To understand why you have money problems—why you’re heavily in debt and can never seem to make ends meet or handle emergencies—look in the mirror. Your financial situation is the result of your behavior, according to radio talk show host and author Dave Ramsey.
In the Total Money Makeover, Ramsey lays out a program for freeing yourself from debt and money worries by changing your behavior: following a monthly budget, buying only what you can afford, eliminating debt, saving for emergencies, and investing. The program is intended for everyone—from high earners to people thousands of dollars in debt.
The Total Money Makeover motto is: live differently from everyone else in the present so you can live differently from everyone else in the future. This means that to live a better life than most people, you need to do what most people won’t do—make sacrifices now in return for the payoff of financial security later.
The fix for your financial situation isn’t a bigger salary, a windfall, or a better job, but acknowledging that your poor financial decisions are your fault and changing your behavior. This book lays out what you need to do, but only you can do it.
People who get into financial trouble do so in part because they believe a host of societal myths about debt and money that encourage taking on debt and spending foolishly in order to buy things they can’t afford.
One of the biggest myths is that debt is normal. Debt has become so ingrained in our culture that most people can’t imagine living without it. We don’t know how to get a car, buy a home, or go to college without debt, and most people can’t imagine living without a credit card. Further, financial institutions, stores, and other lenders aggressively push you to borrow because they benefit when you owe them money.
You must reject the view that debt is normal before you can get control of your finances. The central tenet of the Total Money Makeover program is living debt-free and buying only what you can afford (what you can pay for immediately).
The belief that debt is normal and a way to improve your life promotes these myths:
Your Total Money Makeover requires first changing your view of debt, and then getting and staying out of debt.
The Total Money Makeover process comprises seven simple steps, referred to in the book as baby steps. No matter how big your financial challenges, you can overcome them by taking each step, one at a time.
It’s important to follow the steps in the prescribed order, because they build on each other, like prerequisites for taking college courses. If you jump ahead to later steps, you’ll fail at them because you haven’t laid the foundation. Just concentrate on one step at a time in sequence. But before you start the sequence, there are two preparatory steps.
Create a written budget each month determining where your money will go; if you don’t, it will just disappear without your thinking about it.
Here are the basic steps for creating a budget:
Besides creating a monthly budget, get current on all loan and credit card payments. If you’re behind on any payment, you need to catch up. If you’re really behind, pay for your necessities first—food, shelter, and transportation—then catch up on monthly loan payments. You can’t start a Total Money Makeover, which hinges on eliminating debt, until you’re keeping up with your payments.
Now you’re ready to begin the process of putting your financial problems behind you by following these steps in sequence:
Everyone needs a rainy day fund because it’s guaranteed to rain—there’s always a financial emergency at some point.
Saving $1,000—fast—is the first step in the Total Money Makeover because, without a financial cushion for emergencies, an unexpected expense will prompt you to dig yourself deeper into debt by borrowing more. Granted, $1,000 won’t get you through a life-altering crisis, but it’s enough to keep smaller crises from triggering debt. You’ll build on this amount in step #3 when your finances are in better shape.
Do whatever you can to round up $1,000: cut your spending, work extra hours, or sell something (by having a yard sale, for example). Most people can find the money in less than a month, but if you can’t, sell more or take on an extra job.
When you get $1,000, stash it where it’s accessible in an emergency but not so easy to grab that you’ll be tempted to spend it for non-emergencies (for instance, by keeping it in your sock drawer).
You need to get rid of debt to get control of your income and put it to work for you. The debt snowball method is the way to pay off debt. There are two steps:
1) List your debts in order, from the one with the smallest balance to largest. Exclude only your mortgage, which will be addressed in another step.
2) Each month, apply every extra dollar you have after basic expenses toward paying the smallest debt until it’s paid off. Make the minimum payments to stay current on the other debts on the list.
After the smallest debt is paid, apply the payment you had been making on it, plus any additional money you have, toward paying off the next smallest debt. When the second debt is paid off, apply the payment amounts from the first two debts, plus any other money you can find, to the third debt on your list, and so on.
Each time you pay off a debt, you increase the amount you can pay on the next one—your payments continue to snowball until your debts are paid off.
The next step is boosting your emergency fund to give yourself a cushion against life-disrupting problems like a job loss or medical bills.
You need an emergency fund large enough to cover three to six months of expenses, enabling you to manage for up to half a year without an income. In one survey, 49% said they couldn’t cover even a month’s expenses if they lost their income. To make sure you’re not in this situation, the amount in your emergency fund should be between $5,000 and $25,000.
As noted in step #1 (create a $1,000 emergency fund), your emergency fund must be in the form of cash and easily accessible. A great option is a money market account with no penalties, and on which you can write checks.
The next step is building your wealth by investing for retirement—it’s the key to being financially fit for life.
Invest 15% of your gross annual income for retirement, and make compounding interest work for you. When calculating your 15%, base it on your gross annual income before taxes. Exclude any company 401(k) match, as well as potential Social Security benefits. You can’t count on the government coming to your aid in future years—it’s your job to provide now for your future needs.
The best way to build your wealth over time is to invest in growth-stock mutual funds. Mutual funds go up and down in value in the short term, but over the long term (more than five years), they provide an average 12% annual return on investment.
Choose mutual funds with a record of growth for more than five years, preferably 10. Spread your investment dollars over four types of funds:
When deciding where to invest first:
While most people think college is important, most don’t save for their children’s college education, and they end up taking out huge loans (which people think is “normal”).
Save for college and pay cash. The most effective vehicles for saving for college are an ESA (Educational Savings Account), which is like an IRA for education, and a state 529 plan.
College tuition increases faster than inflation, at about 8% versus 4%, so when you save for college, you need to factor in tuition inflation. There are tuition prepayment plans, but they just break even with inflation.
You can do much better with an ESA funded in a growth-stock mutual fund—like an IRA, it will grow tax-free. Here’s how it compares to a prepaid tuition plan:
If you need more, also consider a state 529 plan, which similarly allows you to invest money tax-free for your child’s education. There are several types of 529 plans—stay away from the “life phase” (poor returns) and the “fixed portfolio” plans (too restrictive). The best option is a “flexible” plan that allows you to move your investment within a family of funds to get better performance.
At this point in your Total Money Makeover, you’re nearly debt-free, you have an emergency fund covering three to six months of expenses, you’re investing 15% of your income, and you’re saving for your kids’ college education. Your next step is to pay off your mortgage and become 100% debt-free.
Most people believe that paying off a mortgage, especially early, is next to impossible. But numerous Total Money Makeover adherents do it. For three to five years, they live differently from everyone else—sacrificing by spending less and working extra hours to pay off their mortgage. Then they continue to live differently from everyone else by being debt-free.
The biggest myth about home-buying is that you need a mortgage in the first place—that it’s the only way to pay for a home. There’s another way: paying 100% down. Paying cash for a home is possible if you save enough, long enough.
That said, if you choose to take out a mortgage, follow these two rules:
This is the only kind of debt acceptable in the Total Money Makeover, but you should pay it off early at this point in the program.
Completing six Total Money Makeover steps puts you in rare company—among the 2% of Americans who are debt-free. Because you’re debt-free, live on a budget, and have money for emergencies, you’re in control of your income and are building wealth. The only remaining question is what to do with your discretionary income.
There are three purposes for money:
You should do all three of these things. Achieving financial fitness is like achieving physical fitness. You didn’t put in the work just to look good. Now you get to use your financial muscle:
By now you can see that the Total Money Makeover is about more than money—it makes you face up to who you are in the mirror. Because personal finance is 80% behavior and 20% knowledge, you’ll either have the courage and determination to remake your life—or continue to be miserable.
