Archive for August, 2009

How to Snowball Debt ‘Till It’s Gone

Posted By damien on August 31st, 2009

snowballNow, just to set things straight at the outset, we’re talking about a debt snowball here, not the kind made by Hostess.  Many personal finance gurus have variations of the debt snowball; I prefer Dave Ramsey’s as written in The Total Money Makeover.  In the last post, I discussed how debt is not a tool to become wealthy, an assertion backed up by lots of empirical evidence gathered by Thomas Stanley in The Millionaire Next Door.

Problem is, the average American is in debt, and not just a little bit!

So, let’s work out a plan to get you out of debt.  Before we can talk about where to put your money to become wealthy, we have to free that money up from creditors.  Once you are out of debt, then we can talk about 401ks, Roth IRAs and real estate investing.  The Debt Snowball is at once simple in definition and difficult in execution (will power required).  It is not a get-rich-quick scheme.  It will not get you out of debt overnight.  It will, most likely, require some changes to your lifestyle.  It is difficult, but it works.

Brain versus Heart

There are two approaches to the debt snowball: the math-based and the emotion-based.  For the math based approach, list all of your debts in order of highest interest rate to lowest.  Pay the minimum on all debts except for the one with the highest interest.  Put all the money you possibly can towards this debt (highest interest).  Once you have paid that one off, roll your payments into the bill with the next highest interest rate.  Keep doing this until all your debts are paid off!

Do you see where the term “debt snowball” comes from? You start with a small snowball: the payments toward your first bill.  Then, once it’s paid off, you roll that payment into the next, then the next, and your snowball (payment) grows and grows!

Most of Us Are Humans, Not Robots

The other approach, what I call the emotion-based one, has you list your debts in order of smallest amount owed to largest.  You then start the snowball by focusing on the smallest amount and working up to finish with the largest.

The math-based approach, in theory, will get your debts paid off the quickest.  Notice that I said in theory.  Dave advocates an emotion-based approach to the debt snowball, not because the math adds up better, but because it takes advantage of the non-rational human heart.  Here’s what he says:

The reason we list smallest to largest is to have some quick wins…Face it, if you go on a diet and lose weight in the first week, you will stay on that diet.  If you go on a diet and gain weight or go six weeks without any visible progress, you will quit.  When training salespeople, I try to get them a sale or two quickly because that fires them up.  When you start the Debt Snowball and in the first few days pay off a couple of little debts, trust me, it lights your fire.  I don’t care if you have a master’s degree in psychology; you need quick wins to get fired up.  And getting fired up is super-important.

I think Dave makes a pretty strong point here.  A few easy wins boosts a person’s confidence and gives them the drive to keep going when it gets tough.  This is why I recommend the emotion-based debt snowball.  List your debts from smallest to largest, pay the minimum on all except the smallest, and conquer your debt!  Then we can get into the exciting stuff: wealth building.

Unless, of course, if you’re a robot.

Posted in Building Wealth, Dumping Debt, Selp Improvement
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How to Destroy Murphy’s Law With an Emergency Fund

Posted By damien on August 27th, 2009

umbrellaAs indicated in a previous post, The Total Money Makeover by Dave Ramsey is my #1 all-time favorite book on personal finance. The principles I learned from this book form the foundation of my personal finance philosophy. Among other things, Dave has taught me that:

  • Debt is not a tool to create wealth
  • Debt creates a master/slave relationship
  • Invest for the long-term
  • Emergency funds are the best hedge against emergencies
  • Slow and steady, as opposed to get-rich-quick, wins the race

In this post I want to focus on Dave’s teachings about emergency funds.  Emergency fund, rainy-day fund, umbrella (ella-ella, great song, Rhianna), they all mean the same thing: cash savings set aside for the express purpose of covering an unexpected expense.

Debt is Not A Tool!

When an unexpected expense comes up, you have two options: use the emergency fund, or borrow the money (from credit cards, family, the bank, etc.).  But if we want to become wealthy, only the first option is viable.  Debt is not a tool to becoming wealthy.  I’ll let Dave explain:

I have found that if you look into the lives of the kind of people you want to be like, you will find common themes.  If you want to be skinny, study skinny people, and if you want to be rich, do what lots of rich people do, and not what some mythsayer [a proponent of debt] says to do…When surveyed, 75 percent of the Forbes 400 (rich people, not your broke brother-in-law with an opinion) said the best way to build wealth is to become and stay debt-free…I have met with thousands of millionaires in my years as a financial counselor, and I have never met one who said he made it all with Discover Card bonus points.  They all lived on less than they made and spent only when they had cash.  No payments.

As you can see, Dave has strong opinions about debt, and I agree with him. So, since we aren’t going to use debt to cover emergencies, that means we better be prepared for them by saving up cash ahead of time.

