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Whereas Dave Ramseyâs Baby Steps have often been dissected one at a time, my goal in this post is to give an overview of the steps as a unit and explain why the order is essential.
Hopefully, these steps can help you create a focused life plan for your finances, regardless of your age or financial well being.
First, the Baby Steps:
- Step 1: $1,000 in an emergency fund.
- Step 2: Pay off all debt except the house utilizing the debt snowball.
- Step 3: Three to six months of savings in a fully funded emergency fund.
- Step 4: Invest 15% of your household income into Roth IRAs and pre-tax retirement plans.
- Step 5: College Funding
- Step 6: Pay off your home early.
- Step 7: Build wealth and give.
The Power of Focus
Daveâs premise with the Baby Steps is that people can accomplish great things IF they can just be focused. When you read over these seven steps, you think, âYes. I need to be saving. But I also need to be investing for retirement. I should get my house paid off early. But I also need to be getting out of debt and saving for my kidâs college.”
You would readily agree that all of these goals are important for successful financial planning. The problem is that your stress level kicks into overdrive with the prospect of doing them all. You clench your jaw and do what you are capable of doing while feeling anxious about the goals you place on the back burner.
The Baby Steps plan works because when you stay focused on one step at a time, you can knowingly put some important goals on hold without the nagging feeling that you are leaving something undone.
You can also check out my YouTube video where I break down each of Dave’s Baby Steps here:
Because accomplishing each step puts you in a great position to accomplish the next one.
You begin to feel an empowerment and a sense of control as you get one step behind you and start the next one. You are making progress instead of treading water.
Why Are the Baby Steps in the Order They Are In?
Steps 1 and 2: $1,000 Emergency Fund and Debt Snowball
Notice that Steps 3 through 7 are all about using your money to do something positive for you and your family. Of course this money comes from your income, but the problem with most of America is that we are using our income on debt payments.
Because we are paying others instead of ourselves, we need to get rid of our debt (Step 2) in order to free up our income for Steps 3-7.
âWhat if I could use all the money I am currently paying to creditors to start âpaying myselfâ?
For many people this is $1,000 to $3,000 a month.
Baby Step 2 debt snowball is designed to do just that. Step 1 is necessary before Step 2 because you donât want to start paying off debt without having a small cushion to absorb the little unplanned expenses that will occur during Step 2.
Step 3: 3 to 6 months of Savings
After completing the first two steps, you are out of debt (except for your house) and now have that cash flow you dreamed about: all of the money you used to pay others is at your disposal. The temptation is to start investing for retirement or saving for your kid’s college or pay off your house early.
NOT SO FAST! You will get to those, but doing so prematurely is way too risky.
Stop, take a deep breath and use that cash flow to build up your emergency fund so you will indeed be ready for emergencies. This fund needs to be liquid (in a top savings account or money market account).
If you skipped the step and started any of the ensuing steps, how would you handle emergencies? Pull money from your retirement account? Rob the kidâs college savings? Borrow money against your house? All bad ideas.
Step 3 is therefore always ahead of the following steps
Steps 4, 5, and 6: Saving for Retirement, College Funding, Pay Off Home
You may be asking,
âWhy is retirement ahead of college funding? Wouldnât a good parent put his children ahead of himself?â
Good question. But what if you end up without sufficient retirement income because you made college funding a higher priority? Who will you be depending on in your later years? Your kids!
The thing about retirement planning is that you only get one shot at it. The years go by and you will someday be retirement age. You donât have a choice. On the other hand, college funding is full of choices: kids can get scholarship, they can work, they can attend community colleges, they can find work/co-op programs, etc, etc.
Step 4 is therefore ahead of step 5. But notice that Step 4 is 15% of your income. If you have cash flow greater than 15% you can apply that to college funding immediately, and if you have more than enough cash flow to accomplish both steps 4 and 5, you can use all of the extra to pay off your house early (step 6).
Note that Step 6 comes behind retirement and college funding because reversing the order could possibly give you a paid for house at the expense of a dignified retirement or helping your kids through college. Most of us wouldnât want that.
Not sure where to start investing for retirement? Here are some tips:
- Best Places to Open a Roth IRA – Figuring out where to start investing your 15% of income can be confusing. A great place to start is a Roth IRA, but deciding a broker is confusing. This list will help you pick the best broker for your Roth IRA.
- Best Online Stock Broker Sign Up Bonuses – You can get hundreds of dollars or thousands of airline miles just for opening up a brokerage account.
- Beginner Investing Strategies – If you’ve never invested before it can be overwhelming. This list breaks down getting started into manageable pieces.
Step 7: Build wealth and give.
Life is now very good! You have no debt, a great emergency fund, and a paid for house. All of the cash flow that used to go toward debt reduction and house payments is now at your disposal.
This, by the way, is the step Mandy and I are on. Being semi-retired, we donât have a huge income, but it is very sufficient because we also donât have any debt. We continue to invest every month and we are able to give more than we have ever given before.