Based on the experience of countless people who followed the steps in this book, you should have hope that you can overcome money problems, live free of debt, and build wealth. It starts with applying common-sense principles. Anyone can do it, however financially dire their circumstances—even you.
To understand why you have money problems—why you’re heavily in debt and can never seem to make ends meet or handle emergencies—look in the mirror. Your financial situation is a result of your behavior, according to radio talk show host and author Dave Ramsey.
In the Total Money Makeover, Ramsey lays out a program for freeing yourself from debt and money worries by changing your behavior: paying with cash only, eliminating debt, saving for emergencies, and investing. The program is intended for everyone—from high earners to people thousands of dollars in debt.
Rather than offering investment advice, original insights, or the “secret” to becoming rich, Ramsey presents common-sense principles assembled in a step-by-step sequence that can change your financial situation and your life.
As a storm reveals weaknesses in the structure of a house, a personal or national economic crisis reveals the weaknesses in your financial foundations.
The 2008 financial crisis illustrated that people and companies can be lulled into doing foolish things in good times that sink them when things go south.
The recession was triggered by financial institutions, companies, and individuals taking on too much risk and debt for the sake of greed. This had ripple effects, destabilizing not only foolish companies, but also many businesses and people who had been relatively well off but who lacked a financial cushion.
The key lesson: what works, or seems to work, in good times won’t enable you to survive in bad times unless it’s based on sound financial principles.
In How the Mighty Fall, Jim Collins writes that the first stage of business failure is a feeling of invincibility that leads to taking risks. For an individual, the risks could be buying on credit and not saving because you’re confident your job is secure or because others are doing it. But overspending, whether it feels “safe” or not, is still foolish. As Ramsey puts it, a turkey may fly in a tornado (people may succeed at doing foolish things in special situations), but that doesn’t mean turkeys can really fly.
Your financial principles will determine whether you succeed in life. If you build a house based on unsound principles, it eventually will fail. The Total Money Makeover principles are sound and, therefore, work in both good and bad times.
Succeeding with the Total Money Makeover requires first taking responsibility for the financial situation you’re in. You caused it and you can get out of it, if you’re willing to pay the price of work and sacrifice.
Ramsey’s story is an example. He got into a financial hole while in his late twenties by overspending and borrowing, while saving too little. He had borrowed and invested in real estate, even becoming a millionaire. But within three years, he and his family (his wife and two small children) were bankrupt. Feeling overwhelmed and hopeless, he began reading about finance and about how millionaires managed their money, and he realized that his behavior was the real problem. When he took responsibility for his finances, things began turning around.
Your money makeover begins with the same challenge: changing yourself.
If financial success were easy, everyone would be successful. What to do isn’t a mystery: most people know what to do—they just don’t do it due to the challenge of changing their behavior. Managing your money successfully is 80% behavior and 20% knowledge. This book gives you the knowledge, but you have to take the steps to change.
The Total Money Makeover has worked for thousands of people. But as with any situation, winning requires paying a price of short-term sacrifices.
The program’s motto is: live differently from everyone else in the present so you can live differently from everyone else in the future. This means that to live a better life than most people, you need to do what most people won’t do—make sacrifices now in return for the payoff of financial security later.
For example, it means not buying a new car or a bigger house or putting a large-screen TV on credit. It may mean working longer hours to pay down debt. As you work harder and forego buying things others are buying, the motto reminds you that the payoff will be worth it.
Two Money Makeover converts, Mark and Kari, struggled with student loans, a car lease, credit card debt, and a big mortgage, but undertook this book’s challenge and, in a six-month period, paid off $57,000 and donated $7,000 to their church. The key was transitioning from credit to cash, then realistically assessing their income and choosing to start living below their means. The payoff was peace of mind and the control they gained from being debt-free.
Stories like these appear throughout the book as encouragement and evidence that the program works. However, remember that the Total Money Makeover works only to the extent that you apply it.
The fix for your financial situation isn’t a bigger salary, a windfall, or a better job, but acknowledging your bad decisions are your own fault and changing your behavior. This book lays out what you need to do, but only you can do it.
Total Money Makeover success first requires understanding the five obstacles that could hinder you: denial, debt myths, money myths, lack of financial knowledge, and desire for approval. These hurdles stem in large part from what you’ve been taught by society about money. The next few chapters examine each of these obstacles.
The first obstacle is denial. Achieving financial fitness is somewhat like trying to lose weight and improve physical fitness. While this requires intense focus on your goal of resetting your eating or spending habits, you’ll have a tendency initially to downplay just how out of shape you are.
Most people are in denial about the state of their finances. You might tell yourself that maybe things aren’t so bad—maybe you’re no worse off than the average person. The unfortunate truth is that most people have financial problems—that counts as average in today’s society, the way being overweight has become average.
You get a lot of social reinforcement for bad financial practices. Financial institutions and retail stores want to give you credit cards or increase your credit limit, so you take it as a sign you’re doing all right financially. Banks are willing to loan you money for the bigger house or new car you want. If you can afford the payments on something, you feel you can afford to buy it.
But this thinking keeps you in average financial shape (moderately in debt) at best. The Total Money Makeover program is about being better than average: it’s about becoming debt-free.
There are two ways to break out of denial: you can wait for a crisis or you can proactively choose change.
1) Wait for a crisis: While you can’t argue with the scale when you’re trying to lose weight, you can fake financial health for a while (others will tell you you look great), but eventually your habits catch up with you. A wake-up call can be losing your job or business or suffering a major unexpected expense or health problem. Or, problems or debts may accumulate gradually until they reach a critical mass. Suddenly you can’t pay your debts or meet living expenses, and you can no longer deny that you’ve been skating on thin ice.
Sara and John got such a wake-up call. They felt financially secure with two incomes totaling $75,000 and “typical” debts of student loans, a car loan, and $5,000 owed on credit cards. So they built a new home, but shortly after they moved in, Sara was laid off. Upon losing half their income, they couldn’t deny their financial state and were forced to change their spending habits.
2) Choose to change: The alternative to waiting for a crisis is to look in the mirror, acknowledge your reality, and choose to change. Hopefully, this book will motivate you to want better-than-average financial health and to meet the makeover challenge.
The second obstacle to gaining control of your finances is the widespread belief that debt is useful and normal—that everyone has it. In addition to this belief, there are a variety of related myths that encourage different types of borrowing.
You must reject these views of debt before you can get control of your finances. Society encourages us to take on debt starting as young adults and to carry debts throughout our lives. There are several reasons:
So debt is widely viewed as the way to do things. We’ve bought into it to such an extent that we get defensive if we hear anything negative about debt. But the borrower is the slave to the lender. Your income is your primary means of building wealth, and when it’s tied up in debt payments, banks gain and you lose. If you invested your income, you could build wealth and security. How much discretionary money would you have each month without debt payments?
Here are some of the biggest myths about debt that you must give up:
The biggest myth about debt is that it’s a tool or leverage you can use to build wealth—for instance, to get a car, home, or start a business that will be a foundation for building your wealth, that is, an investment in your future. It’s smart to use other people’s money, we’re told.
However, debt doesn’t usually make you more prosperous. It creates risk that, over time, builds and erases any initial advantage.
If you want to be wealthy, you should do what wealthy people do instead of believing myths pushed by lenders. Three-quarters of the Forbes 400 wealthiest people in America told pollsters that the best way to build wealth is to stay out of debt. Millionaires live below their means and pay cash.
Three of the biggest lenders at the time this book was written—Sears, JCPenney, and Ford—were founded by people who actually opposed debt. For example, Henry Ford thought debt was a lazy way to get things; his view was so strongly held that his company didn’t offer financing until a decade after GM did. Today, credit is one of Ford’s (and any car company’s) biggest profit generators.
