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 not so quickie article on what ways I would tweak the Baby Steps to “improve” it. (In fact it is part II because part I started to get long)
Welcome to Part II
- 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 3. Save 3-6 Month Emergency Fund
As stated in part I the book Financial Peace by Dave Ramsey was written in 1997 (20 years ago). I would want to eliminate the possibilities of any late fees from anywhere. Having an emergency fund is great but, having an emergency fund in the right place is helpful and more beneficial. Pay every bill ahead at least one month so there is a credit with each account. (The exception to this is the mortgage but, those payments can be in an earmarked account to make it easier to make the monthly payment.)
Pay ahead using the snowball method; smallest to largest until you are one month ahead on every bill. This provides you with a great advantage. After you are ahead one month with all bills, future bills can then be paid any time in the month that you choose – on your schedule not the company who is billing you.
The risk of late fees is eliminated; you have self insured against frivolous late charges. If you lose employment you have one month to concentrate on finding another job rather then diluting your efforts by stressing over bills. (Also this is the same reason for having a paid for car!)
Build up your emergency fund based upon your estimated time to get re-employed if you had to look for a job. The rule of thumb is usually one month for every $10,000 of annual income. Of course the more expenses, the more money it would take to fill the fund. (Expenses usually increase with income for most people.) If you are the sole supporter or the main bread winner of your family the emergency fund should be larger because if your job is lost all or most of the family’s income is gone. Nine months should be the minimum in such cases.
Step 4. Invest 15%
Dave Ramsey’s recommended action is to invest 15% into a 401(k), IRA, Roth IRA or other traditional retirement vehicle. Why does it have to be in one of those retirement vehicles? Why is 15% the limit? If a retirement fund doesn’t get released without a penalty until you are in your 60s or 70s What happens if you want to retire early? These are the questions I ask myself when I look at this step.
The first thing I look at is the company match on the 401k if available; don’t leave money on the table. Then look for more interesting ways to invest. I use the S&P 500 fund for my yardstick. (the average return that I see reported is between 8-12%; I split the difference and say 10%) In the 401k I’d put the S&P 500 fund based upon John Bogle‘s findings.
Once the company match is made I can look for other vehicles. The vehicle may not be the obvious and may change based upon what plans I have. I may buy an index fund outside of the retirement plan or if I feel stocks are overpriced a extra payment can be made to the principal of a mortgage buying back interest and time. (This is a jump on the step six.) The dollar per dollar ROI is usually better than 10% on mortgage prepayment.
Another option might be to start or enhance a side business. Even different still might be to increase your skill set to become more valuable.
Part III coming soon… so much for quickie article.