This week, The Simple Dollar is conducting a detailed review of radio host Dave Ramsey’s The Total Money Makeover. This book is basically a printed distillation of Dave’s “financial preacher man” style on his radio show. Is there serious meat to be found here, or is it a bunch a fluff around a few small ideas? Let’s find out.
The second portion of The Total Money Makeover, which includes chapters six through eight, is the building of a financial foundation upon which you can grow. Dave’s a big proponent of the one step at a time concept and proposes a “three step” plan for building a foundation, but upon careful reading it becomes clear that there are actually six steps.
First, develop a budget. To many people, this is a scary step, but it’s actually quite easy for a first-timer to make a simple budget. The goal is to find areas that you’re spending too much on and cap those areas – these tend to be shopping, expensive cars, and other non-essentials.
Second, get all of your accounts current. Hopefully, you can skip this step, but if you have any late bills, pay them off first. You don’t want late bills hanging around that continue to damage your credit.
Third, build up a $1,000 emergency fund as fast as possible. This fund exists to keep you from failing in your plans if a disaster occurs, such as a damaged vehicle or so forth. This is absolutely essential, to the point that Dave encourages people to take out second jobs and sell some of their stuff to create such a fund. He also requires that it be liquid (in a savings account, not in a CD or something you can’t easily touch) so that you can get to it in an emergency and not risk sliding back on your progress.
Fourth, pay off all debts (except the home). Dave advocates a “snowball” approach, in which you list all of your debts in order of balance due from smallest to largest, then make minimum payments on all but the smallest and make a large as payment as possible on that smallest debt. Once that’s paid off, apply everything you were paying on that smallest debt to the new smallest debt, and so on. Eventually, when you get to the big debts, you’ll be making very large payments on them and paying them off quickly.
Fifth, build a “real” emergency fund. Once your debts are gone, you should continue to build up that emergency fund up to the point where it can replace three to six months of salary. You should basically just move the total debt payment you were making in the past straight into saving for this emergency fund.
Sixth, start saving for real purchases. Once your emergency fund is built, now is the time to start saving for big items. That debt snowball payment should now be directed into saving for expensive items, such as a house down payment or a new car that can be paid for in cash.
According to The Total Money Makeover, once a person has reached this level, they have a firm foundation upon which to build. What will they build? I’ll write about that tomorrow.
The Total Money Makeover is the fifth of fifty-two books in The Simple Dollar’s series 52 Personal Finance Books in 52 Weeks.