The Money Makeover - Milestone 3: The Emergency Fund II

At this point, we are totally rocking and rolling with our makeover. We have got the fundamental tools in place (like the budget and emergency fund I), we are continually reviewing and cutting unnecessary expenses and we have cleared our debt.

So what’s the next step? Well, we need to get a safety net, a big safety net to offer us increased security and peace of mind. The Emergency Fund II.

What is the “Emergency Fund II”?

Like the emergency fund I, this is money in the bank “just in case”, but rather than act a a buffer against unexpected “casual” expenses, this exists to help shield us against something potentially far worse, unexpected job loss. Unfortunately (especially in recent times) this can happen, and when it does, it can hit hard and have a disastrous “rippling effect”.

In a nutshell, the fund:

• .. is 1 years salary (gross).
• .. is allocated meaning we do not touch it unless we absolutely have to.

So, take your salary (not your take-home). That’s what we are aiming for. Yes, it is scary isn’t it.

Why do I need this “emergency fund II”?

• First and foremost, it is a big safety net. The last thing you want to worry about when unexpectedly losing your job (for whatever reason) is how to pay for things like groceries and other things you need.
• Not to mention the stress saved when the situation occurs, it removes the stress of worrying about if the situation might occur. Less stress (anywhere) is good!
• Keep in mind, we are saving a years salary gross of tax. This means that it will last at least a year without any loss of quality of life. Not to mention that if things did get “difficult” you could snap in to “survival mode” and stretch it out even more.
• It’s your cash! Rather than paying in to some random insurance fund and letting have someone else do the same thing as you are (and taking a slice), it’s your cash in your bank and all the interest is yours.
• On the “insurance” note – not only is it all yours, it’s accessible to you with no questions asked. Again, if you are going through the stress of worrying about income, the last thing you want to deal with is someone from an insurance company trying not to give you the cash you need.

So, it’s all about reducing stress and adding safety nets. All positive. Good stuff!

How the hell do I fill a fund that big?

Well, however many months ago when we started the makeover – how scary did all that debt look? The very same debt that we have cleared! At this point we have all the tools and discipline to make this fund a reality which is precisely why we are starting it now.

At this point, we have got pretty good at “finding cash” – we are able to strip back expenses and not have anything sneak up on us and blow a hole in our budget.

All that cash you was putting in to debt? Start by putting that into an account for your emergency fund II.

It’s that simple.

As well as that, we can also do the following:

• Look for high-interest savings account that are geared to longer-term and regular investment. Since we are not going to need the cash “immediately” (and we have our emergency fund I to assist with that) we can afford to wait a bit before getting our hands on the cash. For example, many banks run a “30 day notice account” which yields higher interest, but you must notify of intent to withdraw, which takes 30 days to clear.
• All that yummy interest from our high interest account should be reinvested to help build the fund quicker.
• Ensure that our fund target is at or above our current salary. If you take a pay rise, then bring the fund up too. If you take a pay cut, bring it down (or leave it where it is if higher).

Always try to keep it simple, but also try and get as much bang for your buck. You might find the bank starts to play more nicely with you once they get wind of our financial intentions (since they don’t like us right now because we aren’t lining their pockets with interest from credit cards and charges from overdrafts etc.).

In Summary..

The process is simple. Since I have only just cleared my debt I have only just started building my emergency fund II, however, I have set some targets for the end of the year and really hope to meet them (but I have a rather challenging year ahead so not gone public with the commitment :).

I have to be honest, I am really excited about getting this one done. It must be such a liberating feeling that no matter what happens with your employment status, you are going to have a pretty strong safety net that should last a year.

Happy saving!

The “Money Makeover”– Milestone 2: The Debt Snowball

At this point, we should have created our budget, allocating savings and have our emergency fund 1 to prevent surprises and naturally cutting expenses where we can.

So, what’s the next step? Well, we really need to own our responsibilities and clear our debt.

What is the "Debt Snowball”?

Put simply, it is a list of all of the debt that we have. Loans, credit cards, money owed to friends/family, overdrafts whatever. The only debt it doesn’t include is the mortgage.

The aim of the snowball (at a high level) is to simply provide some visibility and focus on the money that we owe to other people. As you can see, a central theme to our makeover is removing surprises and setting expectations of our money.

As people in command of our cash, we should always clear debt before having our own fun with our cash (and we never borrow again once we have cleared it).

Why have a “Debt Snowball”?

