Quick summary:  Step zero, the awareness step, collecting all receipts and categorizing them. If you’ve been doing this for 4 weeks, congratulations, you now have a months worth of data and a rough idea where the money is being spent.

Step 1, setting up an emergency fund. That piece of mind, knowing that in the back of your mind if something critical goes wrong you have cash set aside.

Step 2, the snowball debt reduction strategy and how this moves forward to larger items. Get off that treadmill of revolving credit. Start filling the hole rather than making it deeper.

Now we’re on to what some would term more interesting (positive saving) things and the creation of what I like to term a cushion or a buffer. The goal in this step is to gradually work on building up enough cash reserves, such that if you become unemployed or sick or your income drops to near zero for some reason, that you have a cushion or a buffer zone to fall back on.

The big question that comes up naturally is, what size of cushion do I need?  The rule of thumb is 3-6 months of EXPENSES. Not 3 to 6 months of income that’s totally different. You want to know that for 3-6 months you have enough cash to cover all your monthly obligations if some life event happens.

Hopefully you see how this is building. You’ve been collecting receipts for a month, so you know today what the monthly funds are going out. You’ve found an item or 2 that are non-essential expenses and have started to attack your debt.

At this point, I say the choice is yours. You can finish paying off your credit card/loans and then start building a cushion or you can repeat step 2 and put the new found cash into a separate savings account. A little more belt tightening for sure. Thing of it as short term pain for the ability to give yourself choices in the future.

I would argue that today, jobs are less long term secure (working for 1 company for 40 years) and more short term and dynamic (2 or 3 years changing jobs but staying within an industry). Given this new reality, I would say starting to save now (along with debt reduction) for that next job change might be a good idea. Even if you only manage to save up 1 months expenses in a year, you at least have that 1 month more than you had before. Having a little margin in life is better than no margin at all.

Again, similar to the emergency fund, you want to put this into a separate account, away from your daily use chequing/savings account. You want to be able to watch this account grow over time.

Now if you are self-employed or commission based, like me, I will suggest you examine your peaks and valleys and determine how long the valleys last and work on an income levelling plan as well. For example February is my worst month. Things start up again in March, but that usually means I don’t get paid until April (30 day closings). For me I know that I have to have enough saved (after Christmas) to be able to go 3-4 months (worst case) and try and reduce my expenses during that time of year.

Next post we’ll be looking at planning for the future… unless you want to work for WalMart in your retirement years.

The first two steps have been easy. Both easy TO do and easy NOT to do.

So has anyone been following along? Have you been keeping *ALL* receipts? Categorizing the stack of receipts at the end of each week and decided that maybe the category of miscellaneous is just slightly too all encompassing (i.e. more than half your receipts fall into this area)?

You’ve bit the bullet and managed to put aside $800 for an emergency fund, even though your brother’s sister in-law’s third cousin twice removed is getting married and invited you to be with them on their special day in Hawaii? You recognized that this is not an emergency. Your son/daughter will just not be able to make it to the hockey tournament halfway across the country. It’s time to take a serious look at your finances.

If you’ve made it this far, GREAT! Easy wan’t it? If you’re still collecting receipts, but haven’t found that extra cash to create that emergency fund as you are still getting through that last emergency, keep working on it. This is a critical step. It will give you a small amount of mental freedom once you do.

Now on to the part where people get excited. The part where we actually start to see a change in how we do things and see tangible results.

From the exercises previously, you should now at least have a sense for where your money is being spent. By creating categories for all your receipts, you have (or are presently) showing yourself where all your money is being spent. Food, utilities, rent/mortgage, gas, car maintenance, etc.

The goal for this next step is to examine where money is being spent and work hard to try and find AT LEAST $100 (likely in that broad MISC category) that you don’t need to spend each month. “But everything I buy I NEED”, I hear people claiming. Let’s take the simplest example. I’ll borrow from David Bach’s book and call it the Latte Factor.

Do you have something simple, such as buying a coffee, everyday that if you reduced or eliminated could save you that cash that you NEED to start the next step of this plan? Think about it for a minute. If you buy a Latte from Starbucks every day (I’m estimating the price), that’s $3 x 30 days in a month. That’s $90/month.  If you have a typical family of four and you eat out more than once a week at McD’s, that’s another $100 savings.

I will put in a caveat here for all you coffee drinkers (like my wife) who CANNOT function without a coffee, remember I said REDUCE your expenses. Either exchange Starbucks for Tim’s or make coffee at home or find some other non-essential item. If you are a couple, you EACH need to find something.

You’ve gone through all your receipts and managed to find a way to carve out $100 (or MORE) each month. What we need to do now is to look at all your credit card statements. You need to write down on a paper the name, balances and minimum monthly payments for each.

At this point, I’ve seen all kinds of ideas on how to approach paying down your debt. Most involve using math, which one has the highest interest, which one has the highest/lowest balance, take the amount divide by interest, etc. etc. The key here is to PICK ONE credit card and start the process. Getting started and into the correct habit is more important than which method you use or how you determine which will be most advantageous to start with.