Once we got our house paid off, we started to budget âblessâ money, which we put into an envelope every month just to have available so we can bless others as we see the needs. We are also able to help our grown daughter and daughter-in-law cash flow their college.
As I said, life is good. Mandy and I are experiencing great financial peace and we are very grateful for Dave Ramseyâs Baby Steps.
I wish the same for you.
This article is a general overview of what Dave Ramsey has to offer and is not intended to replace his course, nor is this sponsored or endorsed by Dave Ramsey or the Lampo Group.
The post Dave Ramseyâs Baby Steps Explained appeared first on Good Financial CentsÂ®.
The post The Ultimate Guide to Using a Cash Budget appeared first on Penny Pinchin' Mom.
There are many types of budgets you can try.Â A quick Google search will show you lots of options – including the cash envelope budget.Â If you say it will not work for you, it means you did not try doing it the right way.
Whether you are getting out of debt or not, you can probably use some help in making sure you control your spending. Contrary to what many people say, the best way to do this is to use cash. Â If you are trying to get out of debt, this is the next step you need to follow!Â The cash envelope system is an important step to your debt paydown plan.
Ask many financial experts such as Dave Ramsey or Clark Howard and they will agree that using cash is an important factor in controlling your spending. And it is not a system only for people trying to get out of debt, but everyone as it really makes you think more about your spending.
HOW TO USE THE CASH BUDGET
WHY A CASH ENVELOPE SYSTEM?
Cash is King!!Â I say this all of the time because I genuinely believe this. Â When I bring up using cash, the first rebuttal I get is “If I have cash, I spend it far too easily.”Â Sorry, I don’t buy it.Â The main reason that people fail on a cash budget is a lack of tracking what they spend and assigning it a task.
[clickToTweet tweet=”The truth is that when you use cash, you spend more wisely. ” quote=”The truth is that when you use cash, you spend more wisely. “]
When you have only $200 for groceries, and you also know that it must last for two weeks. Â It forces you to think twice before you buy that extra item. Â A cash budget never lets you overspend because once the money is gone – it’s gone.
CASH ENVELOPE CATEGORIES
Getting started using the envelope system for budgeting is pretty simple. Â To begin, look at your budget. Â The following are cash envelope categories you should consider using:
- Dining Out
- Hair Cuts/ Beauty
- Doctor Visits
- Random Spending (which is your spend as you want – only if you can afford it)
- Doctor/Dentist Visits
You will notice that I didn’t include gasoline on my list.Â The reason I didn’t is that most people won’t overspend at the pump.Â Most of us just fill up our tanks and go about our merry way.Â You also don’t drive around and burn fuel or decide to fuel up because your neighbor did.Â It is on your budgetÂ but is not one you where you will overspend. Not only that, it is usuallyÂ much more convenient to pay at the pump.
PRINTABLE DIY CASH ENVELOPE TEMPLATE
When it comes to using the cash envelope system, you can purchase one such as that sold by Dave Ramsey or you can just use the envelopes in your desk drawer. Â I’ve even got a cash envelope template you can use as well (purchase HERE for $2.99).
HOW MUCH CASH DO I NEED?
Once you have your categories, you have to determine how much cash you need for each group. Â You will figure the amount based on your pay period.
For example, if payday is every two weeks, take the total monthly grocery budgeted amount and divide it by 2.Â You will then know how much money you will need for each of the two pay periods for that month.Â It is important you have a budget that works (including using budget printables as needed).
Next, review, each category you will use cash for and figure up the amount you will need. Â Once you have done that, you will also want to figure out how many of each denomination of bill you will need. Â List the total amount, by denomination, on a piece of paper. Â Take that, along with a check from your account for the amount, to the bank. Â You will make a withdrawal and then split up the cash into each envelope.
HOW TO USE THE DAVE RAMSEY ENVELOPE SYSTEM
Sometimes, it is easier to understand something if you can see it in action.Â Follow this simple cash budget example to see how it works.
START WITH YOUR REGULAR BUDGET
Let’s say you bring home $2,500 per month. You have completed your written budget and have items such as your mortgage, utilities, food, dining out, debts and other expenses.Â Most of your expensesÂ are paid with a check or electronic transfer. Those are not the categories to consider for your cash budget.Â Instead, look at those items that you don’t pay for all at once, but rather over time.
These are the items that will work best if you use cash.Â In this case, you will include groceries, clothing, random spending, doctor visits and dining out.Â (We don’t include fuel because there is never a chance you will overspend on fuel).
In this example, we will only use cash for these items:
Groceries – $500
Clothing – $100
Random Spending – $80
Doctor – $50
Dining Out – $100
DETERMINE HOW MUCH CASH YOU NEED PER PAYCHECK
As you can see, the budget above is based on your monthly income.Â Since you are paid every two weeks, that means your take-home pay is $1,250 twice a month.Â You only need enough money to cover half of each of these categories.Â Your spending for each will look like this for each pay period:
MONTHLY BUDGET DIVIDED FOR BI-WEEKLY PAY
Groceries – $250
Clothing – $50
Random Spending – $40
Doctor – $25
Dining Out – $50
Total cash needed: Â $415 per pay period
Now that you see what you have budgeted to spend on each category each pay period, you need to determine how many bills of each denomination you will need to get from the bank.
