- Baby Emergency Fund of $1,000
- Debt Snowball
- Fully Funded Emergency Fund (FFEF)
- 15% of gross income into retirement
- Kid’s college
- Pay off the House
- Build Wealth
Picture this with me. You have spent the last 18-24 months (or longer) putting every single dollar you could scrounge towards debt, and saving for your FFEF. Since you’ve gotten to this point I have no doubt you were super intense. It’s as if you’ve been riding in a speeding car with the windows down. The road and trees flying by so fast you can’t make anything out. You’ve had one thing on your mind and that was to kick debt to the curb, and arrive with enough buffer money to last in the event of some unexpected situation. Congratulations. You’ve made it. Now it’s time to slow down a bit, and become a little more strategic with your money.
Can you see yourself reaching this point? I can. I know you can do it. I can testify it’s one of the most satisfying feelings you’ll ever experience. What’s next? Glad you asked. Let’s move on.
When you free up your income by paying off everything except the house, you have accomplished what many see as unattainable. You should now have what’s known as cash surplus. You’ll have money left over at the end of your month instead of the other way around. The TMMO (Total Money Makeover) suggests you now begin thinking of the future by adding 15% of your gross income towards retirement.
Baby Step 4 - RetirementThere are a few different types of retirement investments Dave suggests. Since the goal of this post is purely informational, and meant to explain what Dave teaches, I will not attempt to argue whether he is right or wrong. First, if your employer offers a matching 401(k) plan you should contribute up to the amount that is matched. If your company offers a 3% matching plan, then you should contribute 3% of your check. Free money is always a good thing.
The next recommended investment type is an IRA, or Individual Retirement Account. You have two types to choose from. There is the traditional IRA, and the Roth IRA. There is nearly a limitless supply of information on these types of retirement choices. I will not attempt to go over them here.
Since we’re in our thirties, my wife and I contribute to a Roth IRA, one for her and one for me. As of this writing we can contribute $5,000 each per year. Although we pay taxes on the money we put into a Roth IRA, we do not pay taxes on the amount that grows once it’s in the IRA Account. When it’s time to pull money from the Roth, we will not pay taxes on what is taken out. Dave suggests mutual funds inside your IRA that fall into four categories.
- Growth (25%)
- Growth & Income (25%)
- Aggressive Growth (25%)
- International (25%)
The risk level in funds runs from safe (growth) to risky (aggressive growth), and then takes advantage of an array of international companies. The funds should be at least 10 years old (or somewhere close to this), and should have a 10% return (or more) over that time. These funds exist, but you must look at the record over the LIFE of the fund not over the short term. Other things to consider would be if the fund is a no load, what the expense ratio is, and the turnover rate of the funds. Again, you’ll need to do your own research, and understand your investment choices. If you need help with this go to http://www.daveramsey.com and click on ELP (Endorsed Local Provider).
Baby Step 5 - Kid’s CollegeStep 5 is devoted to setting aside money for college. College is expensive, and getting more so every year. A 2008 study from the National Center for Education Statistics discovered that 50% of all college graduates have an average of $10,000 to pay back in loans. I’ve known people personally to have MUCH more than this. It’s important to our children’s financial freedom to make sure they do not start off life with debt. It’s not always completely avoidable, but it can be drastically reduced based on many factors, and good choices. I also hope to encourage my kids to work through school and help with the cost of their education.
Dave recommends using the Educational Savings Account (ESA) to build college savings. It works much like a Roth IRA in that you get to choose the funds, and the money is not taxed when it’s properly used. There is plenty of information on the Internet to help you understand the details of an ESA. Google is your friend.
Baby Step 6 - Pay off the HouseUp to this point I can speak from experience. This step is still in the works for us, although we currently have a relatively low mortgage balance. Up until Baby Step 4 (Fully Funded Emergency Fund), you have a clear idea of exactly how to know when the step is complete. Save $1000. Pay off everything but the house. Save three to six months of expenses. Put 15% towards retirement. Then, in step 5, you aren’t given a percentage or an amount. You are simply told to ‘save for college’.
Exactly how you choose to implement the previous steps will help determine how much surplus you have to apply to Step 6, pay off the house. Dave suggests any money left over after steps 1-5 should go towards paying down the mortgage.
I’m going to chase a rabbit real quick. Come along with me. I’m the type of person who likes things to be as close to black and white as possible. Tell me what to do, and I’ll do it (within reason). Many people get confused after the FFEF is complete. At what point can we begin to save for vacation, new furniture, special dinners, new toys, etc? This is unofficially called baby step 3b. If you want to save up $2,000 to go on a vacation, the only thing you’ll need to make sure of is that you are completely done with baby step 3. I have stopped 4-6 in order to save for something on 3b (temporarily), and then rolled back into 4-6. I think this is okay, but you need to decide this for yourself. As long as you’re not adding debt back to your life, I feel like this approach is okay. You obviously don’t want to make a 6 month habit of it, but if you need a few pay periods, or a few months to hit a short term savings goal, then it should be fine to either cut back, or stop the other steps. Others may disagree, and this point isn’t really spelled out by Dave. Let’s exit the rabbit trail, shall we.