I hope you enjoyed the first part of this installment where I covered baby steps 1 and 2. If you missed it, Click Here
That being said, lets dive into baby steps 3-7!
Baby Step 3: 3 to 6 months of expenses in savings
Dave Ramsey suggests that, after paying off all debt besides your home, to save up an extended emergency fund of 3 to 6 months. This step actually has a lot to do with your personal preferences. Depending on your situation, 3 to 6 months of savings are actually a good range of finances. Personally, I believe that 3 months of savings would be good enough. If you have situations that leave you more exposed to having to dip into your savings, a larger emergency fund would be better. This should create a comfortable safety net.
This emergency fund will be your savings floor. Never go below your floor unless it is, well, a bona-fide emergency. Now, with Dave Ramsey’s baby steps, you will be doing steps 4-6 concurrently but how about getting some additional leverage out of baby step 3? After you have your emergency fund in place, keep stashing away a percentage of your paycheck in your account. Keeping your 3-6 months of savings but adding some additional cash will allow you to take advantage of awesome deals, unexpected emergencies or investment deals too good to pass up. That new BBQ goes on sale, your teenager gets into a fender bender or you come across an investment property. Having some additional cash around is handy. After all, cash is king. You don’t have to get crazy, just an additional 10% of your disposable income. You should also keep this additional money in a different savings or money market account. I know Ally Bank, an online bank, offers a 1.80% Annual Percentage Yield, as of this writing, on money deposited in a savings account. (https://www.ally.com/). Your emergency funds might be parked for a gloomy day but there is no reason your money needs to be earning minuscule returns.
What is very important is that you do not want a huge amount in this fund. I am going to cap my fund at $50K, with a $10K emergency fund floor. Too much cash in this account can prevent you from earning precious compound interest in your investment portfolio. Which brings me to…
Baby Step 4: Invest 15% of household income into Roth IRAs and pretax accounts
Invest 15% of your household income? Not unless you want to retire in 42.8 years* ! According to networthify.com, it would take 42.8 years with an ROI(return on investment) of 5% per year for your investments to cover your monthly expenses. I am not sure about you but I am not working for 42.8 more years. Even bumping your investing up to 20% can drop you down to 36.7 years. That is six years you don’t have to punch the clock! I highly recommend playing around with the investment calculators on networthify.com. It can really shed some light on the power of investing… or the cost of not investing!
Since you are now debt free, you should be fully taking advantage of any 401K that is being matched, if you have a company that does that. It is like getting free money that is tax free! Oh and that tax free money just compounds to make you more money! If you do not take advantage of the full 401K match your company provides, you will just be leaving money on the table.
So what are you investing your money in? Now, I am going to briefly touch on this subject as it will be a subject for another, in depth blog post. So Dave Ramsey suggests that you find a good mutual fund that has been beating the index year after year. I have just a couple issues with that philosophy. First, how do you find these funds? Just because a person managed to claw themselves out of debt doesn’t mean that they can navigate the thousands of mutual funds offered out there. Mutual funds are a money making product. Every fund out there is going to state that they are beating the index. How do you really know that they are regularly performing or if they did just two out of the past five years? Secondly, since mutual funds are actively managed, they usually have higher fees. These fees are a HUGE drain on your money’s ability to create wealth. Finally, there is an easier way to manage your money yourself via index investing. This will save you time and money as the fees on index ETFs are marginal… more on this in a later post, but if you would like to learn more please check out http://jlcollinsnh.com/ or the book The Simple Path to Wealth. This is a great resource to learn about index investing.
Baby Step 5: College Funding for Children
I have not dug into this step too deeply as I only have one child who is 2 weeks old at the time of this writing. I did however hear a couple awesome strategies on how to fund college. Aside from the common 529 College savings plan, an interesting way to pay for college Junior is to have someone else pay for it. How can you have someone else pay for college you might ask? Investment property. I came across this strategy on the biggerpockets.com forums. The general idea is this. First, you would need to purchase an income property that you can, at minimum, get your mortgage on the home paid for by a renter. This mortgage should be on a 15 year fixed,in order to pay down the principle as fast as possible. When your child enters college, you would be able to draw from the equity on the home to pay the tuition. The only investment would be the initial down payment and any ongoing maintenance costs associated with the property. Now obviously this strategy is a bit riskier and holds some assumptions about the investor. The investor needs to be able to find a home where the rent would equal or exceed what the mortgage payment is. Also that the investor has a good amount of time before their child enters college. Imagine investing in a 100k home when your child is 3 years old and having renters pay the mortgage on that home for the full 15 year note. You would be able to either sell or refinance that money without doing too much work. Just an interesting way to think outside the box on this subject.
The second strategy can actually apply to older students who wanted to go back to school as well. I wanted to give a shout out to my alma mater, Arizona State University. ASU has partnered up with Starbucks to offer a paid tuition to ASU online for working at the company full time. It is a great program to take advantage of! Here is a link with some additional information on the program. https://asuonline.asu.edu/starbucks-and-arizona-state-university
Again, some out of the box thinking on this could save you and you children some serious cash and what better way to give your children a leg up in life by not having the burden of student debt.
Baby Step 6: Pay off your home early
This step is really up to personal choice as well. I completely understand wanting to wipe out that final big debt but let’s dive into the opportunity cost of this. As we went over in review of baby step 4, the average rate of return on index investments had historically been about 8%, conservatively. Knowing this, if you are paying on mortgage that is at 4% interest than you are theoretically missing out on 4% return that your money could be earning in the market. Who can really put a price on the piece of mind that a payed off home can bring. Markets can ebb and flow and even job markets can change over the course of time. Having a paid off house can ease the stress of these times. It really just depends on your risk tolerance and your personal situation. Just some more food for thought as you navigate through these last baby steps.
The final baby step: Build wealth and give!
This step isn’t really fleshed out by Dave Ramsey. I feel like I covered a big chunk of wealth building in baby step 4 with index investing and touched on some real estate investing in baby step 5. All I can really say about this last step is to take advantage of your debt free position and follow your passion. Take that trip, start that business or write that BLOG! Your options are almost endless now that you have accumulated your F- you money.
Give… this is a portion of the steps that I am passionate about. It is important to realize what a fortunate position you are in and to give back. Giving back doesn’t need to be all monetary or even a time donation. Really just be humble with your situation. Volunteer your knowledge in an area of expertise, tip a bit more at the restaurant, work with your local church or donate time with some disadvantaged youth. Just give back to humanity… It will do your soul good.
Well thank you for reading my Dave Ramsey Baby Step hacks. Please leave a comment or opinion below. I would love to read them.