Thursday, August 4, 2011

BSquared's Financial Baby Steps Revisited

I've done this before, here, but now life has moved on and 2 years later it is good to reflect again on what are the financial fundamentals and how they apply to my excellent life right now. It all starts with the Dave Ramsey Baby Steps which I list below but alter for my own personal method. And as a reminder these are the big steps, sure there are other purchases built in but this is more of the skeletal structure of the financial body as buying a car, having a wedding, having a kid or 3 are all more like the flesh that sits on and is held up by the base structure.

1.       1,000 to start an emergency fund
2.       Pay off all debt using the debt snowball
3.       3 to 6 months of expenses in savings
4.       Invest 15 percent of household income into Roth IRAs and pretax retirement
5.       College Funding for children
6.       Pay off home early
7.       Build wealth and give

Let me start by saying I really like Dave because he tells it like it is and isn't afraid to hurt someone's feelings or to give them a pat on the back. And I think his steps could be a great map for some people but I think we can better achieve what we want to achieve using a slight variation on some of the steps.

The BSquared version of the Baby Steps: (explanations afterwards)
1.       1,000 as an emergency fund (have to first have a little to keep something little from throwing everything else out of kilter)
2.       Pay off all debts under $10,000 using the Debt Snowball, excepting those with a sub 3 APR (no debt is good debt but I think if your debt can be beat by inflation which is 4% over time then don't go crazy until further down the steps, with an exception I'll talk about at the end; I will also say that Dave's way takes the thinking and impulse control out of this with the no 3 APR exception which can be a good thing but for us we have proven over the past few years that we can handle the task of trusting the math and not abandoning the plan)
3.       Bump up the Emergency fund to $5,000 (this is big for us as we carry fairly high deductible insurance on some things, lets assume a medical thing like I had last year then it takes $2k to the deductible, 5k here makes that keep everything from going crazy, also if have a bad car accident have to think 500 to get the car deductible another 500 for medical, if its not enough 2k for medical to kick in, its bad but it could be much worse w/o this safety net)
4.       Invest $10,000/year (or whatever is the Roth max) in retirement (for better or worse none of us are getting any younger and compounding interest does magical, magical things when applied to 30 or 35 years, start now or forever eat canned tuna fish instead of Sushi)
5.       Create savings of 3 months expenses (these numbers can seem kind of scary when you think about what is required BUT if you have paid off all debt except for sub 3's and the house it may not be as much as you think). Plus I will say that putting 3 to 6 months as I had before was just a little silly, everyone would stop at 3 and never get to 6 to get to the other steps BUT check out number 9, 6 months comes back around later.
6.       Pay off debts over $10,000 using the Debt Snowball, excepting those with a sub 3 APR (this can get really discouraging, trust me, we know, the snowball rolls very slowly when trying to pay off $17k like with a car but it happens and when it does it makes you feel really good; also I count a 2nd mortgage in here, 1st goes to the house, 2nd goes to not having enough cash at time of purchase IMO so it's just a loan debt)
7.       Build that children’s college fund, I know this is lower than some people might have thought but maybe having its ranking here maybe me hedging because of my old thoughts versus my new thoughts. There is a tradition in my family of parents not paying for college, my grandfather didn't pay for my dad, my dad didn't pay for me, and on some level I would like a kid of mine to have the satisfaction and self reliance that comes with making it on their own. Plus there is nothing wrong with junior college and state universities so it is affordable as long as you stay in state. That being said, it was the old way of thinking with me because I realize how financially positive it would be for someone to be able to get out of school with no debt hamstringing them, how much sooner they can walk up these steps per se. So … I think the hedge is to support them but not so early in the process it hurts our own steps.
8.       Increase the retirement savings to at least $15,000 a year, perhaps more if a good investment (thinking real estate) comes available. Remember though that pretax is always a better investment than even things like real estate because what type of returns on investment bring you the 25-33% that avoiding taxes do? Really? None that I know of that are legal.
9.       Create 6 months expenses and having in savings. Now you want to talk of piece of mind, this is the way to do it. Being able to lose your job and not freak out about it, very nice.
10.    Pay off home early (with this I assume your house isn't a sub 3, I’m pretty sure ours isn't, but keeping a house payment for the tax implications just isn't smart, you don't rather keep a deduction than keeping all that money you are spending in interest on the house; run the number % of house payment going out not to principle v. what you are saving on taxes)
11.    Pay off any loans with a sub 3 APR (here is the magical place we are still way away from (mostly because of the house but if you have paid the other stuff and put your retirement money in and built up 6 months of expenses you can certainly kill this and then you have all sorts of money to play with every month)
12.    Stuff as much into investments and retirement savings as possible to shoot for early retirement (plus remember, in theory social security will still be around in 2045 when I hope to retire and if it is (but I'm not counting on it) that is just gravy to the preplanning we have laid here)

I almost forgot the exception I promised in #2 - The exception I include for paying off sub 3 APR stuff is if you anticipate a tough situation coming up or something where a cash infusion might be needed and you feel it best to clear a recurring debt (i.e. Car Loan at $350 a month) to make each month better if someone were to lose a job or something of the sort than I'm ok with forgetting the sub 3 APR thing because flexibility in tough times is worth its weight in gold (and piece of mind) regardless of the mathematical equations regarding inflation beating the loan.

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