How to Reduce Debt and Build Wealth

With a thoughtful strategy, you can build a mountain of wealth over time.

If you're staring down a pile of bills and an empty retirement fund, wealth and prosperity can seem a lifetime away. Getting out of debt and building wealth seems daunting at first glance, but this is actually a very attainable goal. When you break the process down into manageable steps you'll see that financial freedom is indeed in your grasp. With a healthy dose of commitment and dedication to improving your financial health, you can cut down your bills while your own funds continue to grow.

Instructions

1. Make a list of all your debts as well as the interest you're paying on each. Be sure to count all forms of debt, including personal and student loans, credit cards, car loans, medical debts and debt to the IRS.

2. Set a plan for paying off your debt. In "The Total Money Makeover," Dave Ramsey recommends beginning with the smallest debt and working up to the largest for the fastest and most satisfying progress. If you'd prefer saving on interest to getting these quick wins, pay your debt off by tackling the ones with the highest interest rate first. Arrange your list in the order that you want to pay the debts off.

3. Reduce your daily expenses as much as possible and channel all your extra funds into paying off your debts. Pay the minimum on all your debts except the one at the top of the list. Pour your extra funds into the top runner on the list until it's paid off. Then, focus all your money on quickly paying off the next debt on the list, and so on.

4. Invest 15 percent of your income in a retirement fund. Now that your debt is gone, you can begin building long-term wealth. Dave Ramsey suggests you use the maximum available benefits offered by your employer first. If your employer will match your 401K to a certain amount, put that amount in before investing in other areas. Next, focus on a Roth IRA and growth-stock mutual funds for the rest of your long-term investing.

5. Invest in a variety of index funds to diversify your money-making potential. Funnel some of your extra funds into stocks as well if you're a young investor. As a rule of thumb, subtracting your age from 120 will give you a rough idea of what percent of your extra money can safely go to stocks.

Tips & Warnings

• Continue to live a frugal lifestyle for the maximum potential funds for retirement. This is especially important if you can't find any extra money in your budget for paying off debt or investing. Try cutting back on your cable or cell phone plan, cooking from scratch at home and buying used to save extra money.

• If you have some debts that need to be paid off in a set amount of time, such as debt to the IRS or medical bills, bump these to the top of your list regardless of amount or interest.

References

• "The Total Money Makeover"; Dave Ramsey; 2007
• CNN Money; 10 Rules for Building Wealth; Jia Lynn Yang