Personal Finance Done Right: Breaking Away From The Joneses

There were many ways we could have started off these posts but there was really only one topic that would make sense if you knew me, and hopefully you all stick around long enough to do so!  We are beginning with a topic that involves each and every one of us however, most of us put little to no consideration into its importance, mainly because we have all been “conditioned” to operate in autopilot; the only problem is that 8 out of 10 of us Americans are riding this plane straight into a ditch. This seems like a rough start but don’t worry, I wouldn’t bring you into this if there were not already a proven fix to this problem. What’s the topic you ask? Well it’s personal finance of course and in this post, we are going to give a quick crash course on simple, proven, methods that will break you away from what many of us consider to be normal, i.e. broke. So stick around and let’s discover why the old adage of “Keeping up with the Joneses” is not exactly the bar I teach my Marines to strive for!

Let’s be frank, a big part of why I decided to discuss the topic of personal finance before any other is about as straight forward as it comes. First of all, I know this topic very well. If you are not already aware, my wife Nelli and I had our own bout with being “normal” some years back. It wasn’t until we were shown that “Keeping up with the Joneses” really just meant that we were buying things we didn’t need with money we didn’t have, just to impress people we really didn’t care about, that we woke up and changed our family tree forever. For more about this back story please read my story titled “Being Normal,” where I go in depth into my personal story about being stupid with money.

As a Marine I have sought out and earned certification as a financial specialist and I have helped coach hundreds of Marines and civilians alike on this topic. To this day I have helped educate families and individuals on how to pay themselves out of more than $800,000 in combined debt, regain confidence and control of their finances, as well as stick to a proven plan that will lead them to significant levels of financial success. I can take credit for the spreading of this word but what I cannot do is say that I created this program that breaks us from the norm, that distinct honor goes to the one and only, Mr. Dave Ramsey.

If you are not familiar with Dave Ramsey, I implore you to become so. Mr. Ramsey takes a seemingly dry and soulless topic, personal finance, and captivates, educates, and guides you on how to stop being “normal” with the mindset that debt is just something we have to live with. Similarly to recruit training, Mr. Ramsey’s program will tear you down and have you questioning things that you had once “known” to be fact, things like believing that car loans are normal and that debt is in any way good. He will then build you back up with basic, yet time tested principles, that will help begin your path to financial success, principles such as spending less than you make, “a concept that congress can’t grasp,” and saving for your future.

Using Mr. Ramsey’s teachings, along with my education and experience I would like to share with you the plan that quite literally changed my family’s life as well as the lives of hundreds I have counseled. The tools that I personally recommend are the book The Total Money Makeover and Dave's first class budgeting app, EveryDollar.com (Click below to download the free app from the App Store for iOS or Google Play for Android!)

It all begins with “The Baby Steps.” These seven steps are so basic, so simple, it is almost comical looking back, yet the power of these steps are not to be taken lightly. I strongly encourage each of you to read/listen to Mr. Ramsey’s book, The Total Money Makeover as this is where it all started for my family breaking free from the norm. I will do my utmost to now share with you the seven “baby steps” as well as explain each and put them into context.

Dave Ramsey’s Seven Baby Steps to Financial Peace:

Step 1 – Beginner Emergency Fund ($1,000)

The first recommendation is to save, as quickly as possible, $1,000, to fund your beginner emergency fund. The purpose of this fund is to act as an insurance policy against any unexpected events in which you simply cannot plan for and that you would otherwise have swiped the expense onto a credit card or signed away onto a loan. Remember, the goal is to prevent you from going further into debt and digging a deeper hole than you are already in.

Examples of an emergency would include getting a flat tire, a pipe bursting in your home, or an ambulance ride to the hospital. There are endless examples however the one commonality is that they are all unexpected. If you can plan the expense in advance then it does not constitute an emergency and you will have to save for it later.

I recommend opening a new savings account with your bank or credit union and changing the name from “share savings acct XXXXXXX” to “Emergency Fund,” this way there is no mistaking what that money is for and it doesn’t “accidentally” get used to order a pizza!

Step 2 – Pay off Debt

The second step is more commonly referred to as the “Debt Snowball!” In this step you will list all of your debts in order from smallest to largest, except your mortgage, we will get to that later!

The way this steps works is brilliant. First of all you need to ensure you are taking care of your family’s basic needs; food, utilities, and basic survival items need to be paid for first. With the leftover money, you will tackle your debts with “Gazelle Intensity” as Dave says.