Many people think they’re helping friends or relatives by loaning them money. But a loan will be a barrier in your relationship because it creates a power dynamic where the borrower is the slave of the lender.
If you’re the borrower, the loan can create resentment or shame if you can’t pay it back. If you’re the lender, you’ll be judgmental about how the borrower spends her money as long as she owes you (you wonder why she’s going out to dinner or taking a vacation instead of using the money to pay you back). This applies to parents loaning adult children a down payment, or grandparents loaning a grandchild money.
If you value the relationship more than the money, the best recourse is to remove the master/slave dynamic by telling the borrower that you forgive the loan. But if you do this, make two stipulations: that the borrower pay it forward by helping someone else someday, and that she never loan money to friends or relatives.
In the future, give money to friends if you want to, but remember that a loan will bring more harm than help.
Like loaning money, people often have the impulse to help a family member or friend by cosigning a loan. But there are two big problems with this:
1) If you cosign a loan, there's a good chance you’ll have to repay it.
2) You could end up ruining your own credit.
Regarding your risk of having to pay it back, consider these facts:
In other words, the bank doesn’t expect your friend or relative to repay the loan—you’re ignoring the bank’s experience-based assessment, maybe because you feel you know the person better and are convinced he’ll pay. But if he needs a cosigner, he can’t afford the payments.
Parents often cosign loans for their children, thinking that they’re teaching financial responsibility—instead, they’re teaching irresponsibility. The message is that it's OK to buy things you can’t afford.
Besides having to pay back the loan, the cosigner often ends up with ruined credit. For example, when you cosign a car loan, here’s what can happen:
Even if you learn that payments aren’t being made, you can’t force the defaulter to sell the car—it’s not yours, although you have to pay for it.
If you really want to help someone, don’t cosign a loan—it’s too risky. Just give them money.
Payday loans, rent-to-own deals, and “tote the note” car lots are examples of predatory lending schemes intended to exploit low-income people who are looking for a quick fix or instant gratification.
These operations are always located in a poor section of town, because low-income people are the ones most vulnerable to being ripped off this way (wealthy people won’t bite). If you’re poor and you sign on to one of these “deals,” you’ll remain poor. Here’s how the most common scams work:
1) Payday loans: This is legal loan sharking. For example, you write a postdated check for $225 (dated for payday). The lender gives you $200 in cash and keeps a $25 service fee (this fee equates to 650% interest annually).
When people can’t pay back their loan, they borrow money to do it from another lender and soon get snared in a web of loans with lenders threatening to sue them for writing bad checks. The only way out is to stop paying and meet with each lender to develop a payment plan, then figure out how to pay the loans.
2) ‘Tote the Note’ Car Loans: Tote the Note dealers offer their own in-house financing for people with bad credit. They take a downpayment close to the amount they paid for the car, then charge 18% to 38% interest on a loan for the rest. If the payments aren’t made, they’ll repossess the car and sell it again.
3) Rent-to-own: If you succumb to instant gratification by agreeing to rent-to-own something, you’ll pay a high price: average interest rates exceed 1,800%. It works this way: to get something they can’t afford, people rent items at a weekly rate, which seems affordable. Over time, however, they pay far more than the items typically sell for. For instance, they might pay $20 a week for a washer and dryer over 90 weeks, or $1,800, when you could buy new (low-end) appliances for $500 or used ones for even less.
4) Ninety days same as cash: Many people believe that signing a “90 days same as cash” deal, where you don’t pay interest for that period, means you’re using other people’s money for free. These deals are popular for furniture, appliances, and electronics. The problem is that most people (over 80%) don’t pay off the purchase in 90 days (or in 30 or 60, if that’s the deal). When that happens, the deal becomes a loan with interest rates of 24% to 38%. In addition, the interest is charged back to the purchase date. Even if you make the payments as scheduled or pay it off early, you may still be charged interest if fraudulent fees were added.
Many people believe car payments are simply part of life, that you’ll always be paying on a car. But this is a myth—car payments are both foolish and avoidable.
Purchasing a new car with loan payments eliminates your ability to build wealth. Car payments are most people's biggest monthly outlay except for a mortgage, so they diminish or steal more from your income than any other expense.
Over a lifetime of car payments, you’ll literally spend a fortune. Most people start paying on a car, then continue car payments on successive cars throughout their lives.
Car payments are worse than a rent-to-own deal. Consider an average monthly payment of $495 over 64 months:
You’re far better off driving older cars and saving your money than making payments forever on new cars. Contrary to what most people think, millionaires typically buy two- or three-year-old vehicles.
Some people think leasing a car is a good idea because you can lease things that depreciate and take the tax advantage. However, spending unnecessarily to get a tax write-off makes little sense.
Leases seem appealing because you make a smaller down payment and pay less per month. However, leasing—in effect, renting-to-own—is the most costly way to get a car. Here’s how car leases work:
A zero-interest loan on a new car seems like a good deal, but it’s undercut by the fact that a new car loses 60% of its value in four years. You’re losing so much in value, especially compared to buying a used car, that you’re still being ripped off.
For example, a new $28,000 car will lose nearly $100 a week or $17,000 in value in four years—think of it as throwing a hundred-dollar bill out the window each week while driving. Instead, you can get a reliable, late model car that’s already done most of its depreciating.
A Smart Money magazine article explained why car dealers push these kinds of deals:
Dealers make their money financing and repairing vehicles, not selling them.
People are often advised, particularly when they’re young, to get a credit card to build their credit. That’s equivalent to saying you need to start incurring debt so you can make it a way of life.
Banks, mortgage lenders, retail stores, and car dealers push this myth because it benefits them.
But you only need to build credit by borrowing and making loan payments if you want to spend your life making loan payments.
Many people are proud of having a high FICO or credit score, which reflects how you’ve handled debt, including your debt payment history, debt amounts, length, and so on. However, another way of looking at a FICO score is as an indication of how much you love debt.
In a Total Money Makeover, you won’t use credit, except possibly to pay a mortgage.
Many mortgage lenders do rely exclusively on your FICO score out of laziness. But as of this writing, you could get a mortgage without a FICO score (no credit history), based on other measures, if you looked hard enough.
For a 15-year fixed-rate mortgage, instead of a FICO score, you need:
Another credit card myth is that you need a credit card to rent a car, make a hotel reservation, or shop online. But you can almost always do these things with a debit card associated with your checking account. Check with car rental companies in advance—most take debit cards, but a few don’t.
Of course, before you can buy anything with a debit card, you have to have the money in your account. But buying only what you can afford and not going into debt are central to the Total Money Makeover. A debit card does virtually everything a credit card does—except get you into debt.
Another myth is that a debit card is riskier to use than a credit card—this has almost become an urban legend. However, Visa requires that banks issuing Visa debit cards provide the same protections against theft or fraud as they do for credit cards. To get it, be sure to run the card as a credit transaction (not using your PIN).
Another credit card myth is that paying your bill in full every month gives you free use of other people’s money.
But while they may intend to, 60% of people don’t pay their full credit card bills each month. Thus, if companies can get you to accept and use a card (by giving prizes and points), they stand a good chance of making money on you. And offering rewards doesn’t cost them much because people often don’t claim them—for example, 90% of airline miles go unclaimed, according to MSNBC.com.
People also spend more when using credit cards than when paying with cash—for example, a study found that people spent 47% more at McDonald’s when using credit than with cash.
But credit card use leads to debt and worse. An American Bankruptcy Institute study found that 69% of people who filed for bankruptcy cited credit card debt as the reason.
Millionaires pay cash; less-smart people use credit cards.
Parents often encourage teenagers to get a credit card, supposedly to learn financial responsibility. But getting a credit card teaches teens to buy what they can’t afford and incur debt, which is financially irresponsible and launches a lifetime of debt.