For me, I love the idea of the snowball for the following reasons:

• It’s simple. Always KISS.
• It gives me clear success criteria. A requirement for any real project/task. Once a debt is cleared, you can cross the item off the list.
• It provides focus. Again, we need to focus on important things to get them done quickly and efficiently.
• It provides a mechanism for “gearing”. If you have a lot of debt, owed to a lot of different people, things can get overwhelming. You can have a lot of little fish nibbling away at you as well as the big sharks. This can be really overwhelming. The snowball allows you to focus on one enemy at a time and systematically take them out, as well as preparing you to take down the sharks too.

The last point is a good one – I can’t reiterate enough through removing surprises and fear, this whole “money” thing becomes a lot easier and makes for much better sleep at night.

How do we create our “Debt Snowball”?

Like I said, I love the snowball because it’s simple:

• Grab all your bills/contracts and whatnot. Everything that means you have some kind of “credit agreement” with an organisation.
• Write down any money you owe to friends/family.
• Now list ALL of them on one piece of paper/spreadsheet (whatever your tool of choice is). Ordered from smallest to largest, clearly showing how much is owed, and the minimum payment required (where applicable).
• Now add these items to your budget (the ones with minimum payments are already there though, RIGHT? ;). Even if some of them have “0” in.

This is our snowball. If you have a snowball like mine, you are probably looking at the bottom figure and sweating a bit. Don’t worry, that’s fine. It will be gone soon enough :)

So, I have a scary list/”snowball” – now what?

OK, so we now have three important things:

1. We have a sight for our weapon (the budget).
2. We have a mechanism for generating extra ammunition (through cutting).
3. We have a hit list (our newly creating snowball).

So, let’s start taking these things out shall we?

1. Every month when you create your budget, take every surplus £/$/whatever and pile them all on to item at the top of the list.
2. Make the payment to the card/company or whatever ASAP (to stop accruing interest as quickly as possible). If this is not an option, then get it into the allocated savings to gain some interest and prep to take it out in one fell swoop. Remember, allocated savings are allocated – it’s not the “buy a new plasma TV fund”.
3. Keep paying the surplus each month to the top item, or saving. Once you have cleared the debt cross it off the list. Go ahead, you can smile/dance/streak – it does feel great crossing it off :)
4. Now, you should have some extra surplus (the minimum payment to the debt you just cleared) as well as the surplus created through cutting. Load ALL of this onto the next item.
5. Rinse and repeat until the list is history.

A few points to note:

• We are always paying minimum payments first. You make a commitment to these credit people, stick to it.
• We are focusing our real effort (the cutting) and it’s product (the surplus) on one thing at a time.
• Once we have killed one target, we then throw everything at the next.
• You will be amazed how much velocity you can build up. Worried about when you start getting to the bottom of the list and those big scary numbers? Well, you are going to be throwing a LOT bigger punches by then. They don’t have a freaking chance.
• We don’t start having fun with the surplus until the list is dead.
• Responsibilities first, fun later.

The last two points are important – it’s easy when you start getting to the bottom of the list to think “oh wow I don’t need to put that much into that debt”. Well, guess what? You DO. YOU NEED TO PAY THE DEBT.

And the best bit:

Once the list is done, you are going to have a lot of steam built up to start putting in to fun things. And you should do so, you have earned it my friend.

Some Tweaks

The book prescribes the method as above – however, I did make a couple of relatively minor tweaks – these should only be done if you have the discipline to not mess around!

Interest Rates

I re-jiggled some of the smaller debts to clear based on rate of interest. Some credit cards have a crazy interest rate and it can cost a lot more if you keep them running for too long.

However, I would say only re-arrange debts that are within a few hundred £/$ of each other. You need to keep the really big fish towards the bottom of the list because the motivational power of killing all the small fish first can really give you a boost in cutting more (not to mention it’s one less debt to worry about).

Loans and Early-Exit Penalties

Some (read: “most”) loan agreements have an early-exit penalty. If you want to clear the account early, then they will charge you an additional rate based on the term remaining. Make sure you read the loan agreement carefully (it should be in a clearly-marked section) or you can get a nasty surprise when the account suddenly has additional debt piled into it after you make what you believe to be your final payment.

In situations like these, put the cash into your allocated savings and draw from it each month when a payment goes out. This enables you to get a little bit of interest on the cash, as well as remove the debt. Just keep it allocated and don’t touch it.

In Summary

A simple, yet effective tool for tackling the debt owed. I love the way it focuses us on building our velocity up to run through each and every account. Believe me, it feels really good crossing off those big fish at the bottom :)

Happy debt-slaying :)