Two things, that are important to do here. First, pay the minimum amount on each credit card and DO NOT add anything to the cards unless you have planned in advance for the expense and have the cash set aside. Second, you now want to take this extra $100 that you’ve managed to carve out of your expenses and apply that amount to ONE card.

For example, typically people have an average of 3 credit cards with a balance of $15,000. Lets say $30K to make it more realistic for most. For argument sake, let’s say $10,000 a card.

Your minimum payment on any card will be 3% or $300/mo. To that minimum you want to add $200 (couple who both eliminate Latte’s). So each month, you will pay $500.

At this pace, it will take 20 months to pay off the principal on one card. Add 18% interest to that and say another 4 months.

“Big deal, 2 years to pay off 1 card”, you say. That’s just the start I say. We now take that $500 and add it to the next credit card, for a total of $800/mo. Card number 2 will now only take 14 months to pay off and applying this same amount to the last card (or $1200), works out to 9-10 more months (including interest).

3 years plus to get ride of $30K in credit card debt. If that’s not exciting, how about the next step. Adding $1200/mo to your mortgage payment.

If we take a typical 25 year amortization for an average amount of $250K and add $1200 extra payment per month (just shy of doubling), you end up with zero debt (i.e. mortgage free) in just over 10 years.

Think about that for a minute. $30K in credit card debt and a $250K mortgage all eliminated in in 13 years, by simply finding and extra $200/mo.

Don’t buy into what the banks want you to believe that having debt is OK. Everyone has a mortgage and will for most of their working life. They want you to believe this because that’s how they make money.

Have I given some of your HOPE? That your debt CAN be eliminated and within a reasonable amount of time?

That’s the quick overview of the “snowball” method of debt pay-down. While writing this out, I thought of several other things that I didn’t include. I’ll try and squeeze those into the next few posts as we move onward and upward.

The next few steps that I’ll cover can in theory be done in tandem. Many argue the focus should be debt reduction first and only. I say all work and no play makes Johnny a dull boy.  In other words, the likelyhood of someone continuing to focus for a long period of time without self-sabotage is very low. You need to focus on something positive while also paying down debt. It’s human nature.

I’m reminded of that Yogi Berra quote: “In theory, practice and theory are the same. In practice, they’re not.”

OK, I was slightly ahead of myself when I went to sign off last time. Snowball is the step after this one.

We are on to Step 1 after covering of the pre-step or step 0 last time.

Setting up and emergency fund. Once again, this sounds like a fairly simple and straight forward thing. It is. The challenging part is knowing you have funds available and yet continuously NOT using them.

The most important thing in this step probably is to define what constitutes an emergency. I’ve heard all kinds of stories on this topic.

“My sister is getting married, I HAVE to buy her something. She bought me this HUGE thing-a-ma-bob for my marriage. This is an emergency because…<insert random justification here>. We have no savings, but there’s “room” on my credit card…” Ugh.

Strangely enough, these are also the same people who seem to have at least 1 “emergency” a month.

Two questions I’m sure the readers are asking themselves. How much goes into an emergency fund? Who decides what an emergency is?

Neither have a simple answer. As a rule of thumb, I will suggest the emergency fund be at a minimum $1000. If that’s “way out” of the realm of possibilites, then initially focus on putting aside at least $500 and increase this over time (we’ll get to that in another post). The goal here is to be able to take on what life sometime dishes out unexpectedly. Upfront, this is really important. Further along the process, less so, but a good habit to start.

Who decides? Hopefully both partners decide together (assuming there are two, or you and an accountability partner). The key is you need to decide the difference between really, really important stuff and actual emergency. I can’t tell you, only you can. Everyone is different.

If you run a business that depends upon an operating vehicle for your primary source of income (pizza delivery) and there is a repair required (beyond normal maintenance), this is an emergency (direct impact on income is an emergency). If it is a second car that is used occasionally, but makes life much much simpler, NO.  It stays in the driveway until there is extra in the maintenance budget to pay for it.

A good suggestion is to keep the emergency funds in a place that is not easily accessible or requires waiting a day. The reason for this is it forces you to think about your actions. Maybe you come up with an alternate less expensive solution or simply realize that what appears to be an emergency today has somehow changed given the light of a new day.

What we did was to set up an ING account. There is one ING ATMs that is available in town and only available during business hours, etc. The way we accessed funds was to transfer it from ING to another bank that was slightly more convenient. Normally it takes 24 hours to transfer from 1 institution to another (sometimes more, deal with it).

Step 1 Summary:

Set aside $1000 as an emergency fund (credit card “room” and lines of credit don’t count, cold hard cash only).

Decide ahead of time what constitutes an emergency (impacts earning potential is a good rule of thumb).

Make sure you have some kind of delay mechanism in place  in order to access these funds. Safety deposit box or transfer between bank accounts for example.

Step 0: awareness, keeping track of inflows and outflows. Keep all receipts for 2 weeks to 1 month. (previous post)

Building slowly. I’ll keep saying this through out, simple to do and at the same time simple not to do. The choice is yours.