Young people, as potential life-long interest payers, are key targets for credit card companies, which portray getting a credit card as a rite of passage. It’s important for lenders to snag them early in life, because people tend to stick with the first bank that issues them a credit card. The marketing works: a majority of college seniors have credit card debt well before starting a career.
Credit card companies even work to build brand awareness among children by advertising through toys in hopes of influencing their choices later. For example, several Barbie dolls and accessories come with brand name toy credit cards.
Parents who encourage teens to get credit cards are endorsing something harmful. Instead, they should teach teens to say no to compulsive spending and debt.
When people’s debts become overwhelming, they may turn to services that will consolidate their debts.
Debt consolidation is appealing because it can lower interest on some of the debt, and you have a single smaller payment. But there are several problems:
Your Total Money Makeover requires changing your view of debt, and getting and staying out of debt.
A major obstacle to gaining control of your finances is the widespread belief that debt is useful and normal—and it’s a stepping stone to prosperity. But you’ll never build wealth while a significant part of your income is tied up with making loan payments.
Before reading the preceding chapter, what were your beliefs about debt?
How have these beliefs impacted your life and how you handle money?
How much total debt do you have and what are your monthly payments? What else could you be doing with that money?
Like myths about debt, there are myths about getting and handling money. They run counter to the Total Money Makeover principle of effort and sacrifice, of living differently from everyone else now so you can live differently from everyone else in the future. Becoming financially fit has a cost and there aren’t any shortcuts.
Money myths stem from two basic mindsets:
1) Ignoring risks: People who are poor at managing money often ignore the risks of deals that seem attractive on the surface, or they ignore risks of failing to act when they should. There are several reasons:
Regardless of the reason, those who deny a so-called deal’s risks end up disillusioned and worse off financially.
2) Looking for shortcuts: People facing money challenges often look for a shortcut or an easy solution, whether it’s winning the lottery or falling for a TV offer to make quick money or fix debt problems. But shortcuts, like microwave dinners or instant coffee, produce disappointing results.
These two mindsets help fuel the following myths:
Myth #1: Things will work out if you don’t plan for retirement.
No one's going to come to your aid in your old age. You especially shouldn’t expect the government, with its poor record of managing money, to effectively manage Social Security and Medicare. You need to plan and invest in your own future, starting now (a later chapter will explain how).
Myth #2: Gold is a good investment, especially in an economic crisis.
Gold has long been promoted by advertisements and TV advisors as a secure investment that won’t lose value in a bad economy.
But its track record over time is mediocre. Going back to Napoleon’s era, gold has shown average gains of only about 2% a year. In the last 55 years, gains have averaged 4.4%, comparable to inflation and savings accounts. In contrast, you could get a 12% return over time with a growth-stock mutual fund. Gold has done well since 2001 due to predictions of doom about 9/11 and the 2008-09 recession—but that’s been its only spike in history.
As for gold being valuable in an economic crisis, history shows that people turn in such instances to trading useful items and skills, not buying with gold nuggets or coins.
Myth #4: Cash value life insurance or whole life insurance are good ways to save.
Cash value policies (including whole life, universal life, and various combinations) constitute more than two-thirds of the life insurance policies being sold today. This is unfortunate because these policies, which combine insurance with saving and supposedly grow in value, are terrible investments.
They generate extremely low returns; while sellers have charts showing a growth trend, the policies seldom deliver as promised. For the first three years, the bulk of your monthly payment goes to commissions and expenses rather than to savings. After that, typical returns are: whole life—2.6%, universal life—4.2%, and variable life (including mutual funds)—7.4%. As noted before, you can do much better investing in growth-stock mutual funds.
Further, when you die, your family receives just the face value of the policy—not the savings you eventually accumulated.
Myth #5: Prepaying your funeral or your children’s college tuition protects against inflation.
There are better ways to save for both.
While it’s smart to plan your funeral in advance, instead of prepaying the expense it’s better to invest the amount in a mutual fund with a 12% average return. If you invest $3,500 at age 38, it would be worth $368,500 at age 78. Investing in a mutual fund is also a better way to save for college.
Myth #6: Buying a mobile home is better than renting because it’s an investment.
In truth, mobile homes are a poor investment because they quickly lose value. For example, if you buy a mobile home for $25,000, in five years you’ll still owe $22,000 on it, but it will be worth only $8,000. For comparison, if you put $25,000 into a mutual fund and it dropped in value to $8,000 in five years, that would be a terrible investment. The same is true for mobile homes.
No matter how many improvements you make, it will still be worth little, should you decide to sell it—rather than a step toward owning real estate that will increase in value, it’s an impediment. The best way to save for a home is to undergo a Total Money Makeover, while living in a cheap rental unit.
Myth #7: When you’re divorced, you’re not liable for loans your ex agreed in the divorce decree to pay.
Regardless of what the divorce decree says, you’re still liable if your name is on credit cards, car loans, or a mortgage, and your ex doesn’t make the payments. Your credit will be damaged too. You can tell the judge if your ex doesn’t pay, but you’re still liable for payment and can be sued by the lender. Even if your ex is regularly paying on a vehicle or home, you could still have difficulty getting a loan due to having too much debt on your record.
If you divorce, refinance all debts to exclude your name, or sell the items. If you don’t, you’re asking for trouble.
Myth #8: It can’t hurt to play the lottery—you never know, you might get rich.
If the lottery truly helped you build wealth, rich people would stand in line for it—but they aren’t the ones who line up for lottery tickets. The lottery is a government-run scam that taxes the poor—that’s why it’s most popular in the poorest ZIP codes.
Myth #9: Books and DVD sets touted on TV can tell you how to become wealthy by working only a few hours a week.
Anything that promises a huge return on a tiny investment is a scam. No one earns a six-figure income in a few hours a week. Don’t believe get-rich schemes in real estate, work-at-home jobs stuffing envelopes (machines do this much faster), or online medical billing courses.
Books and courses promising big incomes and investment “secrets” are deceptive, although they may sell better than money management books that preach what really works: hard work, living on a budget, and getting out of debt.
Myth #10: No one has time to plan a monthly budget, or make a retirement or estate plan.
Many people fail to plan because it’s human nature to focus on things that are urgent and put off thinking about the rest. You pay the electricity because your service will be cut off if you don’t; however, there’s no immediate result if you don’t draw up a budget or retirement plan.
Successfully managing money includes thinking about how you want to use it from now through the end of your life. Everyone needs to plan a monthly budget and save for retirement.
The only way to control your money is by creating a written plan allocating it. As motivational speaker John Maxwell noted, if you don’t have a budget directing where your money is to go, you’ll later wonder where it went.
Myth #11: Debt management companies advertising on TV can help you pay off your debts.
These companies may get you out of debt, but you’ll end up with ruined credit. Companies like Consumer Credit Services and AmeriDebt (which was forced by the government to shut down) get a single monthly payment from you and allocate it among your creditors after working out lower payments and interest with them. This differs from debt consolidation in that you’re not getting a loan. If you later try to get an FHA or VA loan, you’ll be treated like you filed a Chapter 13 bankruptcy and have ruined credit.
Further, in letting someone else fix your problems, you don’t learn and change your spending habits.
Myth #12: A credit repair service can “clean up” your credit, erasing past problems.
These services, or “kits” they sell, are mostly scams. You can only remove something from your credit record if it’s wrong; this requires writing a letter to the credit bureau requesting the error be removed.
These companies often tell you to contest all bad credit. But if you try to get something removed (by lying) so you can get a loan, you’re committing fraud. Some kits or services also advise you to get a new Social Security number—a second identity—so you can start a fresh credit report, but this is also fraud. Rather than lying to clean up your credit, pay cash instead of credit—and in seven years, bad credit will drop from your record.
