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1. Make minimum payments on all your bills. Squeeze your budget until you've accumulated $1,000 cash. This is your beginner emergency fund.
You'll never make headway in your quest to get out of debt if you don't have at least a little something to fall back on. That "little something" is called an Emergency Fund, and that's what this first $1,000 is for (or $500, if you make less than $20,000 per year). Put everything else on
hold. Make only minimum payments on all your debts; take on a second job if necessary; forego retirement-plan contributions (temporarily) if you can. Get your emergency fund together first. Get it together fast.
If you already have more than $1,000 in savings, and in anything other than a retirement account, withdraw everything except the $1,000. Use these proceeds for Baby Step #2, regardless of penalty (if the money were in CDs, for instance, there would like be a penalty for early withdrawal).
Once you have accumulated the $1,000 (or $500), keep it someplace where you cannot easily get at it. It must be available, but not easily available, and not easily spendable.
"Sometimes," Ramsey instructs, "you have to protect yourself from you."
2. Pay off your debts, smallest to largest. "Snowball" the payments.
Write down all your debts except your home. (If you're into spreadsheets, something like my DebtTracker spreadsheet will come in really handy here!) Arrange them in order from smallest balance to largest. Do everything you can to pay off the smallest debt listed (take on a second job, or sell stuff if you have to!) while making minimum payments on everything else. Once that first debt is paid and gone, then "snowball" that monthly payment money over and apply it to the next-smallest debt (in addition to that debt's normal payment). When that one is paid off, then take that monthly payment amount and start applying it toward your next debt. Get the picture? The more debts you clear off, the more your "snowballed" payments are increasing, and the more headway you'll make — faster — on your larger balances.
Ramsey writes: "The reason we list the debts from smallest balance to largest is to have some quick wins. This is where behavior modification is more important than math."
One important caveat: If you're working on this second Baby Step and some emergency arises which forces you to spend any part of your emergency fund, immediately stop this step and return to Baby Step #1 until you've refunded your emergency fund in full.
Check my "Debt Snowball" page for a more thorough discussion of this part of the Baby Steps.
3. Create a full-fledged emergency fund containing 3 to 6 months' worth of expenses.
Bad luck and rainy days are a part of life. Expect them. Prepare for them.
If you'll keep three to six months' worth of bills and living expenses in a savings or money-market account, then you'll have gone a long way toward erasing the "what if" stress from your life. The emergency fund allows your family to always be ready for whatever life hurls at you. Sure, that Murphy guy might still stop by your residence every so often, but he won't be able to run roughshod over your financial life the way he used to. Ramsey takes the analogy a step further: "Don't forget that the emergency fund actually acts as Murphy repellant."
You must also flip a mental switch regarding your e-fund: It is there for bonafide emergencies. Nothing else.
Ramsey elaborates: "Beware not to rationalize the use of your emergency fund for something that you should save for and purchase. Something on sale that you 'need' is NOT an emergency. Prom dresses and college tuition are NOT emergencies," he says. [Aside: This, of course, is where Mary Hunt's Freedom Account concept enters the picture.]
In any event, get your full e-fund together, and you'll be in a financially-elite class. You won't need your credit cards any longer ... even for emergencies. And the next time your car's alternator detonates?
"What used to be a huge, life-altering event," Ramsey says, "will now become a mere inconvenience."
4. Fully fund 15% into pre-tax retirement plans and Roth IRA, if eligible.
Now it's time to get your retirement funds in shape. Contribute the maximum amount you can, your target being contributions of a full 15 percent of your household's gross (pre-tax) income. If you have tax-advantaged plans (401k or Roth IRA, for example) available to you, then exploit them to their fullest extent. If your company matches any part of your contributions, do not consider this as part of your 15 percent. Additionally, do not include expected Social Security benefits in your retirement calculations. "I don't count on an inept government for my dignity at retirement, and you shouldn't either," Ramsey says.
At this point, if you haven't already done so, it is time to begin seriously educating yourself about mutual funds, stocks, and the financial markets.
"Getting older is going to happen," Ramsey says. "You must invest now if you want to spend your golden years in dignity."
5. Take care of college funding.
If you have kids, then you'll have college to worry about. The earlier you start, and the more attention and funding you're able to give to it, the better off you and your kids will be. Since college tuition inflation averages around 7 to 8 percent per year, your investments will need to (hopefully) do better than that. Always use tax-advantaged accounts (such as 529 plans or Education Savings Accounts) to their fullest extent to assist with this. These plans do have certain income limits and other restrictions and/or fees, so be sure to check the fine print before diving in.
6. Pay off your home . . . early.
For most people, the mortgage payment is the single largest monthly payment they will ever have. Just imagine what you can do with that money when you've paid it off. Imagine how you'll feel when you make that last payment. Round up every spare dollar you can find and put it toward your mortgage, regardless of all the oft-quoted benefits of mortgage-interest tax deductibility. (How wise is it to continually pay, say, $5,000 in interest to a bank each year, just so that you won't have to pay $1,500 in taxes to the government? The small minority of folks who own their homes debt-free probably don't mind paying that $1,500 a bit.)
For more comments regarding home, home loans, and their affordability, you might refer to my "Home, Expensive Home" article from Aug. 30, 2002.
7. Build wealth (mutual funds / real estate) and give!
With every bit of your debt zeroed-out and your savings tanks on the full mark, you can finally reach for the "pinnacle" — that point where your money works harder than you do. Invest more so that you can continue to grow your wealth. Give more so that you can continue to grow your self.
Nicely done.
Millionaires don't become millionaires by spending like them, they become millionaires by saving like them.
Anyone invest in a ROTH ira? What do some of you suggest and what are some of the interest rates?
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