Radio host Dave Ramsey has a debt elimination framework he calls Baby Steps. It seems to work well from the people I have talked to who have used it. I often think many frameworks can be improved. This is just a quickie article on what ways I would tweak the Baby Steps to “improve” it. (Humbly I don’t know if I could but, that doesn’t mean I shouldn’t try.)
- Save $1000 Starter Emergency Fund
- Pay Off Debt
- Save 3-6 Month Emergency Fund
- Invest 15%
- College Fund Children’s Education
- Pay Off Home
- Build Wealth and Give
Dave Ramsey is a leader in the personal finance improvement field. The reason he is because he has a simple to follow framework that is easy for everyone to understand and the method is effective. Not everyone is in the same financial situation or has the same aptitude because we are not all clones. In each step I’d like to see if there are ways to use different strategies to enhance the step.
Step 1. Save $1000 Starter Emergency Fund
The book Financial Peace by Dave Ramsey was written in 1997 (20 years ago). $1000 doesn’t get you as far as it use to. It is about $1500 in today’s money (according to www.usinflationcalculator.com/). Or to look at it a different way the $1000 emergency fund today would have been $750 in 1997.
I would think a more tailored approach might work better. Set your emergency fund to either $1500 or your monthly housing payment. (Whichever is greater.) The idea behind this is to have at least one month’s rent or mortgage sitting ready so your place of residence is more secure.
Step 2. Pay Off Debt
The method Dave Ramsey uses to pay off debt via a debt snowball is a great one. The basic idea is to list debts smallest to largest and pay them off in that order with the smallest getting the maximum extra cash while the other bills getting the minimum payment. When one bill is paid off the freed up cash flow is then applied to the next lowest debt. This continues until all debts are paid off with the exception being the mortgage.
I have seen pundits argue the lowest interest rate should be attacked first but, the Ramsey method of paying off the smallest to largest is superior because it focuses on cash flow. Better cash flow per month increases opportunity and security.
The speed of paying off debt is a factor of spending, cash flow and interest rates. The tweek should focus on these factors. Controlling your spending is the most important of these factors. If you can’t control spending the other factors are worthless to pursue.
Spending can be controlled creatively. Ask yourself what can I get away with not buying? Spend a week writing down on a list what you are not buying with prices. (Things that you would normally buy.) Take a look at the end of the week total. Did it change your lifestyle that much?
You’ve just done two things: stopped digging a debt hole and have more cash to apply to the debt. Not buying is more powerful than looking for sales and getting deals. You have a 100% off deal. Make it a game challenge yourself week by week. Plot it on an excel if that is your thing. Keep in mind when you choose to spend on things that are
Ask yourself what can I do without changing lifestyle to improve my monthly cash flow? This is the idea that you look for lowering expenses one at a time. Each expense may not be a game changer by itself but, collectively you improve your cash flow meaningfully. I had wrote previously on this (Give Yourself A Raise). These low hanging fruit tweeks help build momentum.
Interest rates are the friction on your debt reduction momentum wheel. The lower the interest rate the smaller the friction and the quicker your wheel will go. Look around your financial footprint and see all the interest rates you are paying. Add the dollar mount of the interest up for the month. Take all the credit cards, student loans, mortgage payments, etc and add them together for the month. This is your friction level.
Start with credit cards; get lower rates. These type of loans are usually figured on the average daily balance. Sometimes it is cost effective to roll the cards to an introductory offer of zero % but, always factor in the cost of the rollover to see if it is worth it. The rest of consumer loans can be looked at as well. Can you roll them into something more efficient? There is a danger if you move cards around and acquire new debt, you have the old debt vehicle now available. If you use the old credit card again you’ve just decreased your cash flow and added more friction. Look to lower every interest rate you can keeping in mind of fees associated with the financing. You may be able to lower your interest on a mortgage, but the fees may be more than the savings if you just put the extra money towards the principal payment.
Take another look at your financial footprint. Add up all the dollar amount of interest for the month and compare it to before you lowered interest. This is the amount of cash flow you’ve increased per month that can be applied towards principal payment of debt. This is money taken out of play for the debtors and put in play for your benefit.
Focus on cash flow per month towards reducing the debt. Sometimes you can be working in the wrong direction if you don’t keep your eye on the big picture. A 30 year mortgage may be cheaper on a per month basis over a 15 year mortgage but, if you are intended on paying it off you will increase your overall debt. (long term negative cash flow)
Eliminating expenses lessens the friction on your debt reduction. Different than controlling spending on needed items, this eliminates the spending on not-needed items. You effectively have the item you were going to buy at 100% off.
The debt elimination stage is really about how bad do you value your freedom.
Part II coming soon… so much for quickie article.