Myth #13: It’s easy to file for bankruptcy and start over.
On the contrary, bankruptcy is painful—it’s one of the top five life-changing events, along with divorce, serious illness, disability, and loss of a loved one. It permanently damages your credit.
Chapter 7 bankruptcy remains on your record for 10 years and Chapter 13 for seven years. However, a bankruptcy will continue to follow you for a lifetime. Applications for loans and jobs may ask if you’ve ever filed for bankruptcy and if you lie, no matter how old the bankruptcy, it’s fraud.
Most bankruptcies can be avoided with a Total Money Makeover, which is painful, but less so than a bankruptcy. It’s better to fix your problems than suffer a bankruptcy, lawsuits, and foreclosure.
Myth #14: You can get away with skipping insurance.
Going without certain insurance is a risk no one should take. The types of insurance recommended as part of your Total Money Makeover are:
Myth #15: It’s not important to have a will if you’re young.
Everyone should have a will. If, like 70% of Americans, you die without a will, your state will decide what to do with your assets. Get a will for your family’s sake: a will makes it much easier for your loved ones to manage your estate.
Besides the myths about debt and money and denial that you have a money problem, there are two more obstacles to a Total Money Makeover: lack of financial knowledge (ignorance) and peer pressure (overspending to “keep up with the Joneses”).
Ignorance about money makes some people defensive, but financial knowledge isn’t something you’re born with—it’s a skill you need to learn, like how to drive a car. If you give the car keys to someone who doesn’t know how to drive, they’re going to crash the car. Trying again harder isn’t the answer—it’s getting proper training. The same is true of money management—people make financial mistakes due to lack of training.
We’re educated in how to earn money, but not in what to do with it. Given that the average family in the U.S. makes over $2 million in a lifetime, high schools and colleges should be teaching personal finance. If you haven’t learned financial management, you still can by doing the following:
You’d take similar steps to improve your marriage, by reading and attending a class or retreat. You don’t need to become an expert, but you should spend as much time on your 401(k) options as you do planning your vacation. Remaining ignorant will just keep you poor.
Most people want to fit in and look successful to others, which can mean overspending to live a showy lifestyle.
However, going into debt to impress friends and neighbors who also are in debt isn’t success. If you want to be truly successful, you should learn and emulate the habits of wealthy people, not financial fakes.
Professor Tom Stanley studied the lifestyles of millionaires in the 1990s. He writes in The Millionaire Next Door that, contrary to what most people think, the typical millionaire lives modestly in a middle-class home, drives a used car paid for with cash, and buys clothing from discount stores.
Unlike those who spend to keep up with the Joneses, wealthy people don’t strive for approval, but for financial security, by living below their means so they can grow their wealth. (Shortform note: Read our summary of The Millionaire Next Door here.)
In contrast, because of debt, average people often have a negative net worth. It’s hard to change when you like your nice things and you don’t want to admit to yourself or others that you’re broke.
The Total Money Makeover requires giving up the drive for approval and undergoing a change of heart about how you view spending and debt. For example, it might require that you stand up to your family and reject the tradition of going into debt to buy a Christmas gift for each extended family member.
In addition, you need to recognize your weak spot, where you can’t seem to stop overspending. Everyone has one—for example, excessive clothes shopping, giving money to adult children, or buying expensive vehicles. Until you acknowledge your weakness, you’ll be susceptible to temptation in that area.
Ramsey’s weak spot was cars. He got a Jaguar (with the help of a cosigner) because he thought it would bring him respect and admiration. Even after going broke, he kept the car but couldn’t afford the upkeep or payments. His cosigner finally quit making payments and Ramsey was forced to sell the car a day before it was to be repossessed.
Eventually, he straightened out his financial mess and realized the harm he’d caused for the sake of a status symbol. He renounced status cars and began buying only common used cars with cash.
If you’re doing anything with money in order to win respect, you still need to change at heart before you’ll succeed in a Total Money Makeover.
Myths about debt and money, denial that you have a money problem, a lack of financial knowledge (ignorance), and peer pressure (overspending to “keep up with the Joneses”) are obstacles that can keep you from achieving financial fitness.
What are your main obstacles to financial fitness?
How have these obstacles affected your life?
What can you do to get rid of them?
Now that you’ve dispensed with the common debt and money myths, you’re almost ready to begin the Total Money Makeover process, which consists of a series of seven simple steps, referred to in the book as baby steps. No matter how big your financial challenges, you can overcome them by taking one small step at a time.
However, it’s important to follow each Total Money Makeover step in the prescribed order, because the steps build on each other. If you jump ahead to later steps, you’ll fail at them because you haven’t laid the foundation. Just concentrate on one step at a time in sequence.
Before starting, however, there are two preliminary steps:
Create a written budget each month determining where your money will go; if you don’t, it will just disappear without your thinking about it.
Successful people have written goals; simply put, a monthly budget is your money goal. It wouldn’t make sense to build a house without blueprints, nor does it make sense to spend your life’s earnings of $2 million without a plan.
Motivational speaker and author Brian Tracy notes that having written goals is a more important contributor to extraordinary success than education, connections, talent, or inherited wealth. He quotes a study of Harvard graduates, which found that two years after graduating, the 3% with written goals had greater financial success than all others combined.
(Shortform note: read our summary of Brian Tracy’s book, Eat That Frog, here.)
Ramsey’s monthly budget forms can be downloaded here.
Here are the basic steps to get started:
Besides creating a monthly budget, the next thing you must do before taking your first Total Money Makeover step is to get current on all loan and credit card payments.
If you’re behind on any payment, you need to catch up. If you’re really behind, pay for your necessities first—food, shelter, and transportation—then catch up on debt payments. You can’t start a Total Money Makeover, which hinges on eliminating debt, until you’re keeping up with your payments.
Now, get fired up about putting your financial problems behind you and focus intensely on the steps that follow.
Everyone needs a rainy day fund because it’s guaranteed to rain—there’s always a financial emergency—at some point.
In a typical 10-year period, according to Money magazine, 78% of people will have a major financial challenge, such as a layoff or firing, an unexpected pregnancy, or illness. Things happen and you need to be ready with an emergency fund.
Saving $1,000—fast—is the first step in the Total Money Makeover because, without a financial cushion for emergencies, an unexpected expense is likely to derail the program. If you respond to a financial emergency by turning to debt after starting a money makeover, it will be like breaking a diet and you’ll feel like a failure.
Besides keeping your reform efforts on track, having an emergency fund is a hedge against Murphy’s law—trouble seems to dog anyone without a safety net. Granted, $1,000 won’t get you through a life-altering crisis, but it’s enough to keep smaller crises from triggering debt. You’ll build on this amount in step #3, when your finances are in better shape.
Many people think you should have a credit card for emergencies, but it’s better to plan and save for emergencies than to borrow when they happen, which puts you at even greater risk. The Total Money Makeover is about breaking the cycle of dependence and eliminating credit.
An emergency fund is for emergencies only—for instance, a medical problem or an expensive repair for a car that you need for work. It’s not for things you suddenly want, like a couch on sale or a weekend trip.
Christmas isn’t a financial emergency, although many people treat it that way. It’s a yearly event that you can save and budget for it. The same is true of your kids outgrowing their clothes—it’s expected and you need to plan for it. These kinds of things feel like emergencies only when you haven’t planned for them.
Do whatever you can to round up $1,000: cut your spending, work extra hours, or sell something (have a yard sale, for instance). Most people can find the money in less than a month, but if you can’t, sell more stuff or take on an extra job.
