March 11, 2008

Personal Finance | Dave Ramsey "The Total Money Makeover" Review

Building Wealth - Review of Dave Ramsey's "The Total Money Makeover"

A sucker for personal finance books, both the get rich quick kind and the get rich slowly kind, I couldn't pass up checking out this book when I was perusing at the book store. As the cover implies, it is your traditional get rich by scrimping, saving, getting out of debt, building wealth, and throwing as much money as you can into retirement (good advice by the way - just not worth paying for). If you are wondering how to create wealth, you might want to check this book out.

Although it is full of much of the same information, he did have some points worth repeating. Essentially he laid out seven steps toward "financial freedom." Some of them are good for everyone, some of them you should take with a grain of salt. Let's take a look. All of these are supposed to be done in sequential order.

1. Save up a starter emergency fund of $1,000.

This one actually makes a lot of sense and is something everyone should do. This fund is essentially untouchable unless an actual emergency arises. Things that would not qualify for emergencies would be Super Bowl parties, a chance to play 18 at that exclusive golf course, a sale at Macy's, or a chance to score those Bon Jovi tickets you've been searching for. Things that would: car repairs, house repairs, hospital bills, etc.

It is astonishing how hard it is to dig yourself out of financial ruin when one of these emergencies arises. Not only does it make it feel like you'll never get out, but it actually does make it harder. Imagine the difference in putting $400 of an emergency fund toward a car repair versus $400 on a credit card. The implication with a credit card is that you don't have the cash on hand, starting once again that cyclical fall into debt.

This is important for everyone, and should be done.

2. Debt Snowball.

The next thing prescribed by Dave Ramsey, and another I completely agree with, is beginning your own debt snowball. What is a debt snowball, you ask? A debt snowball is simply a term used to describe a method of paying down credit card debt. It works like this (there are actually several ways to do it, but this is the one Dave recommends and the one I use): line up all of your credit card balances and their minimum payments from smallest to largest. If you are paying more than the minimum balance (or just over it), take that money out and document it so its available. Next, see if there is any additional money coming in that you can allocate to credit card debt. Put that money in the same pile as the pile with the extra money. Finally, put all your credit cards away and stop using them (you really don't need them).

Once you've done this it's time to get the debt snowball rolling. All you do is take the smallest balance and put the minimum payment and all the other money you have over and above the minimum balances into that smallest balance. When that one is paid off you move onto the next balance, putting all the money from the first into the second. In no time at all you have paid off your credit card debt!

This really works and I would recommend using this method if you want to get rid of credit card debt and are looking for a way that works fast and provides postitive reinforcement (there is nothing better than paying off that first card!)

3. Finish the emergency fund.

After the credit cards are paid off, it's time to move on to building up that emergency fund so you can really take a financial hit and still stay afloat. Dave Ramsey recommends 3-6 months expenses in your fund, but I'd stretch it out to 6 if you can. There is nothing that helps you sleep at night like knowing you are financially secure in the event if a tragedy. I'd recommend this one too.

4. Invest 15% of your income in retirement.

Again, I say go on ahead with this, especially if you are young. The more you save now, the plusher your lifestyle (and your kid's kids lifestyle) will be in the future. And the great thing is this shouldn't be that hard to do because you can apply the money you've been paying off credit cards with toward this. I think you'll find it won't take much more to get up to 15%.

And this is a little more specific than Dave discussed, but make sure you are maxing out your 401K and Roth IRA contributions first. These will be discussed in much greater detail later, but not only is much of this either tax deferred or tax exempt when paid in, with the 401K your employer likely matches your contribution up to a certain percent. That is free money for you for doing nothing! Take the time to learn about these savings vehicles and become familiar with them. It will pay off enormously in the future.

And while I'm telling you where to go, let me tell you where not to go. Savings accounts with your local branch are the worst place to store your money. The interest rate is not high enough to make it worthwhile, particularly with all the high-interest savings accounts available. If you need the safety of a savings account, make sure you have a competitive interest rate (nothing below 3%).

5. Save for college.

Now is where Dave Ramsey and I start to drift apart. I am all for saving for college, and Dave recommends using an education savings account or 529 plan, which is sound advice, but there are other things you can do with your money that can provide a greater return and still pay for your kid's college in the end.

Alternatively, taking some of that extra money and putting it into making sure your kid has a solid elementary, middle, and high school education is also an option. College is lost on so many who don't have the foundation to excel and succeed there. Give your kid a head start and he or she will likely be getting paid by their college of choice to attend (and there are tons of scholarships available, don't forget to look).

6. Pay off your mortgage.

Again, I'm going to have to diagree with Dave Ramsey on this one. Mortgages, like student loans, are great to have, especially if you are paying them on time. They provide a great source of credit information for lenders and anyone else who relies on credit score to evaluate your risk tolerance and the interest rates are usually so low you can invest the extra money you would be paying toward your mortgage some place else and see greater returns (isn't this what building your empire is all about?).

In following this plan, I'd probably skip this step. It isn't a financial step backward, put to me it feels like treading water instead of swimming ahead.

7. Build Wealth.

Now he's talking. Building wealth means many things to many people. For some it is getting that vacation home, for some it's starting or investing in that business idea you've always had, and for others it is simply accumulating enough wealth so you can do whatever you want whenever you want.

This blog's focus is on building wealth, which for me includes all of those things previously mentioned as well as building several streams of passive income so while I am playing I am continuing to build more wealth. I'll touch more on building wealth in future posts, but I'd highly recommend focusing on this immensely when you have time (even before you've completed some of your other steps, if you can).

All in all, I'd say Dave Ramsey's book, The Total Money Makeover has a lot of great content. Some of it is original and fresh, but most is information everyone has already heard before, or can hear right here. It's not a bad book for the shelf, so if you have the extra cash, I'd pick it up and take a look.

Personal Finance Building Wealth

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