Dissecting Dave Ramsey’s “Total Money Makeover” - Start the Debt Snowball [Part 2 of 7]

Posted by panzer on July 9, 2008. Filed under [personal finance]
Tags: [7 baby steps, Dave Ramsey, financial freedom in Singapore, financial literacy in singapore, personal finance, personal finance in Singapore, Total Money Makeover]

Step 1 of the 7 Baby Steps in “Total Money Makeover” by Dave Ramsey talks about starting an emergency fund of $1,000. Today, we discuss Step 2 which is to start the debt snowball.

Debt is a good servant but dangerous master

Debt is one of the most damaging thing you can take on if you are not careful. Unsecured debt in the form of credit cards, car loans etc. especially when the money goes to pay for consumption is a drag on our ability to save and invest for your retirement, your children’s university and for financial independence. Dave Ramsey absolutely abhors debt as he’s gone from millionnaire to bankruptcy all before the age of 30. He has since got back out of bankruptcy but he warns people not to go through it as the record stays for 7-10 years and you will find it difficult to conduct financial activities if you have a bankruptcy record. Even in Singapore, you cannot be a director if you are an undischarged bankrupt and need the permission of the official assignee to travel out of the country.

What is the Debt Snowball

Conceptually it is straightforward.

List down ALL your credit card debts from the smallest amount to the largest. Start paying off the smallest to the biggest because of the quick win and psychological boost you get from clearing them first. You do this after making sure you take care of your (moderate) living expenses, credit card minimum payments etc. In order to arrive at step 2, you need to be making progress on step 1 which is to begin your emergency fund. For those who live hand-to-mouth, this can be a challenging thing to do.

The snowball effect comes when you start paying off the smaller credit card balances, the freed interest and payments to those balances can be snowballed into paying off the larger balances and thus you build up momentum to clear your credit card and related debts over time. But Dave shares that it takes an average of 2-3 years of living frugally and gazelle intensity of focus on clearing off the debt to make it. It’s not easy and takes sacrifice and discipline to achieve it.

Panzer’s Take

I am fortunate enough to emerge from my full-time national service in the Singapore Armed Forces with a positive net worth as I saved some of my NS allowance by staying-in and eating the cookhouse food. My University education was funded by a local scholarship which mean that my tuition costs of about $10,000 for a 3 year degree program was not a burden to my parents and I even had an allowance of $4,200 a year ($350 a month) to live on.

I can see how overwhelming debt can be as a recent article posted in the main stream media shared how more 30 somethings were being made bankrupts for debt  of $10,000 or more. The increasing cost of college tuition and consumerist culture of Singapore has lured many young people to using debt to fund their lifestyle needs. Living within your means becomes less important to keeping up with the neighbours.

One of my ex-colleagues once used his credit cards to make payments for his MBA program that costs about $20,000+. It took him almost 18 months to clear the interest and principal and it was quite bewildering to me why someone who was financially trained would pay 24% on interest to fund his MBA which did not directly contribute to increased income at his work. That made me realise that not everyone saw debt the same way.

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Dissecting Dave Ramsey’s “Total Money Makeover” - Start Your Emergency Fund [Part 1 of 7]

Posted by panzer on July 8, 2008. Filed under [live within your means, personal finance]
Tags: [7 baby steps, book review, cash management, Dave Ramsey, financial freedom in Singapore, financial freedom principles, financial literacy in singapore, personal finance, personal finance in Singapore, Total Money Makeover]

Panzer’s penchant for performing book reviews surfaces again as I embark on my next series reviewing Dave Ramsey’s “Total Money Makeover” that took me a weekend to read but many more sessions to digest each of his 7 Baby Steps. This 7 parter will be less intense that the previous “Are You Ready for Retirement” series as Dave’s 7 steps are more intuitive and require lesser number crunching and running through of CPF rules.

I had heard of Dave Ramsey many times because many personal finance blogs make reference to the concept of “debt snowball” that is popularised by Dave Ramsey. I had heard of that term many times but never really understood it until I picked up a copy of “Total Money Makeover” through our excellent public library system.

Who is Dave Ramsey
He a best-selling author, radio host and someone who was a millionnaire before his 30s and he became bankrupt before discovering the knack for counselling people in dire financial straits. Like any popular figure, he also has his share of criticisms as you can see in this wikipedia article.

“Total Money Makeover” is one of his popular books and is the subject of our discussion.

Debt is BAD, BAD, BAD!

Make no qualms about it, Dave Ramsey is an interesting writer because his writing voice is informal and feels like he’s talking to you through the book. He peppers the books with side notes on “Dave’s Rants” or “Myths” that he dispels about debt and money. His approach to your total money makeover of a typical debt-ridden family or individual is to get with the program to become Arnold Swarzendollar. I kid you not…

His approach to getting yourself and your family’s finances back into shape is to follow the 7 Baby Steps:

1. Save $1,000 cash as starter emergency fund
2. Start the debt snowball
3. Finish the emergency fund
4. Invest 15% of your income in retirement
5. Save for college
6. Pay off your home mortgage
7. Build wealth

Baby Step #1 - Emergency Fund

When I visit many financial portals such as SgFunds or HWZ’s Money forum, many newbies like to ask how to start investing. The advice that tends to come first is to build up your emergency fund. This is also what Dave Ramsey advocates that we should set up our emergency fund at 3-6 months of your income (or living expenses). The average American in his book earns USD 40,000 a year, so 3 months is about $10,000. But the $1,000 is a pyschologically more achievable target for many who are so in debt that even saving a few dollars after paying the bills seem impossible.

The reason why you should have an emergency fund is because, “duh”, emergencies DO HAPPEN in real life and you need to have a buffer so that you won’t rack up NEW DEBT or dip into INVESTMENTS when it strikes. It is pretty common-sense and yet very true. Most investment books advocate that you should have some cash as part of your portfolio for that bit of liquidity.

For those who are just starting out your investments capital. Do start an emergency fund first. I personally also keep a emergency fund that varies from 3-6 mths of my income to buffer for unforseen expenses. It also allows me not to cash out my investment in stocks and shares should I need urgent cash for a major outlay that is unplanned.

An emergency fund looks easy but is not for those who are used to living BEYOND your means at TO THE LIMIT of your means. I count myself fortunate to have parents who were rather frugal and their frugal habits rubbed off onto me as I grew older and started working and earning an income.

To set up your emergency fund is to live within your means to build up the savings.

Delaying gratification is increasingly one of the great challenges to our consumer culture.

Be well and prosper.