Personal Finance
There is probably no better teacher of personal finance right now than radio host and nationally known speaker, Dave Ramsey. His stance on savings, debt, home purchasing and giving are timeless, classic and biblically sound. I strongly recommend purchasing his "Total Money Makeover" book and following his guidelines on budgeting, saving and the "order" of how to do things. His principles, in brief detail, are as follows:
Dave Ramsey's "Baby Steps"
1. Save $1,000 in a starter emergency fund
2. Pay off all non-mortgage debt from smallest to largest using the "Debt Snowball"
3. Finish the emergency fund to 3-6 months of expenses
4. Invest 15% of your income into tax-favored retirement accounts
5. Save for kids' college in ESAs and 529s
6. Pay off mortgage early
7. Max out investing, build wealth and give more
Dave also says we must do these 5 things with money:
1. Get out of Debt
2. Act your Wage (live on less than you make)
3. Save for emergencies, purchases, and long-term wealth building
4. Live on a zero-based budget
5. Give
There are some disagreements that most of the investing community have with Dave's principles, but his overall plan to help America get out of debt and save for the future are excellent. Some of these discrepancies are:
1) Dave quoting "12%" average rate of return for the S&P 500. Although it is true that each year the average return since 1926 has been about 11.8%, the Compound Annual Growth Rate (what an investment actually earns when accounting for the years the investment is down) is 10%. This sounds small, but run a calculation on 30-year projection of 10% versus 12% earned on your nest egg - this is pretty big.
2) Dave recommending that we pick mutual funds based on performance. This is discussed in Index Funds. Active management brings on considerably more risk and costs. Also, there is no way to accurately predict which fund will be a winning fund tomorrow based on which fund was a winner yesterday.
3) Dave recommends 100% equities (stock funds) for all investors no matter what age. This brings on a much higher degree of risk for those who may not wish to take on that much risk of holding 100% stocks such as older investors with a mortgage and only a modest nest egg. In 2008, stocks fell 36% and the market stayed low for several years before coming back. Those who retired at the onset of '08 with only a small nest egg and a portfolio of 100% stocks really struggled for several years. Those who had more bonds would have seen an increase to the bond portion of their portfolio during that time (explained in Investing Basics).
4) Dave recommends an 8% withdrawal rate in retirement. According to a widely-used study on safe withdrawal rates, an 8% withdrawal rate has only a 41% chance of lasting 30 years into retirement. If you live until age 65, you have a strong chance of living to 95... so you'll have a better chance of running out of money before you run out of breath! A more "safe" withdrawal rate is between 3-5% with a more balanced holding of stocks and bonds.
5) Dave recommends that we use a broker to invest. This is not a bad idea if you are someone who cannot stomach the thought of their investments losing value (they all do) and can prevent you from making a costly, emotional decision when the evening news is predicting doom for the stock market. Most people, however, can invest perfectly fine on their own and save thousands of dollars over their investing life by being a DIY investor (which is the purpose of this website!). Also, keep in mind that Dave makes a large portion of his profits with his "Endorsed Local Providers" - people that pay him to advertise their services and then charge you commissions on your investments. This is a conflict of interest to you unless you absolutely feel you need it.
Some other great tips for successful personal finance:
1. Cut up credit cards and only use debit cards and cash
2. Develop an envelope system that you put money in each paycheck for food, gas, entertainment and clothing. This will help control spending away from home.
3. Set up as many bills on automatic withdrawal as possible. Use your bank's e-bill pay feature to save on envelopes, stamps, check-writing and time.
4. Spend all of your money on paper before the new month begins (all the way to zero) with a written budget
6. Combine all checking/savings accounts if you are married
7. Keep a spreadsheet or checking register current with all purchases (don't just periodically check online)
8. Reconcile the checkbook monthly
9. Purchase proper insurance (term life, health, auto, home/rentor's, long-term care if over 60, disability)
10. Pay yourself FIRST (save money!)
11. If you are still renting, don't buy a house until you have paid off all debts (including student loans), have an emergency fund of 3-6 months of expenses, and have a down payment of at least 10%. A home mortgage payment should be around 25% of your monthly take-home pay, but never exceeding 35%.
12. A car is the most expensive thing we buy that goes down in value. A $20,000 new car will be worth $5,000 in just a few years. Instead, take your old car payment and save for a great used car and invest what you would have spent on a new car. If Sam Walton (Walmart founder) can drive a beat-up old pick-up as a billionaire, I think we can drive used cars. Don't blow a life's fortune on a new ride that will be a bucket of bolts in a few years!!