In this method, your smallest debt will be your number one priority. You will pay minimum payments on all of your debts and after those minimums are met, all of your extra money will go towards paying off that first, smallest, debt. After you pay off that first debt, you now continue to pay minimum payments on your remaining debts and you now pay off that next largest debt with a vengeance, and so on and so forth and your debt payments will “snowball” until you are out of debt, except your home!

Now my degree is in psychology and one thing I love are the endless ties between personal finance and behavior. Many people, when looking at Baby Step 2, immediately ask “well why wouldn’t you pay these debts off in order of highest interest? Wouldn’t that make the most mathematical sense?” The answer to that is simple; Yes, however if we were doing math here you wouldn’t be in debt, would you? Personal finance, as with just about everything for that matter, is around 80% behavior. By paying off the smallest balance first you are setting yourself up to win at a psychological level for each time you pay off a debt you register that as an accomplishment and success, which will give you the steam and motivation to continue on to those larger debts which will take longer to tackle. If you were to pay the higher interest loans off first, there is a significant possibility you will come across a large balance debt, such as a student loan, and you will lose steam before you pay your first debt off. Please do not try and change these steps, they are proven and they absolutely work!

Step 3 – Fully Funded Emergency Fund

We now bring ourselves back to the emergency fund and it is time to bring our $1,000 beginner fund to a fully funded emergency fund whose balance is equal to that of 3-6 months of living expenses. In step two we paid off all of our debt and with the completion of step three we are ensuring that debt never finds a way back in. To figure out what amount your fully funded emergency fund should be, calculate how much money you need in order to live for one month, necessities: food, rent, mortgage, utilities, insurance, basic needs, and then multiply by either 3 or 6.

Most people lose their steam after step two and never make it through step three. This fully funded emergency fund is essential to make sure you are not caught off guard by job loss, or any other emergency for that matter. Remember, you have already sworn off debt for good, this fund is a fully funded insurance policy to ensure you never go back into debt again, despite the curveballs life throws.

Who should save for three months and who for six? It all goes to how comfortable you feel based upon factors like job security and other personal reasons however, I personally think that everyone should have six months of living expenses saved in their emergency fund. This way, if you lose your job for whatever reason, you know your family has at least six months of reserves to allow you to go out an interview for jobs. Remember, broke people interview differently than those who are not. Despite people are willing to accept less than those who are not. Scared people wreak of fear during an interview.

And for those of you asking the question, yes, you are leaving that money in a savings account. Yes I understand that it is not earning you any interest, but you have to remember that this is an insurance policy, not an investment. The worst thing that could happen is you invest this money and then an emergency occurs right when the market is down, and you have to take your money out at a loss to fund your emergency. This money needs to be safe, and as liquid as possible to help ensure debt stays out of your life for good!

Step 4 – Invest for Retirement (15%)

You likely completed the first step without a hitch, the second step began to wear on you and the third step left you asking “what the heck did you get yourself into!” Step four will be a huge sigh of relief as the foundation is now set and you may now begin building! It is time to get serious about retirement. The average American earns approximately $2.6 million dollars over their working life ($56,000 mean income x 47 years of average working life, ages 18-65), yet the average American retires with less than $95,000. Statistically accurate, this $95,000 is actually not the most realistic number when you consider that many families have zero savings come retirement and “super-savers” significantly beef up the average. The median savings, those at the 50th percentile, the absolute average, retire with less than $5,000 to their name.

This step is all about building long term wealth by contributing 15% of your income towards retirement, invested in retirement accounts such as Roth IRAs or Roth 401(k)s for example. Dave Ramsey is adamant about spreading your investments into four different categories of mutual funds: Growth, Aggressive Growth, Growth and Income, and International. If started early enough, just investing your leftover cash each month will likely lead you to millionaire status come retirement.

Let’s see some examples as to why it is important to begin saving for retirement as soon as possible:

Example 1:

Mike saves $3,000 a year in a retirement account for six years, from age 21 – 26, totaling $18,000 and never contributes a penny more. By age 65 Mike’s money will have grown to $1,047,608.

Example 2:

Mike saves that same $18,000 however this time he waits 10 years and begins saving $3,000 a year, for six years, from age 31 – 36 and never contributes a penny more. By age 65 Mike’s money will have only grown to $403,898. That means, that in this example, Mike’s 10-year delay cost him approximately $650,000.

