to max out Roth IRAs (Individual Retirement Accounts) and start up your pre-tax 401Ks or 403Bs at work.  Roth IRA's are funded using your take home income (money you've already paid tax on) and grow tax free and taxes on your earnings from the growth are tax free.  You should max these out and invest them in mature, diversified mutual funds.  I'll stop there with my financial guidance as I'm no longer in the business of giving financial advice.  As for  your 401K, at least contribute what they are matching.  All in all, you should be contributing 15% of your income into retirement savings.  That's the benchmark...15%.  Once you've reached the 15% level, you are done with Baby Step #4.  This should simply be a matter of getting it set up and turning the switch on.  Do not linger on this step!  Get moving!

Obviously, this can look very different for every single family.  529 college savings plans and Coverdell accounts are the most popular and work very similar to Roth IRAs in terms of tax advantages, as long as they are used for education.  The goal here is to not send your kids to college on debt.  Your lessons learned now should spill into your kids' lives.  Yea, they might join the military and get it all paid for or may be a tradesman and never go to college...who knows.  There is no benchmark for this baby step but lots of advice out there.  Start here.  Once you have it up and running regardless of your plan, move on!  No lingering, folks!

Oh yea, this is the exciting part.  "But Nick, it's to our advantage to have a mortgage and get the tax write off.  Right?"  What a HUGE misconception that I once had.  Let's break it down: If you have a $200,000 mortgage at 5%, you would have a $10,000 tax deduction. With your income, you’re in a 35% tax bracket. That means with your income you would pay about $3,500 in taxes. So the math you are working says you should send $10,000 to the bank to keep from sending $3,500 to the government.  Make sense?  The money saved by paying no mortgage but paying the taxes is FAR MORE than having a mortgage payment and getting the "deduction."  This has been a huge brainwashing in our country and one that just keeps getting spread by every mortgage lender out there.  Anyway, you now are free to attack your mortgage, guns blazing!  You are debt free but the house, borrow nothing, have 3 to 6 months of living expenses saved, fueling your retirement at 15%, funding college, and now can blast your mortgage.  For us, our goal is before our oldest graduates high school...about 8-9 years from now.  That would pay our mortgage off about 15 years early.   Do THAT math!

Debt Free!!  We can't wait for the day!  We already tried some extra giving on a very small scale a few weeks ago.  We were at Outback Steakhouse and received great service.  It was a very "weird" feeling but we decided to give it a go.  We tipped like 40% or something like that.  While I wanted to peek through the blinds outside and watch her surprise, I didn't.  It felt...well....awesome.  That was so simple and so minor, but it was just a taste of what it feels like to "give like no one else."  WE CANNOT WAIT FOR THIS STEP!  Yea, the wealth building will be nice, but we really want to give spontaneously and often.

Friends, that's the plan.  Our testimony is this: this complete switch that we "cold-turkey'd" 13 months ago has changed our life.  It has enriched our marriage.  It has put us on firm footing to do so much more.  Not the material things, mind you, but for others.  In the past year, we've given more than ever before yet we've paid down thousands and thousands of dollars in debt.  We are proof that it works.  I can't tell you how cool it is to go on vacation, paying for everything in cash, having some left over at the end, AND paying off a car while there!  I used to say that cash is the same as my check card with my bank...after all, it comes from the same place, right?  Yes...and no.  There is an emotional connectional when you hand over cold hard cash for a product vs. swiping your check card.  You order at a restaurant differently, you visit Starbucks less often (well, I actually increased my frequency but use my allowance..my choice...to do so!), and it just changes your perspective on everything.  Trust me...it's not the same.

To you, a swift kick where you need it to become "gazelle intense" and become debt free.  We are living it and hopefully, you can garner this intensity and become "gazelle-like" yourself.  Being weird..."living today like no one else so that later, you can live like no one else," is our new 'normal' and I gotta tell you, it's AWESOME! 


Nick B said...

A bit of an update to my post since I did our taxes tonight. I really played around with the exemptions this year when we started the debt snowball. Last year, federal and state combined, we got $4140 back. "We were so proud!!!" Well, we cut Uncle Sam off this year and said NO MORE!! Ideally, we'd get a few hundred bucks back. However, we owe about $436. I was fearful we'd owe thousands so I am VERY happy with this number. This means they didn't get one penny of our income interest free. Nothing. Instead, it went to debt and WE told it where to go. I've got no problem squaring up our tax bill and writing $300 to Uncle Sam and $136 to Ohio. No problem at all! For this year, just a little tweaking to our exemptions is in order.

Sensationally Red said...

Nick, this was an excellent account of how you and Marjie applied Dave Ramsey's steps to your life. Like many women, I thought baby step 1 with just $1000 was too little. Money is security for me, so I had much more when applying the steps. I'm more comfortable with about 8 months in my emergency fund since I'm single. I'm on step 4 and 5 now, saving for retirement and the kid's college. I've learned so much...mostly that I enjoy living simply. I absolutely loved how well you explained the mortgage deduction myth! Excellent. Unfortunately, my name is still on the ex's mortgage and is unable to refinance due to the current market, however, the ex is responsible enough to pay, and for now I enjoy the simplicity of renting. I live off 70% of what I earn and save/invest the rest. I don't have much in the way of material goods, but this is how I like to live. Options abound when you're debt free and have a good cushion. I do not totally eschew credit cards. I use them, pay them off monthly and would certainly not touch them if I lost my job or something, cause I've got a good emergency fund. Your financial transparency is refreshing. I tried to break even on my taxes, but this is the first year I filed, single head of household, and qualified for a good number of tax credits since my income is relatively low. I got back 2500 back! Yikes. Wasn't expecting it, so I adjusted my allowances and padded by EF with the refund. Love this post. Sorry for the run on comment.