When you get $1,000, stash it where it’s accessible in an emergency but not so easy to grab that you’ll be tempted to spend it for non-emergencies. If you put it in a savings account, don’t attach that account to your checking account as overdraft protection—or you’ll spend it on impulse buys. (One woman framed 10 hundred-dollar bills and hung the “picture” out of sight in a coat closet.)
On the other hand, don’t put it where you’ll be reluctant to tap into it during an emergency, for instance in a CD with a penalty for early withdrawal. This might tempt you to borrow for the emergency instead. When your emergency fund is fully funded (baby step #3), a money market fund is the best place for it—Chapter 8 explains this in more detail.
If you need to use your emergency fund during the Total Money Makeover, pause the program, regardless of the step you’re on, go back to step 1, and replenish the emergency fund.
Along with monthly budgeting, creating an emergency fund may be your first experience of taking control of your money. Having a hedge against disaster for possibly the first time should empower you and give you a sense of hope.
Everyone needs a rainy day fund because financial emergencies will come up, and if you borrow to cover them, you’ll only create worse problems for yourself. You should immediately create a $1,000 emergency fund.
What can you do to save $1,000 (for example, hold a yard sale, stop eating out, carpool to save gas money, work extra hours)?
Where will you put the money so it’s accessible when you need it, but not so accessible that you’ll spend it in a non-emergency?
What will be the biggest temptation to spend it for non-emergency purchases? How will you resist this?
The big problem with debt is that it ties up your income with making payments, which keeps you from building wealth. You need to get rid of debt so you have control of your income and can put it to work for you.
It’s fairly easy to accumulate wealth when you don’t have car payments, a mortgage, and credit card or medical debt. To see how this works, consider the average person with a $50,000 annual income and the following payments:
Total: $1,995
But if you invested $1,995 a month in a growth-stock mutual fund, you’d be a millionaire in 15 years; it would grow to $2 million in five more years, to $3 million in three more years, $4 million in two and a half more, and to $5.5 million in two more years—a total of 28 years.
The key is to get out of debt so you can start investing. This is probably the toughest of the money makeover steps—it requires the most effort and sacrifice, plus your relentless, single-minded focus.
The debt snowball method is the way to pay off debt. It’s easy to understand, but it takes effort and commitment to pull it off. Tens of thousands of Total Money Makeover converts have proven it works. There are two steps:
1) Make a list of your debts, in order from the one with the smallest balance to largest. Exclude only your mortgage, which will be addressed in another step, described in Chapter 11. A form is available for downloading here.
2) Each month, apply every extra dollar you have to the smallest debt until it’s paid off. Make the minimum payment to stay current on all other debts.
After the smallest debt is paid, apply the payment you had been making on it, plus any additional money you have, toward paying off the next smallest debt. When the second debt is paid off, apply the payment amounts from the first two debts, plus any other money you can find, to the third debt on your list, and so on.
Each time you pay off a debt, you increase the amount you can pay on the next one—your payments continue to snowball until your debts are paid off.
Starting with the smallest debts gives you some quick wins to motivate you, and by the time you get to the largest payments, such as car payments and student loans, you’re in a position to pay over $1,000 a month. You’ll soon be debt-free except for your mortgage.
Eliminating debt totaling tens of thousands of dollars is daunting, but with concerted effort, it can be done. Here are a few examples from people who applied the Total Money Makeover process:
In summary, to make a debt snowball work, you need to create a monthly budget, be current on your loan payments before starting the process, and list your debts from smallest to largest. You need to make two mindset adjustments as well:
1) Focus intensely on becoming debt-free: If you’re half-hearted, the debt snowball won’t work. Tell yourself, “I’m getting out of debt, no matter what.” Fully focusing your mind on a goal is as powerful as focusing the sun’s rays with a magnifying glass and setting a piece of paper on fire.
Develop gazelle-like intensity: a gazelle keeps an intense eye on its surroundings to avoid being taken down by a cheetah. Similarly, your focused attention (or gazelle intensity) on your finances will save you from debt.
2) Stop using credit: While you're working through your debt list, remember that your goal is to eliminate all debt—don’t replace any paid off debts with new debt. Make a pledge that you’ll never borrow money again. Before long, you’ll face a test of your gazelle intensity level—you’ll need a major car repair or get the urge to make a big purchase using credit. To eliminate temptation, cut up your credit cards. You can’t get out of your debt hole by digging it deeper.
1) What if you’re in such dire financial straits that you can’t come up with any extra money to apply to your smallest debt and start the debt snowball rolling?
You’ll need to take drastic action. Sell whatever possessions you can get money for: a motorcycle, antiques, collections, baseball cards, or an extra car not used for daily work. If you’re selling a car, choose the one with the most debt. If you have more than a year and a half to pay on a car, sell it. After your Total Money Makeover, you’ll be able to pay cash for the car you want.
Remember your goal is to sacrifice—live differently from everyone else—now, so you can live the way you want to later.
There’s one other way to get a debt snowball rolling: increase your income by working extra hours at your job or taking on an additional job temporarily.
2) While working on a debt snowball, should you stop contributing to a 401(k), even if you get a company match?
Continuing your contributions, especially to get the company match, might seem like a good idea, but focused intensity on eliminating your debts is more important at the moment. If you are radically focused, you’ll become debt-free and can resume your contributions in a few months. In addition, without your debt payments, you can contribute more to your 401(k).
Keep making your contributions only if you’re in an extremely deep hole that will take you longer than 18 months to get out of.
3) If you need to draw on your emergency fund, should you stop your debt snowball to rebuild your fund?
Yes, you should go back to making minimum payments to stay current on all your debts, and focus on rebuilding your emergency fund to $1,000. If you don’t, you won’t be ready for the next emergency and will be tempted to use credit. When you’re finished rebuilding the fund, you can start your debt snowball again.
4) Should you include a home equity loan in a debt snowball?
If your home equity loan exceeds half your annual income, don’t include it in a debt snowball.
For example, if you make $40,000 a year and have a $15,000 home equity loan, include it in your debt snowball and pay it off. But if your second mortgage is $35,000 compared to a $40,000 income, you’ll need to handle this in another money makeover step.
If you have small-business debt, it’s probably personally guaranteed, meaning it’s personal debt, whether it's a small-business loan or credit card debt incurred for the business. Include it in your debt snowball.
If you have loans on rental property, exclude them from your debt snowball, but stop buying property. After you pay your home mortgage in step 6, use the debt snowball process to pay off your rental mortgages from smallest to largest; also consider selling some to pay off other debt.
The debt snowball may be the most important step in your Total Money Makeover because:
At this point, you’ve eliminated debt other than your mortgage and have $1,000 cash for emergencies. You’re now in control of your income and have momentum. The next step is boosting your emergency fund to give you a cushion against big, life-disrupting problems like a job loss or medical bills.
Remember, major financial emergencies are inevitable in life, and if you use debt to cover them, you’ll be back to square one. Everyone needs an emergency fund large enough to cover three to six months of expenses, enabling you to manage for up to half a year without an income. In one survey, 49% said they couldn’t cover even a month’s expenses if they lost their income.
The amount in your emergency fund should be between $5,000 and $25,000.
For example, a frugal family with expenses of $3,000 a month might keep a minimum of $10,000 in an emergency fund. While $3,000 a month may not seem realistic, keep in mind that when you’ve eliminated debt and have adequate insurance coverage, it’s possible to live on much less than your income.
The exact amount you should save for emergencies depends on your situation. If your situation is unstable—for instance, if your job could be at risk—you need a larger emergency fund. Here are some rules of thumb:
When faced with an emergency, pause and take a deep breath before drawing on your emergency fund. Don’t do anything until you and your spouse talk about it and agree on the solution. Then go one step further and sleep on it to be sure you haven’t overlooked anything.
As noted in step #1 (create a $1,000 emergency fund), your emergency fund must be in the form of cash and easily accessible without any penalties.
