As a financial advisor, Nathan Lippincott's passion is to help others with debt. In this blog, he offers his preferred 7 step plan to creating a budget and reaching your financial goals.
After completing a review of Dave Ramsey’s Seven Steps to Financial Freedom, I was asked whether I have my own plan for eliminating debt. Yes, I certainly do. All financial advisors have their own approach, and I am no different. Some of my steps may be similar to Ramsey’s, but others I have adapted based on my own experiences, successes, and observations. Today I will share with you the seven steps I believe you should take to reach financial freedom.
1. Create a Budget: Without a budget, you will never begin your plan to financial freedom. Even if you have an established savings account or a fully funded emergency fund, without a budget, you cannot avoid spending your savings and emergency fund on things for which they were not designed. “Dipping” into these accounts will inevitably happen if there is not a job for each dollar.
2. Build an Emergency Fund: The first law of finances is that if you have no emergency fund established, then you will bear the brunt of Murphy’s Law. When there is no emergency fund, emergencies will tend to happen (tires blown out, sick children, etc) and there will be nothing to protect you. It is best to avoid this at all costs. It does not have to be a large emergency fund in the beginning. The first goal is to save $1,000. A larger and more comprehensive emergency fund will be built in just a few steps.
3. Pay Off Credit Cards: It is impossible to move ahead if you are paying interest rates of 10-18% on credit cards or any other loan that is over 10%. It is imperative to pay these as soon as possible. If you have car loans or additional payments with low interest, continue to keep up the minimal payments while tackling the others full force.
I agree with Dave Ramsey's "snowball method" to paying off debt. Start by paying off your smallest debt first. A small “win” will help your morale and provide motivation to continue.
4. Begin Investing: As I described in my previous post about the Magic of Compound Interest, the sooner you begin investing, the more money you will have in the end. If you have a 401k at work, you must begin with that. Most 401ks include matched amounts from your company. At bare minimum, you should be putting 3% into this, so your total is 6% with company matching. Think of it this way: at the very least, you should invest whatever the company match will be.
5. Create a “Fully Funded” Emergency Fund: At this point, it is time to create an emergency fund that is considered “fully funded.” This means there is enough in the fund to cover three to six months’ worth of expenses. You will know exactly what amount needs to be saved because all you will have to do is consult the budget you created and implemented.
6. Go Back to Investing: Once you max out your 401k match and have a “fully funded” emergency fund, start looking for additional investment opportunities. A Roth IRA and a traditional IRA are both options. A Roth IRA will allow you to invest today, but it is not tax deductible at the time of investment. However, it is tax free upon retirement. A traditional IRA is tax deferred (tax deductible at the time of investment); you are taxed when the money is drawn out at retirement.
The ultimate goal is to be putting 15% of your income into investments of some kind each year. Start with your 401k and your company match. Next, open a Roth IRA and put in the maximum amount per year that you are allowed ($5,500). Then, if you find that you can come up with additional income, return to your 401k and continue adding even more to it, above and beyond the matched amount.
7. Pay Off All Debts Except for Mortgage: If you have car loans or any loans with low interest rates, start to pay them off. This will be fairly simple to do, as you have finished paying off the debts with high interest rates and freed up the payment money to be applied here. I personally recommend keeping your mortgage payment, as it is both tax deductible and typically does not carry a high interest rate.