After we got married just over 8 years ago, my wife and I entered the marriage with more debt than we would have liked. My wife had zero debt, and I came in with student loans, credit card debt (for our honeymoon) and a loan for my car. We weren't happy with having so much debt, and after a couple of years of slowly paying off the obligations, we decided to take things a bit more seriously. We wanted to get out of debt and get on track for an increased net worth as fast as possible.
Here we are several years later and we're now back on track. We have no debt (except a mortgage) and we're slowly building up a nice nest egg that includes savings, retirement accounts and insurance.
Here's are three things that we did that had the greatest impact in helping us to turn things around.
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Start Tracking What You Spend And Set Up A Budget
The biggest change that we made was to actually start tracking what we were spending. When we got to the end of the month normally we would be at the end of our bank account – with not much left over to save or pay extra on debts. The money was just gone and we didn't really know where it had gone.
After reading Dave Ramsey's Total Money Makeover we started actually tracking where our money was going for a couple of months. What we found was that we were overspending by huge amounts of money in our eating out category and in our entertainment spending. There was a lot of room for making cuts.
Once we had tracked our spending for 2-3 months we actually set up a budget and cash flow plan at our house. We started working on a zero based budget suggested by Ramsey where you allocate every dollar to either a spending, saving, investing or giving category before the money even hits the account. You allocate every dollar, and if you have money left over at the end of the month – it needs to be re-allocated to a category. If the money isn't given a name and given a job – that money has a way of disappearing.
We quickly found that once we started using our budget, and not spending more than had been allocated in different categories (using a cash envelope system), we ended up having several hundred dollars a month left over that we hadn't had before. And it wasn't like we ended up making any painful cuts or hard decisions. That's quite a turn around!
Set Up An Emergency Fund
Another thing that made a huge difference for us, while we were paying off debt – and once we had it all paid off – was having an emergency fund. According to a Gallup poll a few years back, Only 10% say they have $1,000 in cash available in case of an emergency. That's not good!
In the past I had always thought that having a credit card was just as good as having a cash emergency fund. But what I realized later on was that using a credit card to pay for life's little “emergencies” just helps to continue a cycle of debt by creating new debt – when you could have instead planned ahead and had the cash to pay for it up front.
So how much should you save in an emergency fund? It depends on what you want your level of security to be, and the amount of risk you want to take on by not having an emergency fund. At our house, and in this economy, we currently have about a 10-11 month emergency fund (we can pay for 10-11 months of our expenses if we were to lose all income tomorrow). We just aren't optimistic about where our economy is heading, and we want to make sure we're prepared for the worst. While we were paying off debt we saved up $2000 in our emergency account because we figured that would cover most problems that could happen.
Try Living A Cash Only Lifestyle
The third thing that we did that had a huge impact was switching from a lifestyle financed by credit and loans, to one financed strictly by cash. If we want to buy something now, we pay for it with cash. Now that doesn't necessarily mean we pay for everything with crisp new $20 bills, but it does mean that we don't buy anything unless we have the cash on hand in our bank account to pay for it.
A couple of examples of how things changed in our life.
- We needed some new furniture for our new house when we moved 4 years ago. In the past we probably would have financed the furniture at the store or put it on a credit card. Instead, this time we had planned ahead and saved the cash to pay for it up front.
- Two years ago my car started having problems, and we knew we'd have to buy a new car to replace it. Instead of buying an expensive model financed at the dealership as we had in the past – this time we had saved up enough money every month in a “car fund” to buy a nice used car – that was new to us. A paid off car just drives so much nicer than one with a huge loan on it!
Paying cash and not having new debt is so much more freeing!
Planning Ahead, Saving Up And Living Within A Framework
When you look at the three points above, they all have something in common. They involve taking a look at your life, and making a decision to live with a plan, to thinking things through and making rational decisions that will pay off down the road. They involve living with delayed gratification, and deciding that you want to make sacrifices today so that tomorrow will be a brighter day. Making those types of decisions isn't always fun, but in the end it will pay off.
What other things would you suggest people do – or what are some things that you have done that have made you more successful? Tell us your thoughts -and your tips and tricks – in the comments!