Tuesday, February 26, 2008

Book Review: Financial Peace

I finished reading the book Financial Peace last night. For several years now, I've been slowly climbing out of debt. I started with around $30,000 in debt not counting my house. Over 3 years I've cut that down to around $17,000 but I've had to add to it several times. I've been referred to Dave Ramsey from several different places in the past 6 months. My parents, friends, I even stumbled across his radio program and felt energized by it.

A friend loaned me the book Financial Peace and I tore through it in only 4 days. Wow. Maybe I read it so fast because it's about money and getting out of debt, two things that I've had on my mind a lot over the last several years. I found that for the most part I'm already doing some of what he suggests, but he has other suggestions that I had not thought of. The book is excellent, and ends with a list of baby steps and the order in which to implement the plan.

1. Pay minimum on everything until you have an emergency fund of $1,000 setup. He does note if your income is low settle on $500. This is the step I have neglected, and several times I have had to pay for it by putting more debt on my credit cards. A complaint I've read is that cutting into this can cause anxiety, it can, but it hurts less to replenish the emergency fund than it does to spend $800 on car repairs with an additional 18% interest on the credit card. Trust me I know, I'm still paying that one off.

2. Implement the debt snowball to pay off all debt except for your house. "Get mad and stay mad until you get out". This is the hardest part if you ask me. Because everything you do for more than a year is focused on scrimping every penny you can until you are out of debt. Sell things you don't need, find a second job, stop eating out, travel less, anything and everything you can do to save money until you are out of debt. I've had a huge weakness in this area. I haven't wanted to give up my vacations. I don't want to stop eating out. But a "quick" meal at Burger King for the family can cost us $20, while eating at home is usually around $8 for the family. That $12 difference, even just once a week for a year is another $624 to pay towards debt. There are hard choices to make here, and they are hard. I struggle with them and find myself slide backwards too, but my wife and I discuss it and try to figure things out again every time.

3. Save the rest of your emergency fund of 3-6 months of your expenses. Keep this in a money market or bank account. This step is another complaint I've read about. However, with the only debt being your house payment, it's easy to figure your monthly expenses for other things and the house payment. I understand that there are much higher investment opportunities for this money, but keeping it in an easily accessible location, like the money market or simple bank account will insure you against losing your job and allow you 3-6 months to get more income coming in without having to sell stocks at a loss to cover your expenses. Long term it won't make much money, but that's not it's purpose, the purpose is to insure you against a job loss or large medical expenses without cutting into your real investments. I am not to this point yet, but I do plan on setting up this account before moving on to further investments.

4. Save 15% of your gross household income in retirement plans. Begin with 401k or 403b. 15% is an easy number for me. That's what the government allows you to put into your 401k pretax. I've read that people making less can have a problem getting 15% into this. I agree, when you make less money the cost of housing and daily expenses can be a larger portion of your income. The problem really is that the housing costs are too high. However, if you are in this lower income and work lets you put pretax money into your 401k, then do it. It saves you taxes now, and reduces your tax footprint. I'm not an expert, but I'm pretty sure that all pretax deductions that you make can help you when it comes to tax time. For those of you that can't get pretax deductions, get as close as you can to the %15, after all, the reason for doing this in the first place is to help you save for retirement.

5. Now and only now is it time to start saving for college funds. Dave suggests using an Education Saving Account or a 529 plan. He does not agree with prepaying tuition, because you are letting the government take your money and make money with it, instead of making that money yourself. I'm up in the air on that one. If I had the cash to prepay for tuition I would support that, but I don't agree with taking out a loan now to prepay tuition, when saving cash and using compound interest to your advantage could make college easier if you just put money into savings.

6. Pay your house off early. Personally, I'm a bit stumped. 5 and 6 could be happening at the same time. Otherwise, I don't understand when 5 stops and 6 begins. I'm not going to pay my house off early after saving for 3 full college funds. I'm going to set aside some money monthly to go towards college savings, and other money to pay the house off early. If I can time having the house paid off with the kids getting to college, then I will have an extra house payment a month available to help with things at that point in time. This is another long term plan. With a 30 year mortgage for 100% of my house, I will probably be paying for another 18 years.

7. Build wealth. This is where you finally start investing into mutual funds or real-estate, or whatever else is right for you. Dave's only real advice in this area is not to invest in something you don't understand.

Overall the steps are great, and he states over and over again, even if one of the people in household is the numbers nerd, all decisions should be made together. I've read complaints that "I'll never have anything nice again" because the idea seems to be live as cheaply as you can and save the rest to invest. I don't think that's true. Large purchases can be for really nice things, but don't buy on a whim. If you want that really nice new refrigerator, price it out, look for sales, wait, ask the store for the floor model at a discount. It's still the same nice refrigerator. And sell the one you have now. Use that as part of the money to offset the cost of the new one. But don't finance it. Don't buy it just because you want it, make sure you can afford it and discuss it with your spouse. All major decisions should be made together.

You may have noticed that I said several times that each step takes a while. Dave never promises to get rich quick, he only promises to help you realize what it takes. My favorite phrase from the book is "The best way to get rich quick is to not get rich quick". Slow and steady wins the race and this book will help you analyze your situation and lay out a plan for getting out of it.

I just noticed that Get Rich Slowly posted a review about Dave Ramsey today as well. His review is for "The Total Money Makeover", but the steps appear to be the same.