Dave suggests having 3-6 months of expenses set aside as an emergency fund. Others, such as Suze Orman, recommend up to 8 months.  Our family has six.  I suggest using your level of risk tolerance and the steadiness of your income to determine how big the emergency fund should be. Also, the emergency fund must be liquid, or easy to access.  This means putting it in a high-yield savings account, not a CD (Certificate of Deposit).

Destroy Murphy’s Law

Murphy’s Law states that “Anything that can go wrong, will”.  By setting up an emergency fund, you turn crises into inconveniences.  Here is a real-life example that I heard just last week:

Some friends of ours recently had an unexpected expense come up.  Now, these people are not (yet) millionaires, they’re college students with a young child.  But they have no debt and several months of savings.  One evening they were preparing to go out for a romantic dinner.  Just as they were getting ready to leave, they were made aware of an unexpected bill of over $1,000.  Now, imagine if they had been a few thousand dollars in debt (like the average college student) and had no savings.  How would their romantic dinner have tasted that night?

Instead, because of their emergency fund, they were able to acknowledge the inconvenient bill, close the door behind them, and enjoy a paid-for dinner.

I hope you now see the importance of an emergency fund.  It is definitely a Big Idea worth writing about.  We have incorporated it into our personal finance plan, and have enjoyed the financial peace it brings.  The Total Money Makeover devotes two chapters to the emergency fund, discussing how to find the money, where to put it, and what to use it for.  Check it out!

Posted in Building Wealth
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Are You Cheap or Frugal? Yes, There’s A Difference

Posted By damien on August 24th, 2009

frugalOne more bite-size idea from Ramit Sethi, in one of my top personal finance books, I Will Teach You To Be Rich:

Think of the word frugal.  What comes to mind?

For me, I think of a scrooge, penny-pincher who hates to spend money.  A person who is a real pain to deal with when it comes to financial transactions, because he/she wants the lowest price and will do anything, will negotiate forever, until they get it.  Put simply, the word frugal does not have positive connotations for me.

Or, at least it didn’t, until uncle Ramit exposed my benighted ignorance and showed me the enlightened path.  He taught me that what I was defining as frugal, was actually cheap. The following is an excerpt from a chart in his book:

CHEAP PEOPLE VS. FRUGAL PEOPLE

CheapFrugal
Cheap people care about the cost of something.Frugal people care about the value of something.
Cheap people try to get the lowest price on everything.Frugal people try to get the lowest price on most things, but are willing to spend on items they really care about.
Cheap people make you uncomfortable because of the way they treat others.Frugal people make you feel uncomfortable because you realize you could be doing better with your money.
Cheap people are unreasonable and cannot understand why they can’t get something for free. Sometimes this is an act but sometimes it’s not.Frugal people will try as hard as cheap people to get a deal, but they understand that it’s a dance, and in the end, they know they don’t intrinsically deserve a special deal.

See the difference?  Cheap people are lame.  Frugal people are wise.

Frugality isn’t about cutting your spending on everything.  That approach wouldn’t last two days.  Frugality, quite simply, is choosing the things you love enough to spend extravagantly on—and then cutting costs mercilessly on the things you don’t love.

Amen, my Indian friend.  Thanks for setting me straight.

Posted in Building Wealth, Selp Improvement
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Dollar-Cost Averaging: Fancy Name, Simple Investment Strategy

Posted By damien on August 20th, 2009

graphIt’s time for another round of investment advice from uncle Ramit at I Will Teach You To Be Rich.  This investment approach, dollar-cost averaging, is one of those simple strategies with a fancy name.  In fact, if you are making regular contributions to a retirement account (401k or IRA) you are dollar-cost averaging.

Well then, what is it? Here’s Ramit with an explanation:

Dollar-cost averaging is a fancy phrase that refers to investing regular amounts over time, rather than invest all your money into a fund at once.  This is the essence of Automatic Investing, which lets you consistently invest in a fund so you don’t have to guess when a market is up or down.

Pretty simple, huh?  Say you have $10,000 to invest.  Instead of buying $10,000 of a fund all at once, you split it into $1,000 contributions each month for 10 months.

But why should you practice dollar-cost averaging?  Why not stick all your money into a fund at once and be done with it?  The short answer is to reduce risk by diversifying your money over time.  But I’ll let Ramit explain:

Imagine if you invest $10,000 tomorrow and the stock drops 20 percent.  At $8,000, it will need to increase 25 percent (not 20%) to get back to $10,000.  By investing over time, you hedge against any drops in price—and if your fund does drop, you’ll pick up shares at a discount price.  In other words, by investing over a regular period of time, you don’t try to time the market.  Instead, you use time to your advantage.

I’m sure many of you with investment accounts already practice dollar-cost averaging.  Go ahead, pat yourself on the back, because you’re a WINNER!  Plus, now you have a great way to make yourself look smart at dinner parties.  Just mention, with a slight  yawn, how you were recently dollar-cost averaging your investments and are pleased with their performance.

