Plans with Exceptions

If you have a financial plan,  you know where you are going and why you are doing what you are doing, therefore, it makes it easier to save and spend less. However, even Dave Ramsey has made exceptions.

Step one of the baby steps for Dave Ramsey is save $1,000 for emergencies while you are paying off debt. However, he does specify that if you earn less than $20K per year, your baby step one should be save $500 for emergencies.

Be flexible and mend everything to your on situation.

Flexibility

Setting financial goals is the best way to achieve what you want in your financial life, however, you must also be flexible.

Recently, I had to raid my emergency fund for a non-emergency purpose: advanced rent of 6 months. However, because I was willing to raid my emergency fund, I believe I received a better deal from my landlord.

Also recently, I made the mathematical calculation to see if it was better to pay off my private loan aggressively or to take it slow now because I am still paying capitalized interest which counts principal and interest as interest payments for tax deduction purposes. My goal was to pay the loan down aggressively, however, after doing the math, it did not make sense until the capitalized interest was paid off.

Therefore, it is always best to be flexible if it benefits you in the long run.

My financial goals are now the following:

1. Continue to contribute up to the match to my 401(k) (4% of gross salary)
2. Make my emergency fund what it was before
3. Contribute 11% of my gross salary to my Roth IRA
4. Then think about saving extra for increased student loan payments in the future

Retirement vs. Emergency Fund

If you do not have a full (whatever that means according to you) emergency fund saved up, you might want to dedicate all of your funds towards the emergency fund and not save anything for retirement. However, I think there is another option that most people do not realize. Your Roth IRA can serve as a temporary emergency fund while you do not have the emergency fund build up all the way.

Most people do not say that all Roth IRA contributions are available for withdrawal anytime without taxes or penalties. Only the earnings on those contributions will incur penalties if withdrawn early. However, this is true.

Therefore, If you have an excess of $500 a month after fulfilling all your expenses and the 401(k) contribution (if it has a match). You have no emergency fund and you require an additional $300/month in retirement savings to be able to save the suggested 15% of your gross income. Instead of putting the entire $500 towards the emergency fund, put $300 in a Roth IRA and $200 in the emergency fund.

If you have a serious emergency such as a job loss or a medical accident you cannot cover, remember that you can withdraw the $300/month you have been putting in to the Roth IRA. The danger in this is that your holdings can go down. Therefore, you can hold all of your Roth IRA investments in cash until you have build up your emergency fund. The more real danger is that you will now always see your Roth IRA as an emergency fund and will empty it if an "emergency," such as a friend's wedding, arises. Don't ever take money out unless it's a real emergency. Remember that you can never replace it.

The main reason for this maneuver would be that if your emergency fund needs 8 months of expenses, then you will need a year or two to build this up. You can only contribute $5K in a Roth IRA per year and if you do not contribute one year, you miss out on that amount.

Suze Orman Expense Sheet - Budget and Emergency Fund Planner

Another great budgeting tool is on the Suze Orman's website, Suze Orman's Expense Sheet. You enter your emergency fund amount and break down how much you spend each month by category. Then, Suze lets you know what your essential expenses are and based on that how large your 8 months emergency fund should be.

If a budgeting category is off from the national average, the cell will highlight yellow and by hovering over the cell, you can see what the national average is. If you are spending less, that's great. However, if you are spending more than the national average on a category, you should reconsider that expense even if you have an above average income.

At the end of the process that takes 2 minutes, Suze will tell you to beef up your emergency fund if you do not have 8 months of essential expenses. If your emergency fund fits the bill, she'll say that you should aggressively pay down any debt.

Unemployment and Emergency Funds

Everyone knows that they should have an emergency fund. However, everyone seems to struggle with how much they should have. Dave Ramsey says $1,000 until you pay off all debt but the mortgage, then 3-6 months of expenses. Suze Orman likes the full 8 months of expenses (and currently of take home pay) in the emergency fund. Liz Weston wants you to have at least $500 in the bank so you don't bounce anything. She says that having a large emergency fund is great, but does not specify the amount. The amount, is really whatever you are comfortable with.

