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Personal Finance 101 – Saving for your Kids’ College

Tsh — Mon, 05 May 2008 01:00:43 +0000

This is the sixth part in my series on Dave Ramsey’s Baby Steps, a proven personal financial plan. My goal is to explain a really solid money management plan in plain ol’ English, for intelligent yet financially “average” home managers.

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O
nce you start funding 15% of your income towards retirement, and once you’ve fully funded your Emergency Fund (and any other big purchases you’re saving for – like a Car Replacement Fund), it’s time to start funding your kids’ future education.

This does not mean you can now afford to save up for the most expensive private school out there, nor does it mean your chid doesn’t need to contribute personally towards his future. But it does mean you are financially free enough to provide at least some towards a college education – at least a start towards entering university life debt-free (and hopefully staying that way).

Here are the nuts and bolts of Baby Step #5 in Dave Ramsey’s plan – put money towards your children’s college fund.

Dave’s Rules for College

These are pretty straightforward:

1. Pay cash. The average college student today graduates with about $15,000 in student loan debt after spending 3-4 years in an apartment. What a heavy weight strapped to a graduate’s shoulders fresh out in the job market! If you’re able to help your child avoid that burden, then do so.

2. And If you have the cash or the scholarship, go. As in, to college.

Student loans are so normal these days; there’s a prevailing myth that you can’t possibly go to a university without them. But they’re just not worth it. Even with the low interest rate most federal student loans have, you just never know what the future holds. I know I’d hate to corner my kids into having to pay for their education after they’ve received it. What if they’re offered some really great opportunity after graduation that pays very little (or not at all), yet is invaluable to their career or overall well-being? What if they want to settle down and become a wife and mom right away? These things would be so much harder to do with student loan debt.

Dave says this:

“If you’ve planned your savings goals and don’t have much room in the budget for college, don’t panic. Knowledge is just part of the formula to success. With what you are able to save, those precious kids can probably get a good degree if they will suffer through lifestyle adjustments and get a job while in school. Work is good for them.”

I wholeheartedly agree. I worked part-time all through college, and while I hated it at the time, I can look back and see the enormous life and business lessons I learned from those long shifts waiting tables. These life lessons are just as much a gift as the money you contribute to your kiddo’s education. Consider giving them that valuable experience.

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Where to Save the Money

Dave recommends putting college tuition funds in either an Educational Savings Account (ESA) or a 529, which are state plans and therefore different depending on your state of residence. College tuition goes up faster than regular inflation – 7 percent for college versus 4 percent for most everything else. This means that in order to keep up with tuition rates, you’ll need to earn at least 7 percent per year to keep up with the tuition increases.

With an ESA funded in a growth-stock mutual fund, your money will grow tax-free when it’s used for higher education. You can currently invest $2,000 per year, per child in an ESA (if you make under $200K a year) – and if that ESA averages 12 percent, you’ll have $126,000 in tax-free education funds by the time they’re ready for college.

If you make more than $200,000, or for some reason you want to contribute more than $2,000 a year (possibly the case if your kids are older than 8), then 529s are for you. There are lots of different 529 types out there, but Dave only recommends a “flexible” plan. He says you could pick from virtually any mutual fund in the American Funds Group or Vanguard or Fidelity and probably be okay.

Application Time

How this applies to you depends on your circumstances.

• If you don’t have kids, it doesn’t apply to you at all because you can’t open ESAs or 529s for people who don’t exist. But seeing as this is Simple Mom, I’m guessing most of my readers are parents.

• If you you’re not debt-free (Baby Step #2), you don’t have three to six month’s of expenses in savings (Baby Step #3), and you haven’t started contributing towards your retirement (Baby Step #4), then you’re not ready to start saving for your kids’ college. Under Dave Ramsey’s plan, you’d hold off contributing to your kids’ college fund until you completed the previous Baby Steps.

This makes sense – why would you save for your kids’ education and not your retirement? In doing so, you’re strapping your kids down with having to take care of their parents down the road. I’d rather not do that and have them work for part of their college funding.

