Wednesday, November 08, 2006

Dave Ramsey's Baby Steps Explained for Free

I actually really like Dave Ramsey (DR) and think his get out of debt method works and makes sense. However I find it greatly ironic that people who are in debt will pay money to him to get out of debt. It seems almost counterintuitive. But he's making a lot of money, people are happy and getting out of debt so whose to complain? But if you are serious about getting out of debt and are a cheapskate trying hard, I'm going explain his steps to you for free.

Pre-baby step 1: Cut up all Credit Cards and draw a line in the sand, NO MORE DEBT!
-At this point, concentrate on getting current on all bills (rent, CC, car payment, utilities)
-Build a bare bones budget starting with the 4 walls (home, food, utilies, health), then determine what are absolute essentials and what are not.

Baby Step 1: Build a baby Emergency Fund of $1000.
-Because you've cut up the CC, this is to prevent more debt from occuring when setbacks or unexpected expenses occur. You may sell stuff off to get this, you might get a second job. The objective is to get a cash cushion as soon as possible.

Baby Step 2: Get out of Debt!
-DR says to pay off debt smallest to largest. Why? Because you are changing behavior and it's easier to stick with the plan if you see small accomplishments along the way. Yes it makes more financial sense to pay off the highest % rate debt, but if you understood finances you wouldn't be here reading about DR, would you?
-Snowball your debt. What that means is pay the minimums on every debt owed, then use your leftover money to pay off the smallest debt. Example you owe $300, $800, $2000 with $10 minimums each. You have $100 to pay off debt, you pay $10, $10, $10, and add the $70 to the $300 debt. That should be paid off in 4 months, then you can take the $10 minimum and $70 extra and throw it to the $800 debt. Got it?
-My main issue with BS2 is that DR says to stop all retirement contributions, something I disagree with and will discuss tomorrow.

Baby Step 3: Fully Funded Emergency Fund (FEFF)
-DR says to put into a liquid account 3-6 months of your expenses. This can be at ING, HSBC, etc. Just somewhere in case of emergency pay it off.
-Now tomorrow I will discuss my issues with DR starting with this FEFF and his lack of details regarding what is an emergency.

Baby Step 3b: Saving for a home.
-DR says to buy a home with 20% DP minimally, 15 year mortgage at no more than 25% of your net take home.
-Again here I disagree, this should wait until after you do your 15% retirement because I think you should base your purchase off your income after you account for saving for retirement. I also think a 30 year fixed can be appropriate or an ARM (I'm writing a column why I love my ARM).
-Also I think that 15 year fixed is more risky than a 30 year because a 30 year can always be paid like a 15 year if you choose to.

Baby Step 4: Save 15% of gross income for Retirement
-DR prioritizes correctly 401k match, Roth IRA, and then back to the 401k.
-He suggest 25% aggressive growth, 25% growth, 25% small cap, 25% international
-I have serious issues with how much he reccomends to save and the fact he does not include bonds in his portfolio asset allocation. He doesn't have a clue what he's talking about and this will be discussed in depth in another post.
-I guess I should add I really like DR for up to Step 2, but after that I have some issues with his common sense.

Baby Step 5: Save for college
-He does not give any numbers for this, because it's personal finance. Great in principal, but realisitically I think there needs to be more guidance and more focus on retirement savings before college. After all the people using him were in debt.
-We'll discuss this in another column as I debate how much to save for my unborn kids.

Baby Step 6: Pay off the house
-If everything else is going well, you have more money and have no desires, pay off the house asap. DR says who need the tax break.
-Do I agree? Yes in principal, but I'm an ultraconservative money hawk. I am the type of person to have all possible scenarios funded like car breaking, vacation, emergency visit home funded, all retirement savings maxed out, all college savings done before paying off the house.
-Why? Mainly because the house is an ill-liquid asset, and right now potentially a depreciating one. So why pay for something you may need cash for?
-DR says everything else should be properly taken care of first, so I guess we agree.
-A lot of die hard followers pay off the mortgage without funding any "sink" funds or go "gazelle." I personally like a little nicer life and can live with a mortgage, though it probably will be paid off when we retire.
-Guess I'll discuss later why to pay off or not your mortgage early. Main argument, better investment wise to not pay it off, but pay it off early if you were the type of person in debt because you probably aren't money savvy.

Baby Step 7: Live Like No One Else
-give, donate, spend on stuff you always wanted because your free.
-I think a lot of people don't know how to spend at this point because they've been so gazelle. But maybe I'm wrong. I enjoy life now so I can't really see increasing my happiness much more than it is now. It's quite luxurious, although if I did have more money I could have a newer car, more expensive type vacations, and go home more...hmmm...


moneyliving said...

Wow ! I think sometimes DR is nuts.

Most of his tactics I just do not agree with.

But like most financial advisors I never agree with them 100%

DEBTective said...

Dollface, just wanted to drop a line and say I'm big-time proud of you for spreading the word about Dave Ramsey and debt freedom! Good luck on deep-sixing your own debt (if you have any). Here's looking at you, kid.