“The average millionaire can’t tell you who got thrown off the island last night.” – Dave Ramsey
A little background on the 75/25 Rule…
Recently I have been receiving a lot of questions regarding my approach to paying off high interest debt versus contributing to emergency fund (and other) savings. This topic has been an orbiter in many of my posts so I figured I would address it directly for everyone to read, analyze, critique, love, hate, smile about, cry over, and provide feedback to.
If you are immersed in debt reduction you are most likely following either the “debt snowball method” or the “high interest first method” of repayment. Regardless of which method you choose you will almost immediately run into the following question:
Should I build my savings first or pay off more debt first?
The popular speaker, author, and fellow debt slayer Dave Ramsey would tell you to approach this question as follows:
- Start an Emergency Fund and focus on building it up to $1,000 – then…
- Shift 100% of your available funds toward high interest debt reduction using the debt snowball method – then…
- Resume contributions to your Emergency Fund until it can cover 3 – 6 months of living expenses.
As you read on remember the following Dave Ramsey quote, “You can’t go wrong getting out of debt.” To that end, this post is not an attempt to exploit some “flaw” in Dave’s approach… because I do not see a flaw. Personal finance is… PERSONAL. Every situation is unique and each person/family will have their own intimate and unique approach that works for them.
So what works for me?
I am one of those people who likes to see my savings grow… no matter what! I LOVE to see my debt decrease in HUGE numbers, but I also need to see my savings grow each week. I feel this way for three main reasons:
- Always pay yourself – I do not like to see ALL my money go out each month without paying myself at lease some of it.
- $1,000 is not enough for us – we built our initial $1,000 EF and a few weeks later the transmission on our only vehicle died costing us $1,600. Shortly after that we ran into another even larger unexpected expense.
- Balance is always good – when I see 100% of my money going out, but none staying home with me, I do not feel properly balanced.
Combining Dave’s great advice with the 2 statements from above, I set out to do what I always do… come up with a strategy that works for me.
I like to cook, and whenever I have a craving for a particular dish that I have never prepared, I find at least a couple highly rated recipes and combine them into a recipe that suits my own tastes. For me, it is no different when it comes to debt reduction and emergency fund savings.
With this in mind I developed what I call The Balanced 75/25 Method.
Here is a detailed breakdown of how I balance my Emergency Fund savings contributions with my debt reduction contributions.
- Contribute 100% of my available monies to build a $1,000 Emergency Fund.
- Once the initial $1,000 is there, start attributing 75% of my available resources to high interest debt reduction and 25% to all my savings funds*.
- Once my high interest debt is gone, resume 100% contributions to EF until it reaches $20,000 (6 months worth of expenses for my family).
- Once that savings is fully funded we plan to fix all (or at least a vast majority) of our available funds on our low rate mortgage and student loans.
*My current Personal Saving Fund goal amounts:
- Emergency Fund – $20,000 – (70% available resources go into this fund)
- Auto Fund – $10,000 – (15% available resources go into this fund)
- Vacation Fund – $2,000/year – (15% available resources go into this fund)
What about you?
Remember above all things… “You can’t go wrong getting out of debt!”
That said, what plan do you follow? Do you follow the Dave Ramsey plan to the tee? Do you follow some other popular debt reduction/personal savings plan to the tee? Or do you create a personalized plan?
Like this article? Here are 3 free ways to join the community and follow the progress – Sign up for email updates, Subscribe to my RSS feed, And/or follow me on Twitter.
DFA is passionately dedicated to helping people break the bondage of debt and work toward financial freedom using biblical principles.