• If you are at the stage of saving for your kids’ college, then Dave recommends sticking to mutual funds through an ESA or 529. And do what you can afford without feeling guilty if you can’t fully fund their education. That’s never been part of the definition of a good parent.

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Our Personal Plan

As of now, our plan when we’re at Baby Step #5 is to provide a “matching promise” for our kids – we’ll match whatever they’re able to save, up to what an ESA allows at the time. And if they don’t have enough saved by the time they’re ready for college, we will highly encourage them to not take out student loans. They’re just not worth it.

I’ll end with another quote from Dave:

“Regardless of how you save for college, do it. Saving for college ensures that a legacy of debt is not passed down your family tree. Sadly, most people graduating from college right now are deeply in debt before they start. If you start early or save aggressively, your child will not be one of them”

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Personal Finance 101 – The Debt Snowball

Tsh — Tue, 26 Feb 2008 13:31:43 +0000

This is the third part in my series on Dave Ramsey’s Baby Steps, a proven personal financial plan. My goal is to explain a really solid money management plan in plain ol’ English, for intelligent yet financially “average” home managers.

Baby Step #2 in Dave Ramsey’s Total Money Makeover is really the crux of the plan. It’s the one that stands out as – well, weird. It’s different than most financial plans out there. It goes completely against the grain of what today’s culture feeds us (my favorite line is “there’s good debt, and there’s bad debt”). It’s this – be debt-free.

He’s not kidding. He’s not talking about just credit card debt, or only consumer debt, or just high-interest debt. He’s talking about ALL DEBT. Become totally debt-free. This even includes your house, although that’s not until Baby Step #6. He says that our goal is to not owe a single dime to anyone.

When I first heard this, I found it absolutely overwhelming, and to be honest, it’s what turned me off to him at first. I couldn’t imagine even hoping for a paid-for house, much less being able to do it. We hardly have any debt, but my husband and I never made wealth building a goal in our life – we honestly never thought of ourselves as “average Americans.” We wouldn’t be surprised if our typical income is always below average, seeing as we could be in full-time ministry for most of our lives. And that’s okay with us. We’re fine with it.

So that’s a big reason I brushed off Dave Ramsey’s plan at first – it didn’t seem like it was for us. It was for people who cared about making a lot of money.

I’ll spare you all the details of God changing my heart on the matter, but He did. In short, He reminded me that He does care about how we steward the money He gives us, and that we are no different than the people who work in “regular jobs.” We are to do well with what we have, no matter how much it is. I could go on and on about my change of heart, but in a nutshell – I now see us as people who should and could do well financially. It’s important to our family future.

Moving on – back to Baby Step #2. He recommends paying off all your debts using the Snowball Method – paying the minimums on all debts except one, which you pile on any extra funds you have. When that one is paid off, you take the money you piled on the first debt and put it towards the second. Then you do that with the third, and so on and so on, until all your debt is gone. All except the house, that is. You pay that off a little later. There’s a lot out on the internet about the Snowball Method, so I won’t reinvent the wheel. A few examples are here, here, and here.

One thing that differs with Ramsey’s Snowball Method than other similar methods out there is that he recommends paying off the debt with the lowest balance first, not necessarily the one with the highest interest rate. Even though it mathematically makes sense to pay off your high-interest debt first, he says there’s something psychologically and motivationally charging when you pay off the small balance debts first. You feel like you’re crossing things off your list. You’re shooting down the little guys so you can get to the big kahuna faster. When you pay off several debts within a few months, you feel like you can do this. When you start with a big debt that could take years, you could easily lose steam.

There’s also a relatively new trend out in the blogosphere called snowflaking – gathering all the little funds you find here and there throughout the month and putting it towards the current debt you’re focusing on. The money really adds up, the way a snowball is comprised of lots of tiny snowflakes. There are stories out there of people finding $400 in change in the couch cushions, so to speak. Once you start looking for any and every bit of extra money you have, it pops up out of nowhere. It really does.

So, to reiterate where we are in a Plain Jane way…

Baby Step #1 – save $1,000 fast, which becomes your Baby Emergency Fund. It will only stay this small while you’re on Step 2.

Baby Step #2 – eliminate all debt except the house using the Snowball Method.

