Friday, February 10, 2012

Financial Friday - Things I learned from Dave Ramsey

Since last October I have been attending weekly sessions at Church of Dave Ramsey's Financial Peace University.  Being that I:
a) was raised Accountant, oops, I mean BY an Accountant (budgeting babysitting money on financial graph paper when I was 12), and
b) am financially hypervigelant (being that I learned from my 2 years of carelessly letting someone run my finances reactively, and being that I'm a geek),
I've been a follower of financial blogs and have been budgeting on a coloured, multi-tabbed spreadsheet for several years.
I was hopeful I would get something out of the course, like in the area of investing or saving for retirement, areas I was pretty sure I knew very little about. But I was even finding very useful tips with budgeting! This is what I thought I already excelled at! Granted I was 10 steps ahead of people who didn't budget at all, but frankly I was surprised how much more there was to learn about budgeting that I hadn't.

So, anyway, here is a brief summary of the great tips I have already implemented, or will as soon as I can.
1) Emergengy Funds - this isn't just one step, there are a bunch of little steps, but the most important  first thing to do is to have $1000 in savings because unexpected events are 100% guarenteed to happen. On average a significant (about $1000) cost unexpectantly happens to people at least every 10 years. Most people use credit card for these unexpected costs, that's their 'emergency fund', but as you'll see in the next step, that's the worst thing you can do.
a) As your budget allows you will want to start sub-divisions of further emergency savings, also called a sinking fund approach, or self-insurance.  i.e. a fund for home/car repair/maintenance, a fund for purchasing a new/replacement vehicle,  furniture, Christmas gifts, property tax, etc. Anything that blows the budget but you can anticipate it coming. I did this on a very small scale but have now added so many self-insurance categories to my budget.
b) After debt is all paid off come back and save some more, save 3-6 months of expenses (necessary expenses to live on, not spending). This is in case of even bigger unexpected events, like unable to work due to illness, unemployment (taking a lower paying job), large financial loss, etc. Again, this is self-insuring yourself against life, an emergency fund is not an investment (don't place it in an account with penalties for withdrawl), DO NOT touch it for anything other than a real emergency.

2) Budget - If you hate that term, call it Cash Flow Planning :)
a) The very first entries into your cash plan, your priorities, should be the 'four walls', the necesseties needed to live, recommended % of net income shown in brackets after: Food (5-15%), Shelter/Utilities (30-45%), Clothing -bare minimum (2-5%) and Transportation -needed for work (10-15%). Total percent of the four walls shouldn't be more than 65%.
b) Every penny of income needs to be accounted for in the plan, budget each month until a zero balance. Tracking every last expendature will help you figure out where you are overspending or not planning for things you could be prepared for. Here is Dave's 'Monthly Cash Flow Plan' online, it mentions some categories even I hadn't remembered to put in my budget.
c) Using cash makes it easier to stick to the budget, paying with ATM/debit or credit automatically increases $$ transactions. The envelope system for cash allows instant tracking and when the cash runs out the spending stops. Challenge yourself to use cash in the areas you typically overspend if you feel you can't move to a complete cash budget right away.

3) Dump the Debt - these are actually more like reasons not to dump debt with a few tips on how.
a) Saving vs. Loan payment - a loan purchase of $4000 has $211 monthly payments at 24% for 24 months, end up paying $5064 in total. Saving $211 for 19 months will equal $4000. Will save you $1064 and 5 months of $211 in expenses.
b) Paying interest vs. Earning interest - that same $1064, if you saved it instead of paying it, invested from age 25 to 65 at 6% interest would earn over $10,000, at 12% would earn over $95,000.
c) Credit is marketed to us as a need, they make billions off us in interest. Credit scores are not necessary, you can be a millionaire but with paying for everything with your cash you will have a bad credit score.  Creditors are hunting for the weakest pray, be strong and realize you don't need it.
d) Once you have a $1000 emergency fund, immediately stop borrowing, do not take on any more debt.
e) Pay off all your debt (other than mortgage) with the Debt Snowball. Paying off smallest debts first, then applying those payments to the next lowest debt and so on. Proverbs 6:1-5 - you may wander or stumble into debt but you need to run with gazelle like intensity to escape the hunter.  You may have to sell something(s) or get more income temporarily, depending on the amount of debt you have, but if you don't escape it, continually paying the interest on that debt will stalk your financial peace and ability to take care of yourself in retirement.