KNOWING HOW MUCH CASH YOU NEED FOR A CASH SYSTEM
Using the same cash budget example above, here is how you will do that:
Groceries – $250 —- 3 $50 bills, 5 $20 bills
Clothing – $50 — 2 $20 bills, 1 $10 bill
Random spending – $40 —- 2 $20 bills
Doctor – $25 —- 1 $20 bill, 1 $5 bill
Dining Out – $50 —- 2 $20 bills, 1 $10 bill
You need to get this cash from the bank.Â You can’t use the ATM as it will spit out only $20s and $10s and will not give you the correct number of bills.Â Make a note to hand to the teller that shows how to break down the cash:
3 $50 bills
12 $20 bills
2 $10 bills
1 $5 bill
Write a check for $415, payable to “CASH” and take it, along with your slip of paper to your bank.Â The teller will cash the check and give you the bills you need.
FILL YOUR CASH ENVELOPES
When you get home with your cash, it is time to add it to each envelope.Â Find the one for each category listed above.Â Pull the cash from the bank envelope and split it into each envelope, per the list above.Â Add the amount of the deposit to the front of the envelope, adding to any amounts that may be left from the prior pay period.
USING THE CASH ENVELOPE SYSTEM
Once you have your cash and your envelopes, it is time to put them to work.Â The only – and I mean only – way that this will work is if you track every. Single. Transaction.Â I am not joking.Â Â Doing this can help you stay on track, and you also have to account for everything you spend.
For example, shop as usual at the grocery store.Â If your total is $20.17, you will pay with the cash from your groceries envelope.Â Place any cash you get back into the envelope and then deduct your purchase from the balance.Â So, if you had $100 and spent $20.17, the new total cash you have left will be $79.83.
The printable cash envelope template above includes lines on the envelope, so you have a place to track your balance.Â If you use your own, add it to the outside or keep a slip of paper inside.
Make sure you track every purchase. You can always see how much money you have left and where it was spent.Â ItÂ helps you monitor your spending at a glance.Â Once the cash is goneÂ – you are done spendingÂ money.
USING THE VIRTUAL CASH ENVELOPE SYSTEM
I also get that sometimes, cash is just something you can’t do. You need (or just really prefer) using your debit or credit card instead. Is there a way you can apply this method when you spend using plastic?
Rather than get paper money to put into your envelopes, you can use either a virtual envelope or paper tracking to monitor your spending.
Virtual envelope systems, such as ProActive, help you monitor and control your spending but allow you the convenience of using your credit or debit card.Â Rather than paying with cash, you swipe but know how much you have left to spend on each category in your budget.
If you would rather opt for something that is free, you can print out cashless envelopes instead.Â They work in the same fashion as cash envelopes.Â You still write down the amount you have to spend on each form and as you shop, you keep track.Â When you are out of “money” according to your envelope tally, you are done shopping.
You can read even more and get started with different ways to use the envelope method even if you don’t use cash.
HOW TO USE A CASH METHOD WHEN SHOPPING ONLINE
So, what if you don’t shop in the store, but rather, make purchases online, how would that work with a cash budget?Â Can you even do that?Â Yes, you can.Â You just have to handle it a little differently.
The first option is to leave some of the money you normally get in cash, in your account.Â For example, if you spend $100 every paycheck through online purchases, get $100 less in cash.Â You can still account for it by using cashless envelopes instead.Â That way, you still monitor your spending and don’t blow your budget.
The other option is to still get all of the cash you normally need.Â Then, if you buy something online, head to the bank and re-deposit that back into your account.Â You still get the full benefit of using cash and seeing the money come out of your envelopes.
You still can use cash when you shop online, you just have to make some adjustments.
WHY THE CASH ENVELOPE SYSTEM WORKS
The reason why the cash envelope system works is pretty simple. Â Accountability.
When you have to make yourself accountable for your spending, you are taking control. Â It also will help you spend less. Â If you only have $100 to spend on dining out over the next two weeks, you think twice about ordering take out three days in a row.Â When the money is gone – you are done spending!!!
It isn’t entirely about cash.Â It is learning self-control.Â That is the one thing everyone will gain in going through this process.Â It enforces this way of thinking. Â You will quickly learn to love using cash, and you will feel more in control of your finances.
Cash also has more emotion attached to it. You don’t think about the consequences of a purchase when you swipe a card. Â However, handing over that cold, hard cash sometimes hurts. Â You do think about each purchase a bit more.
We’ve been doing this for so long that I don’t know how to shop without my envelopes!Â Â It is routine, and it helps us always know, in a matter of minutes, how much money we have available for the things we need.
The post The Ultimate Guide to Using a Cash Budget appeared first on Penny Pinchin' Mom.