I’ll admit right up front that I am a total Plain Jane. I am learning about personal finance at the moment, and am in no position yet to offer advice. But as I learn more and more, and build up the ability to draw conclusions on my own, I can say that so far, there really is very little I disagree with Dave Ramsey. You can pretty much take his advice and go with it. I highly recommend catching his radio show – I listen almost daily, and I live overseas. The first hour of his show is a podcast on iTunes, which is how I listen.

That said, there are also lots of good personal finance blogs out there. I’ve got a number of them linked in my sidebar, and the Money Blog Network can lead you to more than enough reading material out there.

But on top of it all, I highly recommend buying Dave Ramsey’s The Total Money Makeover and devouring it. It’s very easy reading. I read it in a weekend. And I have two kids under 3, so if I can devote the brain cells to the book, anybody can. (And if you buy it via the link above – hint, hint – the proceeds go to maintaining this blog.)

I’ll move on to Baby Step #3, fully fund the Emergency Fund from Step 1, sometime soon. For now, I’ll leave you with a quote from Ramsey’s book about Baby Step #2:

“If you think this Debt Snowball stuff is cute and you might sort of give it a try, it won’t work. Total, sold-out, focused intensity is required to win. Aiming at the goal and nothing else is the only way to win.”

“Many people find a way to shorten the time [to finish the Debt Snowball] with sheer intensity, and God tends to pour blessings on people going in a direction He wants them to go. It is as if you are walking or running at a fast pace, and a moving sidewalk suddenly appears below you to carry you faster than you own effort would. The Debt Snowball is very possibly the most important step in your Total Money Makeover for two reasons. One, you free up your most powerful wealth-building tool, your income, during this step. Two, you take on the entire American culture by declaring war on debt. By paying off your debt, you make a statement about your stance on the issue of debt.”

Missed other parts of my series?

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Personal Finance 101 – The $1k Baby Emergency Fund

Tsh — Tue, 19 Feb 2008 21:43:15 +0000

This is the second part in my series on Dave Ramsey’s Baby Steps, a proven personal financial plan. My goal is to explain a really solid money management plan in plain ol’ English, for intelligent yet financially “average” home managers.

As I mentioned a few days ago, I’m going to tackle the topic of about Dave Ramsey’s Baby Steps over the next few weeks. The concept is still a bit new to me, so a big reason I’m writing is for my personal benefit – to clarify my thoughts and convictions, to succinctly hone our plan, and to reveal any fallacies.

That said, the Baby Steps were created for the regular Jane – the person without a BS in business or finance, the person who does their taxes online (without a CPA) and wants, more than anything, to just gain control over their personal finances. That’s me.

The essential thing to understand about this financial plan is that its purpose is for you to live debt-free. That means getting out of debt and staying out of debt, for the rest of your life. No longer using debt for anything. Ever. Not school, not braces, not weddings. The only debt Ramsey’s okay with is a fixed-rate 15-year mortgage with at least a 20% down payment (although he even advocates buying real estate with 100% cash down, if you’re able). This means cutting up your credit cards. You don’t need them anymore – even “for emergencies” – if you’re on this plan. Baby Step 1 is your new plan for emergencies. Toss the cards. I’ll discuss the evils of debt in more detail on Baby Step 2. If you can’t quite give up credit cards yet, you’re not ready to move on. Stop there.

Moving right along. Baby Step Numero Uno – quickly save $1,000. Quite a few people probably already have this and then some (I’ll explain in Baby Step 2 what to do with the “then some”), and for others, this might be the most they’ll have ever saved up in their life. But the important key here is to save it up quickly. This step is not supposed to take long because you’ll lose momentum. Ramsey recommends getting a little side job, selling something on ebay or craigslist, or seriously cutting back on a spending category of yours for a short while. Step 1 should take one to two months max. Start getting ready for that garage sale.