However, if you are like me and you want to have more information before you know what you are comfortable with, one way to establish your emergency fund is to base it on the unemployment rate. Therefore, you can look at the general current unemployment rate (March 2011) and see that you need 9.2 months in an emergency fund. You can tailor this to your location as well by selecting the city or state on the left hand side. You could also look at the raw national statistics and determine your current unemployment rate by sex, age, ethnicity, educational attainment, etc.

Money in your 20's

Money management skills should be learned as early as possible and the 20's is a great place to start. Here are 10 financial projects you should take on in your 20's:

1. Learn to live on less than you make. Many people who find their first job, go all out with a new wardrobe, a new car, decorations for the new apartment, etc. Control your spending and only spend what you can afford with the money you have. See the Cash Flow blog post to see how you can see your cash flow with ease.
2. Start saving. Use the budget worksheet to see where you are overspending if you are unable to spend 15% of your take home pay. If you have large student loan payments, try to cut down in all areas to free up some space for savings, even if it's $5/month.
3. If your company offers a 401(k) match, start putting in the minimum amount you have to put in to get the full match.
4. Build an emergency fund in a high interest savings account.
5. Maintain a good credit score. Make sure you are never late. Automating your bills is an easy way to make sure of this.
6. Pay down on your student loan or any other debt with any extra funds that you have. If you receive a gift, a tax refund, or a bonus, try to apply it directly to your debt. See the Debt Pay Off Methods to see how you want to tackle your debt. See how even $5 per month extra will make a difference in your debt by using the Bankrate Amortization Calculator.
7. Save for retirement. Starting early is one of the best things you can do. Use a retirement calculator to see how much you should save. Start small if you can't contribute the full amount you are advised and increase your contributions yearly.
8. Designate separate savings accounts for various goals. Retirement should be saved in a 401(k) and an IRA. You should also have separate savings accounts for an emergency fund, grad school, vacation, car, down payment, etc. You can save in each account simultaneously or take it one step at a time and once your emergency fund is full, save for a vacation, once you have enough in that account, you can save for grad school and a car, etc.
9. Get health insurance. One accident can ruin all of your plans. 
10. Earn more money. Ask for a raise at the annual review or find a job that will pay you 15%-20% more and present the offer to the current employer. Be ready to leave for the new job if the offer isn't matched.

Pay Yourself First First, No Really

Every personal finance adviser out there says to pay yourself first. There are websites dedicated to the concept. However, many of us still don't do this simplest thing. For the longest time, I figured I was disciplined enough not to have to do this. However, since I've started a couple of month ago, it has done wonders.

Paying yourself first is as simple as setting up a new savings account (if you don't have one yet) and setting up automatic transfers of at least 15% of your take home pay. It sounds so simple, but paying yourself first lets you see the money that you have left over.

Since I am saving for a couple of things right now, I have one slush fund for the 15% savings and then I distribute from there to other savings accounts based on what I feel I want to accomplish first.

This 15% is the starting point for my savings. I also contribute 4% of gross pay to a 401K and I always end up transferring more out of my checking and into my savings. However, keeping the funds separate and having the automatic savings plan of at least 15% going into my slush fund, helps keep me on track.

Dave Ramsey's Baby Steps

Dave Ramsey is a hugely popular financial adviser. I like listening to his radio show just to see what his opinions are, even though a lot of the times, I do not agree with what he says. Here is the just of what he advises through his 7 baby steps:

1. Save $1,000
2. Pay off all debt, but the mortgage (this includes student loans)
3. Save 3-6 months in an emergency fund
4. Invest 15% of your income in retirement
5. Fund college education for children
6. Pay off your home
7. Build wealth and donate

 I think having a step process works for most people. However, not every household has the same factors in their financial life. I do have to credit him with saying that cheating baby steps in some circumstances might be okay, however, he does not seem to endorse it. I've heard his say, for example, that if you have an unstable job, you should increase the savings that you do in baby step one. However, he is never clear with how much.