The point isn’t investing the money to earn interest, it’s keeping it available and safe—so don’t put it someplace hard to tap into, like a mutual fund. A great option is a money market account with no penalties, and on which you can write checks. Your money will earn a little interest there but again, that’s not the objective.
As you change the way you handle money through the Total Money Makeover process, you’ll find yourself using your emergency fund less, for two reasons:
Aside: Don’t buy a home until you’ve completed this step of the money makeover; too many people buy a home before they’re ready financially (with no other debt and a full emergency fund). Further, you should save first (maybe years) for a substantial down payment or a cash purchase. More on this follows in Chapter 10.
Reaching the end of step #3 takes about two and a half years.
You should have an emergency fund large enough to cover three to six months of expenses, enabling you to manage for up to half a year without an income. Depending on your circumstances, your emergency fund should be between $5,000 and $25,000.
Based on your personal circumstances, how much do you need to save for an emergency fund? (Consider factors such as your income, whether or not your income is stable, and whether or not your job is at risk.)
Where will you keep your emergency fund (it should be readily accessible)?
What is your biggest obstacle to saving this amount of money? How can you overcome it?
The next step is building your wealth by investing for retirement—it’s the key to being financially fit for life. It requires gazelle intensity to get started, but once your nest egg is established, you can maintain your financial fitness with less effort, like a marathon runner who’s built up her strength through long practice and can run with less effort.
Many people invest in retirement so they can eventually escape a job they hate. But investing for the future in the Total Money Makeover program is more positive; the goal isn’t escape, but achieving financial security so you have choices: to work, write a book, travel, create art, and so on. If you invest wisely earlier in your life, you’ll reach a point where your money starts working more and you can work less, if at all.
Many people are likely to find themselves in a less enviable position. Various surveys on retirement saving have found:
Yet many people over age 65 are in dire financial straits. USA Today reported that out of 100 65-year-olds, 97 can’t write a $600 check, 54 are working, and only three are financially secure. Among people 65 and older, bankruptcies jumped 244% in a recent 10-year period.
This step is about acting now so you can be financially secure in your older years.
Invest 15% of your gross annual income for retirement and compounding interest will work for you.
At this point in the Total Money Makeover, don’t be tempted to save more than 15%, because you still need to save for your kids’ college education and pay off your home mortgage early. Also, don’t opt to save less and prioritize the kids’ college education or paying off the house—your children’s degrees won’t pay your retirement expenses, and it’s better to have a retirement fund at age 75 than a house but no money to live on.
When calculating your 15%, base it on your gross annual income. Exclude any company 401(k) match, as well as potential Social Security benefits. You can’t count on the government coming to your aid in future years—it’s your job to plan now for your future needs.
The best way to build your wealth over time is to invest in growth-stock mutual funds. (Shortform note: a mutual fund is a portfolio of stocks, bonds, and other securities managed by a professional. Individual investors can buy into it.)
Mutual funds go up and down in value in the short term, but over the long term (more than five years), they provide an average 12% return on investment.
While this book isn’t a detailed investment guide, Ramsey recommends the following (for further investment advice, you may want to attend one of his classes or read his book Financial Peace):
1) Choose mutual funds with a record of growth for more than five years, preferably 10.
2) Spread your investment dollars over four types of funds:
3) When deciding where to invest first:
Make sure that, in total, you’re investing 15% of your gross annual income.
For a financially secure retirement, you should be able to live on 8% of your nest egg per year. If your investment returns average 12% annually and you take out 8%, your nest egg will continue to grow at 4% a year. The 4% growth enables you to keep up with inflation.
You should build the largest nest egg you can. To determine the total nest egg you’ll need, divide your desired annual income by .08. Here’s a worksheet to help you determine how much to save a month and how long it will take. For example, to live on $40,000 a year, you’ll need a total of $500,000.
Building wealth for retirement requires investing consistently over time—you won’t “get rich quick,” and you can’t jump in and out of investing. But the long-term results can be amazing. For example, if you make $50,000 (the average U.S. household income as this was written), and invest 15% ($7,500 a year or $625 a month) from age 30 to 70, you’ll end up with almost $8 million. If $625 a month sounds like a lot, remember that you won’t have any debt payments. In addition, you’ll probably increase your income over the years.
Disciplined investing now will create financial security in retirement. Starting earlier on investing is better, but starting at whatever age you are now is your only option.
People have many erroneous beliefs about a college education, which lead them to make foolish spending decisions to ensure their children get a degree from an expensive college. For instance, many parents believe that:
But a college degree doesn’t guarantee a job, wealth, or success. Everyone knows a few disillusioned college graduates who can’t get a job. A degree only validates knowledge or indicates you’ve passed certain tests. Knowledge must be combined with other qualities—for instance, character, effort, persistence, creativity, and talent—to create success.
In the book Emotional Intelligence, author Daniel Goleman writes that 15% of success is attributable to education, while 85% stems from attitude, perseverance, diligence, and vision. (Shortform note: Read our summary of Emotional Intelligence here.)
Because of their unrealistic expectations for a college degree, many parents go into extreme debts or skimp on saving for their retirement or an emergency fund. In the process, they pass on harmful views of debt to their children.
While society may overemphasize college, higher education is important and an element of success. Here are three steps for making a smart decision about college:
While most people think college is important, most don’t save for their children’s college education. Only 14% use college savings funds (ESAs) or 529 plans, meaning that an overwhelming majority are saving little or nothing.
People often can’t save because of credit card debt, car loans, and mortgages. They don’t plan their spending with a monthly budget and lack a fund for emergencies. To be able to save for college, you need to complete the first four Total Money Makeover steps as a foundation.
The most effective vehicles for saving for college are an ESA (Educational Savings Account), which is like an IRA for education, and a state 529 plan.
College tuition increases faster than inflation, at about 8% versus 4%, so when you save for college, you need to factor in tuition inflation. There are tuition prepayment plans, but as mentioned earlier, they just break even with inflation. Savings bonds and whole life insurance for babies generate returns of only 2% to 5%. A savings account generates even less.
You can do much better with an ESA funded in a growth-stock mutual fund—like an IRA, it will grow tax-free. Here’s how it compares to a prepaid tuition plan:
If an ESA won’t be enough, start there and also consider a state 529 plan, which also allows you to invest money tax-free for your child’s education.
There are several types of 529 plans—stay away from the “life phase” plans (poor returns) and “fixed portfolio” plans (too restrictive). The best option is a “flexible” plan that allows you to move your investment within a family of funds to get better performance.
By saving for college, you break the cycle of debt for your children.
If you started your Total Money Makeover later in life and therefore didn’t save for college, there are other options, though you have to be creative.
First, you can save on costs if your child starts at a cheaper school, like a community college, that’s also nearby so the child can live at home. Otherwise, look for cheap housing instead of luxury student apartments.
Steps a student can take include:
Whatever you do, don’t fall for the myth that the only way to afford college is by getting loans.
At this point in your Total Money Makeover, you’re nearly debt-free, you’ve saved $10,000+ for emergencies, you’re investing 15% of your income, and you’re saving for your kids’ college education.
Being totally debt-free puts you among the top 10% or 15% of Americans. This accomplishment is like achieving marathoner status as a result of great effort and persistence—but don’t be tempted to rest on your laurels. You can become an ultra-marathoner by completing step #6—paying off your home mortgage and becoming 100% debt-free.
By now you know how to do it. There’s no special formula. Devote every extra dollar you can find, beyond your emergency fund and investments, to paying extra on your mortgage each month until it’s paid off.
Most people believe that paying off a mortgage, especially early, is next to impossible. But numerous Total Money Makeover adherents do just that. For three to five years, they live differently from everyone else—sacrificing to pay off their mortgage. Then they continue to live differently from everyone else by being debt-free.