$1,000 should feel like a rather small emergency fund – that’s because it is. Ramsey says having a smallish safety net (although it is still a safety net) helps with the urgency needed to get out of debt. $1K should be enough to cover those basic emergencies that might come up – plumbing issues at home, air conditioning servicing, gasket and zip-zorp replacement on your car (I obviously know vehicles). But the sooner you get through Baby Step #2 – getting out of debt – the sooner you get to the third step, which is fully funding your emergency fund. That will get you through more serious, potentially longer-term emergencies (such as unemployment). You want to get there as soon as you can, so hurry up and get that baby emergency fund so you can plow your way out of debt and then really save.

A caveat – and this is important – this cash is for emergencies. A new dress for the company party, a weekend away, Christmas – none of those are emergencies (it’s on December 25 every year). Unless something serious comes up, it’s almost best to forget the money is even there. Leave it alone. It’s your safety net (since you’re not using credit cards, or any other form of debt, ever again).

At the same time, keep it liquid. You’re not investing here, so the goal is not the highest possible interest rate (in other words, no mutual funds or something with penalties for early withdrawl). A solid savings account with easy access is ideal. Many Ramsey-ites keep their emergency funds at ING Direct – their savings accounts currently yield 3.40%, and you can easily connect it to an Electric Orange checking account (which, coincidentally currently yields 2.25%). This is where we have our emergency fund.

So that’s Baby Step 1 in a nutshell. It’s the easiest one to understand, so it’s pretty basic. But it’s THE foundation to the rest of a well-tested debt-free financial plan that works, so you gotta have it. Put a thousand bucks in the bank as soon as you can, and don’t touch it once it’s there.

Missed other parts of my series?

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Personal Finance 101 – Dave Ramsey’s Baby Steps

Tsh — Sat, 16 Feb 2008 23:34:53 +0000

This is the first part in my series on Dave Ramsey’s Baby Steps, a proven personal financial plan. My goal is to explain a really solid money management plan in plain ol’ English, for intelligent yet financially “average” home managers.

I’m a firm believer in being debt-free. Not only do I think it’s honoring to God and good for the soul, it’s also a lot more fun. When you don’t owe anybody, you can use money as a tool that benefits your family (and not the bank), and you’re free to live in ways unimaginable when you’re in bondage to debt. You really can live simply and freely. Well, at the very least, it’s a lot easier than for the person in debt up to their eyeballs.

To be honest, I’ve been a bit lost in the fog for most of my adult life when it comes to personal finance. I never found tools that worked for me, I never made it a huge priority to be proactively involved in our funds, and quite frankly, I found the topic boring. I mean, I wanted to have enough money, but I didn’t want to learn how to deal with it. I wanted it dealt for me. Because crunching numbers and balancing accounts is BO-RING.

This past September, I discovered Dave Ramsey and his method of using Baby Steps to control personal finances. Now, we’re still still exploring and tweaking our personal philosophy, but so far, there’s not much the guy teaches that I disagree with. And best of all, he explains money in a way I – a regular Jane – can understand. I’m hooked, and what’s more, I now really like the topic of personal finance. I’ve learned a lot more outside the realm of just Dave Ramsey, and I’m learning more every day.

You can find tons of stuff on the internet about Dave’s method, and there are countless blogs that hype his teachings. So my Cliff Notes version of his thoughts won’t be new. But my plan is to walk through his plan on this blog over the course of a few weeks, for my clarity of mind, if anything. And maybe it will encourage someone out there.

I think I’ll summarize each of his “Baby Steps,”, walking through their basic benefit and end result, and possibly divulge a little of our family’s plan for each.

As an introduction, his Baby Steps are as follows:

Quickly save $1,000 in a Baby Emergency Fund.
Become debt-free using the “snowball method.”
Fully fund the Emergency Fund from step 1 with 3-6 months of your living expenses.
Contribute 15% of your income to retirement.
Fund your kiddos’ college education through an ESA or a 529.
Pay off your mortgage.
Invest money and give a bunch of it away – live like no one else.

As Dave often says, “Live like no one else, so that later you can live like no one else.” We hope we can. His financial plan lines right up with the idea of living simply. And if your goal is to live simply, Dave Ramsey could be your man. I highly recommend looking into his financial advice. You can download the first hour of his daily radio show for free on iTunes. I usually don’t miss it.

Missed other parts of my series?

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