So, if the principle is so simple, why does it have such a fancy name?  The answer, it would seem, is so that self-aggrandizing, so-called financial experts can lend more of an aura of complexity and mystery to their craft.  Make sure to mention your disdain for the “experts” at your dinner parties as well.  And that’s my rant for the day.

Posted in Building Wealth
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Personal Finance 101: You Need to Read These 3 Books

Posted By damien on August 13th, 2009

readingWith the summer drawing to a close, regretfully I will have to read more textbooks (senior year of college!) and fewer personal finance ones. In order to remember the ones I read that were worth the time, I compiled this list.

Personal finance boils down to a few tried-and-true principles, so many say the same things, jut in different ways. If you read these 3, you’ll get the best of the best, and avoid all the fluff and copycats.

The Total Money Makeover

The principles in this book should be the foundation for everyone’s personal finance plan. The teachings in this book form the base for my money philosophy. Dave Ramsey is the expert on helping people get out of debt and create an emergency fund.

Read it first and follow Dave’s baby steps. He will show you why what you believe about money has been keeping you from achieving your potential. This book will change your relationship with money and get your money working for you instead of the other way around.

After you have gotten out of debt and established 3-6 months worth of savings, move on to the next book.

I Will Teach You To Be Rich

Ramit Sethi is the freshest voice on personal finance. Whereas Dave Ramsey has the principles of personal finance, Ramit has the techniques for the 21st century. His teachings on automating your finances have saved me hours per week in handling bills and investing.

His investment strategy, getting the best results with the least amount of effort, is the best investment plan for the everyday person that I have ever read. He got me off my butt, opening my Roth IRA and setting up automatic monthly deposits when countless other books couldn’t.

The Millionaire Next Door

Just what does the average millionaire look like? Dress like? Think like? This book will dispel all the myths we are fed by the media about the lifestyles of the rich. Once you understand how the average millionaire spends and saves his/her money, you can begin to implement their philosophies yourself and speed up the time it takes you to join them.

Where The Total Money Makeover changes the way you think about debt, this book will change the way you think about wealth. Read the previous two books first, as they will give you the specific tactics to form and implement your personal finance strategy. Then read this one to understand the psychology of becoming wealthy.

Get To It!

These three books will give you everything you need to get out of debt, become wealthy and improve your relationship with money. This all the substance you need for a lifetime of financial security. And, should you choose to read anything after, it will just be icing on the cake!

Posted in Building Wealth, Selp Improvement
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The Millionaire Minute: How the Wealthy Make Purchases

Posted By damien on August 10th, 2009

receiptsRobert G Allen’s Multiple Streams of Income is a how-to guide for setting up sources of income in addition to a traditional full-time job.  In his intro, he discusses some of the habits of the wealthy.  One of the habits he lists, which I had never heard of before, he calls the millionaire minute:

Prosperous people have a unique attitude toward each money event [aka purchase]. During a typical transaction, they complete a few extra key activities…I believe that it is these few extra key minutes that make all the difference.  That’s why I call this the millionaire minute.

What exactly are the few extra key things that millionaires do when making a purchase?

1.  They plan the purchase.  As with airline tickets, the longer the planning horizon, the cheaper the purchase.

2.  They expect, ask for, and often get a discount.

3.  They expect, ask for, and always get a receipt.

4.  They always examine the receipt for errors.

I was ashamed to recognize that I am only doing one of these consistently (step 1) and another occasionally (step 2).  I love researching my purchases, especially large ones.  But I have a good friend who obsesses over purchases.  He spent weeks researching baby cribs while him and his wife were expecting their first child.  His obsession payed off—they found an Italian-crafted, hardwood crib from a company going out of business, at a steal of a deal.

After seeing how good he is at researching purchases, I have delegated some of my research to him.  It is a good thing to have a friend do all the work for you.  Delegating this research forms a hybrid with the post I wrote earlier about having others sift through information for you.

Most Americans are afraid to ask for discounts.  For some reason, our culture isn’t really into bartering, not as much as I’ve seen in France, Belgium or Mexico.  But really, it isn’t that hard to ask for a discount.  I’ll even give you a script to follow the next time you make a purchase:

You: Excuse me, how much is this widget?

Store employee: It’s $14.95.

You: Thank you, what discounts are you offering right now?

At this point, the employee will either give you a discount, or (s)he will tell you there aren’t any at that time.  And all you had to do was ask!  No messy confrontation, just a friendly question.

Do you ever check your receipts?  It’s a habit I want to pick up, not because I have an innate mistrust of cashiers, but because mistakes happen, even (especially) when computers are involved.  Since checking out nowadays is such an automated process, we devote less of our minds to it, thus opening the process up to more error.  It only takes a second to check your receipt.  If there is an error, just be polite when pointing it out (like when you asked for the discount) and if the cashier is a decent human being, your problem will be solved quickly.

Oh, and if there is a mistake in your favor, be a decent human being yourself and pay what you owe.

Posted in Building Wealth
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