Tuesday, April 14, 2009

FREEDOM and Financial Peace Testamonial Part 5: How it Works

Part 5: How it Works

Let's get into the nuts and bolts of how Financial Peace works as I experienced it. Dave Ramsey told us that the best credit score is 0 and that having credit is a myth. If you want to have things now and pay for them 4 times over across the next 30 years, then be a typical American. He explained the concept of a plastectomy, the surgical removal of credit cards from your life. For my wife and me, it began with the $1000 emergency fund. This doesn’t sound like a lot, but during the 2 years and 1 month it took for us to get out of debt, we never needed anything more. Whenever anything came up, we dipped into the fund, and then replaced it. It was such a wonderful peace of mind knowing it was there. As life’s bumps came up, we just dropped cash and never had to give it any more thought.
The next step involved budgeting. Budgeting goes beyond listing bills and allocating money for each, it is about plotting the course of your financial life until your next pay check, which was every 2 weeks for us. The key to budgeting as I explained earlier is that it must be done as a mutual endeavor between husband and wife.
Remember that I previously said that my wife and I scored a ZERO in compatibility when it came to finances. Because we argued and were never on the same page, we racked up thousands of dollars in debt. I could put our money into a spreadsheet all I want, but if we both didn’t do it, we wandered listlessly. Once we had the budget template and mutual purpose (getting out of debt), all of the sudden the financial disagreements melted away. Think about it, we argue very, very little when it comes to money and our arguments are usually about where and when to allocate money, while we both maintained the goal. I didn’t realize going into this that the FPU would transform our marriage. If for no other reason, I suggest FPU for marital reasons alone.
The next concept, one that gets worked into the budget, is that of the debt snowball. The debt snowball means that you take all money not needed to survive and apply it toward debt. You take all of your debt and list it from smallest to largest, regardless of the interest rates. It is all about the psychology of debt. You pay only the minimum payments on all debts but the smallest. For the smallest, you apply all the money you can. Once that small debt is taken care of, you then apply everything that you applied towards the smallest debt and apply it to the next smallest debt. You keep doing that until the final debt is paid.
What you accomplish by paying the smallest debt is two-fold. First, you eliminate a debtor, meaning one less bill. Second, you feel the sense of accomplishment. If you pay the largest debt first, it might be months before you feel any accomplishment. During that time, it is easy to become discouraged and give up. If you tear down the wall brick by brick, you at least know that the wall is coming down.
Budgeting provides the framework, debt snowball provides the goal, and an emergency fund is the safety net, but FPU doesn’t stop there. In practical terms, Dave Ramsey knows that if you set aside a sum in a budget, you won’t stick to it unless you stick to cash. For us, what we do is we put the money from my paycheck in each category on the budget, from groceries to mortgage to spending money, all money after this is designated for debt. Every penny from my paycheck must be put into a category. This is called zero based budgeting. For all expenses that are not paid online or with check, we withdraw cash and put it into an envelope. This makes it impossible to over spend. If you set aside $50 for clothing, but need more for groceries, you take from the clothing envelope and not from the credit card. It is simple and it works.
My wife and I have held true to these principles since January 2007. One by one, we have watched credit card debt fall away. This comes at a sacrifice. We have had to say no to spending on money things. We buy our clothes at thrift stores, or they come to us as hand-me downs from friends, or gifts, with the occasional new purchase. Our vehicles were in horrible condition, but they ran. We have never been on a vacation, we spend very little on gifts. All of our furniture is second hand. My wife has turned grocery shopping into a science. Over the years, she has kept track of the prices of all the things she buys. If the Price is Right pitched non name brand items, she would clean up. She creates a list in Excel with all the items she needs. Since she has the prices, she is able to correctly estimate the total grocery bill. First she shops at a discount warehouse. If she finds things on her list, since they don’t have a regular inventory, she can buy them there meaning more money for the rest of the trip. She then splits the remaining portion of the grocery trip between Aldi and Wal-Mart. I’m so proud of what she has accomplished here, saving us so much money. She was on the front lines everyday when it comes to spending and she earned a Medal of Honor.

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