I still believe in Suze Orman's idea of saving an 8 month emergency fund and then paying down the debt like student loans. Of course, if you have credit card debt at high interests and you feel pretty safe at your job, you could get by on a smaller emergency fund until your credit card debt is paid off.

I also think that Liz Weston has a point when she says that you can never catch up on your contributions for retirement. Therefore, I think that getting the employer's match in a 401(k) is a priority over paying for debt.

See my blog post on Prioritizing Savings to see what my personal 8 steps are.

Prioritizing Savings

If you have limited resources, you need to prioritize your savings. As discussed in the previous post, there are lots of goals you can make, but how to choose which one is more important? Here is my list:

1. build $1,000 or 3 month emergency fund (based on your gut feeling)
2. maximize your 401(k) up to the company match
3. pay off toxic debt such as credit cards or anything higher than an 8% interest rate (car, private student loans)
4. build an 8 months emergency fund
5. max out your Roth IRA
6. pay down any other debt
7. build an emergency fund of 1 year of expenses
8. invest/save for a down payment/wedding/etc.

I'm on step 4. I raided my emergency fund to put $2,000 in a Roth IRA to get the IRS credit, so I am back down to 4 months of expenses, which I can bring back up to 6 in April. Once I have 6 months, I think I will split my extra money between building an 8 month emergency fund and paying down a private student loan currently at 6.25% until I have full 8 months of an emergency fund. After my emergency savings account is fully funded, then I will pay off the student loan fully while still contributing to the IRA account so that my retirement contributions are at least $2K per year while I qualify for the retirement savings credit.

Financial Goals

The whole point of learning and keeping up with your finances is to attain our financial goals. What are your financial goals.

Here are some examples of goals:

1. Save X amount in an emergency fund
2. Save X amount of months of expenses/salary in an emergency fund
3. Save X amount for retirement this year
4. Save X% of each paycheck for retirement this year
5. Max out your IRA
6. Pay down my student loan in X amount of years
7. Pay double the minimum on my debt
8. Save for a vacation
9. Save for graduate school
10. Save for a down payment
11. Buy a car with cash

What are you saving/hoping for?  Whatever it is, my favorite tool to keep an easy track of your savings and goals is to open up a high yielding savings account (see my earlier post where to find one), and set up a goal in Mint (see an earlier post about this website as well). You can set up multiple goals as long as you have a different account for each goal and keep track of your progress. Mint will tell you if you are on track, behind, or ahead on your goals and the amount of time it will take you to reach them.

Emergency Fund

Everyone needs to have an emergency fund. The amount of the fund varies. Most experts will agree that you need at least 3 months of your expenses. Suze Orman, on the other hand, believes that everyone needs to have 8 months of pay in their emergency fund. What is comfortable for you, depends on how stable your job is, what your expenses are, how much debt you have, and what type of personality you have.

What is important is that you set an amount for yourself and try to achieve that goal. You should save at least 10% of your salary, however, 25% would be something to strive for. You could start with 10% and every paycheck, month, or year up it by 1%. You would not notice the 1% decrease in the take-home pay, however, your savings, over time, would.

Personally, 6 months of expenses is enough while I pay down a private student loan and put some away in a Roth IRA. I do not have dependents and my job is pretty stable, however, I sleep better at night when I have a larger financial cushion.

An interesting way to determine your financial fund would be to align it to the current unemployment rate. Therefore, since the US currently has 9% unemployment, it would be wise to save 9 months of expenses as it would take longer to find a job.


Use these calculators to see other methods of calculating your emergency fund:

Money Zine Emergency Fund Calculator

Bankrate Emergency Savings Calculator