Dave Ramsey's "Baby Steps"
1. Save $1,000 in a starter emergency fund
2. Pay off all non-mortgage debt from smallest to largest using the "Debt Snowball"
3. Finish the emergency fund to 3-6 months of expenses
4. Invest 15% of your income into tax-favored retirement accounts
5. Save for kids' college in ESAs and 529s
6. Pay off mortgage early
7. Max out investing, build wealth and give more
Dave also says we must do these 5 things with money:
1. Get out of Debt
2. Act your Wage (live on less than you make)
3. Save for emergencies, purchases, and long-term wealth building
4. Live on a zero-based budget
5. Give
There are some disagreements that most of the investing community have with Dave's principles, but his overall plan to help America get out of debt and save for the future are excellent. Some of these discrepancies are:
1) Dave quoting "12%" average rate of return for the S&P 500. Although it is true that each year the average return since 1926 has been about 11.8%, the Compound Annual Growth Rate (what an investment actually earns when accounting for the years the investment is down) is 10%. This sounds small, but run a calculation on 30-year projection of 10% versus 12% earned on your nest egg - this is pretty big.
2) Dave recommending that we pick mutual funds based on performance. This is discussed in Index Funds. Active management brings on considerably more risk and costs. Also, there is no way to accurately predict which fund will be a winning fund tomorrow based on which fund was a winner yesterday.
3) Dave recommends 100% equities (stock funds) for all investors no matter what age. This brings on a much higher degree of risk for those who may not wish to take on that much risk of holding 100% stocks such as older investors with a mortgage and only a modest nest egg. In 2008, stocks fell 36% and the market stayed low for several years before coming back. Those who retired at the onset of '08 with only a small nest egg and a portfolio of 100% stocks really struggled for several years. Those who had more bonds would have seen an increase to the bond portion of their portfolio during that time (explained in Investing Basics).
4) Dave recommends an 8% withdrawal rate in retirement. According to a widely-used study on safe withdrawal rates, an 8% withdrawal rate has only a 41% chance of lasting 30 years into retirement. If you live until age 65, you have a strong chance of living to 95... so you'll have a better chance of running out of money before you run out of breath! A more "safe" withdrawal rate is between 3-5% with a more balanced holding of stocks and bonds.
5) Dave recommends that we use a broker to invest. This is not a bad idea if you are someone who cannot stomach the thought of their investments losing value (they all do) and can prevent you from making a costly, emotional decision when the evening news is predicting doom for the stock market. Most people, however, can invest perfectly fine on their own and save thousands of dollars over their investing life by being a DIY investor (which is the purpose of this website!). Also, keep in mind that Dave makes a large portion of his profits with his "Endorsed Local Providers" - people that pay him to advertise their services and then charge you commissions on your investments. This is a conflict of interest to you unless you absolutely feel you need it.
Some other great tips for successful personal finance:
1. Cut up credit cards and only use debit cards and cash
2. Develop an envelope system that you put money in each paycheck for food, gas, entertainment and clothing. This will help control spending away from home.
3. Set up as many bills on automatic withdrawal as possible. Use your bank's e-bill pay feature to save on envelopes, stamps, check-writing and time.
4. Spend all of your money on paper before the new month begins (all the way to zero) with a written budget
6. Combine all checking/savings accounts if you are married
7. Keep a spreadsheet or checking register current with all purchases (don't just periodically check online)
8. Reconcile the checkbook monthly
9. Purchase proper insurance (term life, health, auto, home/rentor's, long-term care if over 60, disability)
10. Pay yourself FIRST (save money!)
11. If you are still renting, don't buy a house until you have paid off all debts (including student loans), have an emergency fund of 3-6 months of expenses, and have a down payment of at least 10%. A home mortgage payment should be around 25% of your monthly take-home pay, but never exceeding 35%.
12. A car is the most expensive thing we buy that goes down in value. A $20,000 new car will be worth $5,000 in just a few years. Instead, take your old car payment and save for a great used car and invest what you would have spent on a new car. If Sam Walton (Walmart founder) can drive a beat-up old pick-up as a billionaire, I think we can drive used cars. Don't blow a life's fortune on a new ride that will be a bucket of bolts in a few years!!