There have been many high-fliers who have lost everything because they did not understand the fundamentals of finance. Irrespective of the individual’s earning potential, the same principles can be used and applied to ensure that the person has a solid financial foundation. Much like building a home, it is vital to start with a foundation and build upwards from there through a process of steps. Skipping a step will result in a shaky structure that will not stand in trying times.
The financial management system of Dave Ramsey called the Seven Baby Steps is an excellent guideline and starting point. Dave Ramsey is an author, talk show host and personal finance expert, who has developed a method to help people out of debt and financial stress and into a life of saving and giving. Through some bad decisions, Ramsey lost everything and had to start again from nothing. This experience has provided him with hands-on knowledge on how to reach financial freedom from a difficult situation.
Here are the seven financial steps laid out in the program:
1. Build a starter emergency fund
Most homeowners will know that there are always unexpected life events that require additional funding. An emergency fund will ensure that you don’t have to go further into debt to fix the problem. As an initial goal, it is good to aim for a savings of around R10 000 as a start-up emergency fund.
2. Pay off debt
Apart from the bond, make a list of all debts from smallest to largest. Debts with the smallest balances are given top priority, as these can be cleared off the list far more quickly than larger amounts. If two debts are similar amounts, then the one with the highest interest rate should be paid off first. The idea is to pay off the first debt and then use that money to pay off the second debt faster, this will have a knock-on effect and will help clear all your debt in a shorter period.
3. Three to six months of expenses in savings
Unlike the initial starter emergency fund, this step is to build up a full emergency fund that covers all household expenses for at least three months, but ideally up to six months. It will ensure you are prepared for some of life’s larger surprises and will be able to stay out of debt for good.
4. Invest in your retirement
This step in the plan is to build long-term wealth. With no debt and a full emergency fund in place, it is time to focus on putting money aside for retirement. The money that was once used to pay the debt can now be used to build a future. Ideally, around 15% of the household income should be invested for retirement. There are several retirement fund options available, so you should be able to find one that works for you. A broker or financial adviser could prove to be a valuable asset at this stage.
5. An education fund
What better way to prepare your children for the future than to invest in their education. University and all the associated fees can be costly, especially in a multiple-child home. Setting aside money for your children’s education will put you ahead of the curve when they want to study further.
6. Pay off your bond early
One of the best investments you can make is to pay off your home loan faster to reduce the amount of interest paid. Even a small additional monthly payment can make a big difference to fast-tracking financial freedom. An increase of R500 on a 20-year bond of R1 million at an interest rate of 9.75%, will reduce the term of the loan by around three years and save a total of R202 903.00.
7. Build wealth and give
The final step of the program is to live life and be generous. People who have no debt and no payments are free to do anything they would like to do. Exercising discipline for a few years will set you up for the rest of your life. Continue to set goals and budget every month, but have some fun along the way.