4) Make Smarter Purchases - the less you spend the more you can save....for more peaceful spending later :)
a) Don't buy into marketing tactics, most 'great deals' have so many strings that less than 10% of people actually qualify. Get at least 3 quotes and wait overnight before making a large purchase.
b) Carefully consider your buying motives, pay attention to the physiological responses your body makes with big purchases, do not buy because of the way things make you feel, do not medicate with stuff.
c) Consider the 'opportunity cost'. Dave Ramsey gave the example of a young man who got a well paying job early in life, saved enough for a $40,000 mercedes but in the end liked having the security of the money instead, invested wisely and about12 years later pulled up next to a guy in in the exact year mercedes he had wanted, the guy had bought it for $4,000 and he had $300, 000 in his savings.
d) Purchasing impulsively is immaturity, like a child getting upset if they can't get what they want.  Adults can still get what they want but are mature about it and plan to purchase it in the smartest way.
e) Cash is king - it's visual, it's emotional and it's immediate, people will reduce prices for payment in cash because they only get a percent of what's put on credit.  With cash you feel the power to walk away if the 'deal' is not good enough.
f) Bargain hunt, in addition to comparison shopping, try to buy used before new (always use common sense with this, not with safety items, particularily baby cribs, seats, etc.), and don't be afraid of negotiating (almost all world markets other than America's run this way).

5) Investing - first rule of investing, keep it simple
a) Just like your self insurance should not be considered an investment, your investments should not be mixed with your real life insurance. Life insurance should be only life insurance, only covering income someone would lose should you die (or income you would lose should your spouse die). It should not be permanent, if you are smart about your money eventually you will not need this 'income replacement insurance', so do not get the 'cash value' building insurance, all you need is a term policy (recommended 10 x salary you are replacing, invested at about 10% should provide annual income through interest)
b) Start as soon as you can (after 4 walls and debt, other than mortgage, gone) because the first big factor in investing is time, compound interest works in favor of time, no matter how little you start putting away. Aim for 15% of your income, but start with any extra you have - for the cost of a $3 coffee every day over 60 years you could earn in interest (estimating 12%) $11 million dollars.
c) Diversify your investments - the general recommendation (not taking age into account) is 25% in an income fund (low risk, lower rate of return), 25% growth (medium risk, mid-range rate of return), 25% aggressive growth (high risk, high rate of return), 25% international (in case domestic funds in economic slump).  This is a typical standard for mutual fund diversification.
d) Mutual funds are a managed pool of investors, giving the benefit of experienced market analysts and power of 'big purchases', so they typically have better rates and are less risky, they have more stable performance and are good long term investments.
e) Property/Real Estate is only a good investment if you already have a lot of liquid assets as it is one of the investments that ties your money up for a great length of time. If you buy a home though, treat it like an investment, get inspections and surveys done, be smart about it, only 'invest' in a house you could 'unload' quickly if need be.

Just a reminder this is a very abridged summary of my highlights from 13 weeks of video and reading his book, there were many other nuggets of information that were tucked in there that may be even more beneficial for you than they were for me so I highly suggest taking the course or reading his book. As Dave says, living like no one else now (in a disciplined way) and later you can live like no one else (in financial freedom to afford whatever you need/want).  Also, he admittedly isn't the end all be all of finance advice, feel free to keep researching for more information, he always advises talking to experts so you can get advise based on your specific situation.

Best of luck!

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