Most people who start a Total Money Makeover pay off their mortgage about seven years later.
The biggest myth about home-buying is that you need a mortgage in the first place—that it’s the only way to pay for a home.
There’s another way: paying 100% down. Paying cash for a home is possible if you save enough, long enough. For instance, a couple in the Total Money Makeover program paid cash for a $150,000 home. With a household income of $80,000 a year, they did it by living on $30,000 and saving $50,000 a year for three years.
That said, if you choose to take out a mortgage, follow these two rules:
This is the only kind of debt acceptable in the Total Money Makeover, but you should pay it off early as part of the program.
More people would be able to pay off their mortgages if they hadn’t locked themselves into bad deals. Here are the typical mistakes people make:
1) Taking out a 30-year mortgage and promising yourself you’ll pay it off within 15 years. You just want to give yourself a cushion in case something comes up.
The truth is, things always come up—there’s always an extra bill to pay that keeps you from making the extra mortgage payment. Few people, unless they’re completing a Total Money Makeover, systematically pay extra on their mortgage. You’re unlikely to be the exception.
A 15-year mortgage saves you a ton of money on interest, plus it saves 15 years of being in debt with a 30-year mortgage. For example, at 7% interest (typical at the time this book was written), you’d pay almost $150,000 less in interest with a 15-year mortgage, compared to 30 years, on a $250,000 house with a $25,000 down payment.
If you have a good interest rate, there’s no need to refinance a mortgage to pay it off earlier. You can still pay it off in 12 years, for example, by paying extra each month; use this tool to calculate how much to pay.
Don’t refinance unless you can save substantially on interest. If you’re considering refinancing, ask for a “par” quote (without points or an origination fee).
2) Saving on interest with an ARM (adjustable-rate mortgage) or balloon mortgage when you think you’ll be moving in a few years.
While you’ll have lower monthly payments and save on interest initially, these types of loans put you at high risk of foreclosure. Under an ARM, your interest rate goes up after a fixed period when market rates increase. Similarly, with a balloon mortgage, after an initial period of low payments, you have to pay off the entire balance at once.
These loans are risky because if your circumstances change, you won’t be able to make the balloon payment.
3) Maintaining a home equity loan/line of credit as an emergency fund.
Many banks aggressively push their Home Equity Line of Credit or HELOC, a renewable loan against the equity in your home. People often go this route—putting their home at risk—when they’re overextended on other kinds of debt. HELOCs are used for almost anything, including vacations, starting a business, consolidating debt, or as an emergency fund.
A large number of HELOCs end in foreclosure. When you’re in financial trouble, the worst thing you can do is borrow against your home, because you’re likely to lose it.
Of course, you won’t have any of these problems if you save and pay cash for a home, or attack and pay off a 15-year, fixed-term mortgage with gazelle intensity.
Completing six Total Money Makeover steps puts you in rare company—among the 2% of Americans who are debt-free.
Because you’re debt-free, live on a budget, and have money for emergencies, you’re in control of your income and are building wealth. The only remaining question is what to do with your discretionary income.
There are three purposes for money:
You should do all three of these things. Achieving financial fitness is like achieving physical fitness. You didn’t put in the work just to look good. Now you get to use your financial muscle.
If you want something and can afford it, by all means, indulge yourself—you’ve earned it. Up to this point in the Total Money Makeover, you’ve sacrificed by paying off debt and saving for the future—and like a kid who’s behaved so he can have ice cream later—you deserve the reward.
The problem is that most people buy things when they can’t afford them. Many callers to Ramsey’s radio talk show ask if they can afford to buy something major while doing a Total Money Makeover. He always says no, as he expected to do when a caller asked if he should buy a Harley. Ramsey was about to castigate the man, when the caller revealed that he made $550,000 a year and had investments worth $20 million. The man could afford it, so Ramsey encouraged him to buy and enjoy the motorcycle without guilt.
A key reason for a money makeover is to get your finances in order and build wealth so you can have fun later without guilt. If you’ve made it this far in your makeover, take your family on an expensive vacation or buy a new car with cash, because they’ll hardly make a dent in your finances.
At this step, you need to keep growing your wealth. While your nest egg may be substantial, if it’s under $10 million, continue to keep your investing simple.
Always manage your own money and stay on top of what it’s doing—but create a team of advisors to guide you when necessary. Look for teachers, not experts or people who try to take over your finances. You might include, for example, an estate planning attorney, a CPA, an insurance professional, a Realtor, and a financial planner. Also be aware of whether the advisor will profit from the advice she gives you.
You’ll reach a turning point, where your money is, in effect, working more than you are—that is, when you can live on your investment income. To determine whether you’re there, multiply your total investments by .08 and if you can live on that amount annually, don’t be afraid to start drawing on your nest egg at up to 8% a year. Enjoy the fruits of your labor!
Giving may be the most rewarding thing you can do with money. You don’t have to be rich to help people, but you can often do more when you have money. The biblical story of the Good Samaritan is an example: When the wealthy Samaritan came upon a robbery victim lying along a road, he not only treated the man’s injuries, but he also took him to an inn and paid for a room, so he could rest until he recovered.
Wealth gives good intentions greater impact; it also gives you the opportunity to help on a large scale. For instance:
Some people don’t give because they want more for themselves. However—you can get trapped by greed and lose what you’re trying to hang onto. To demonstrate this, Ramsey refers to a method of capturing monkeys in the jungle. The monkeys were given long-necked bottles with nuts in them, and each stuck a hand in a bottle to grab the treat. But they couldn’t get their hands out as long as they held the nuts in a fist. The greedy monkeys refused to let go and were captured. To get the full benefit of your money, put it to all three uses—fun, wealth-building, and giving.
Giving may be the most rewarding thing you can do with money. You don’t have to be rich to help people, but you can often do more when you have money.
What’s a cause near and dear to your heart that you would like to help someday?
What are some creative ways you could design a gift so that it would have a lasting impact on your cause?
Where will you need to be financially before you can make such a gift?
If you follow the Total Money Makeover, you’ll become wealthy within a few decades. While it’s an enormous relief to be out of debt and financially secure, be aware that having wealth can get you into trouble in several ways.
1) You may become overly entranced with it. Money and the stuff it buys won’t bring you happiness. A person obsessed with money is just as enslaved as a person deeply in debt.
2) Wealth will reveal and magnify your true character. If you’re a jerk, money will make you an even bigger jerk. If you’re kind and generous, you’ll be even more so with your wealth. If you feel guilty about having money, your guilt will grow.
It takes spiritual maturity and character to understand that while wealth is fun, it brings responsibility—whether it ruins your life or helps you do good is up to you.
While money isn’t the answer to the meaning of life, it isn’t evil either, as many religious people erroneously believe. This belief is used to justify living a financially unhealthy or mediocre life.
It’s wrong to love and trust money to provide things it can’t provide: happiness, satisfying relationships, and spiritual or emotional well-being. But it’s also wrong to reject money and the good it can do. Further, this thinking would leave all the world’s wealth to evil people.
As a good person, it's your duty to build wealth and do good with it in order to keep it from bad people—for instance, drug dealers and pornographers—who would otherwise use it for evil purposes.
By now, you can see that the Total Money Makeover is about more than money; it makes you face up to who you are in the mirror. Because personal finance is 80% behavior and 20% knowledge, you’ll either remake your life—or continue to be miserable.
Based on the experience of tens of thousands of people who followed the steps in this book, you should have hope that you can overcome money problems and live free of debt, break the cycle of debt in your family by not passing on debt to your children, have a secure retirement, and give to others.
It starts with applying common-sense principles. Anyone can do it, however financially dire their circumstances—even you.