Example 3:

Mike maxes out his Roth IRA from age 22 – 65, totaling $5,500/year or $458.33/month. How much do you think he will have come retirement? $500,000? $1 million? Try $6.6 million (assuming average market returns). Just to put that into perspective, if you achieved that goal and had $6.6 million at retirement, left it invested and just lived off the earned interest, that $6.6 million would earn you an annual income of approximately $660,000/year. Do you think you could enjoy your retirement with an income like that?!

If you never thought about just how much money you will need in order to live the lifestyle you desire in retirement I highly suggest you visit Chris Hogan’s website at chrishogan360.com and try out his R:IQ or Retired Inspired Quotient. It is a powerful tool that will help you determine just how much you will need in order to achieve your retirement goals!

Step 5 – Saving for Kid’s College

We are now out of debt, except the house, and we have begun saving for retirement; it is now time to begin to save for our kid’s college. The amount in which you decide to save will be based on different factors, such as the amount of time you have until your child enters college and your family’s income. Other factors may include personal decisions as to just how much of your child’s expenses you wish to cover. Remember in completing these steps we are working to change our family tree so it would be wise of us to ensure that our children realize that student loans are certainly not an option. We can achieve that by either covering all or a portion of their college expenses. There is nothing wrong with working while going to college, in fact there are many studies that show that those students who work in order to cover a portion of their tuition earn, on average, higher GPAs than those students who have all costs covered. What you will do will certainly be a family decision based upon the specifics of your situation.

In saving for college there are two stand out ways in which you can invest for these upcoming expenses, the Education Savings Account (ESA), and the 529 college savings fund. The benefit of these investment vehicles are that they are tax-advantaged meaning that as long as the money is used for education expense, the growth on your investment will be tax free just as with a Roth account. While both of these products have the same end goal, they achieve these goals in different ways. I personally utilize both the 529 and the ESA for my children’s college savings but I strongly encourage you to educate yourself on the differences between these two products to help you make your decision. I will publish a more in-depth comparison between these two products in the near future.

Step 6 – Pay off Mortgage

Look at you! There is now only one debt remaining between you and complete freedom from debt, paying off the mortgage! This is a big one. Imagine how much saving power you would have if you were able to invest your mortgage payment each month vice sending it off to some bank. On average, any extra amount you can throw into paying your mortgage off more quickly will result in saved years of having to make these payments, equaling thousands of dollars in saved interest.

If you have a traditional, fixed rate mortgage with competitive APR, simply pay it off as fast as you can. There is no need to refinance to a shorter term as a 30-year mortgage will pay off faster as long as you continue to make additional payments.

We only need to refinance for two main reasons: to get a better APR and to get out of any ARM (adjustable rate mortgage). Think about it, mortgage rates are at historic lows, getting an ARM at this time is only guaranteeing that your APR will rise as there is no other direction for it to go. In the instance if refinancing I default to Dave’s guidance on mortgages and that is to take a 15 year, traditional fixed rate mortgage where the mortgage payment is no more than 25% of your monthly income. This is a solid guideline as this prevents you from purchasing too much house and becoming house poor.

Step 7 – Build Wealth and Give Generously

Congratulations, you have made it to the final step! As Dave says, you have “lived like no one else so that now you may live and give like no one else!” This is where you build wealth, become immensely generous, and strive to leave an inheritance valuable enough for your children’s children to enjoy. Dave posts the question, “Do you know what people with no debt and no payments can do? Anything they want!”

We started off tucking away just 15% of our income towards retirement, now it’s time to max those 401(k)s and Roth IRAs out to truly reap those rewards.

And that’s it. Those seven simple steps are all that it takes to change your life. It truly did for Nelli and I and I have personally witnessed these steps work time and time again with the hundreds of families and individuals I have coached over the years.

Here is my personal disclaimer. If you get through these steps and you decide that you miss being in debt, go ahead and get yourself a mortgage or a car loan!

Do you have questions, comments, or wish to share your personal experience on this topic? Please post in the comments section below!

References:

Dave Ramsey Website. (n.d.). Retrieved December 28, 2017, from https://www.daveramsey.com/

Elkins, K. (2017, July 31). Here's how much the average family has saved for retirement at every age. Retrieved December 28, 2017, from https://www.cnbc.com/2017/04/07/how-much-the-average-family-has-saved-for-retirement-at-every-age.html