For the unfamiliar, Dave Ramsey is an author, public speaker, and radio personality that has made millions off his method for people to get out of debt and build wealth. He focuses on 6 “baby steps” that begins with saving a $1,000 emergency fund, taking extreme measures to pay off debt, and moving into investing for college and retirement.
There are many things that Dave Ramsey does right. Everyone and their brother-in-law has some sort of personal finance advice or secret that they have to pass along. Not all of it is going to work for everyone and much of it can be expensive, pointless, or counterproductive. Overall, Ramsey’s advice is common sense and applicable to most people. We are all for people getting their financial lives on track. However, when we see popular advice that goes against what we would recommend to our clients, we feel the need to correct the misinformation.
Approved: Living Below Your Means
One of Ramsey’s catchphrases is “If you will live like no one else, later you can live like no one else”. This means that if you can make necessary sacrifices today, you can reap the benefits of your hard work tomorrow. I have to admit that I think this phrase is excellent and worth emphasizing to people starting out on their journey to financial independence. Through our work with younger 401(k) participants and the children of our clients, we pass along basic advice for beginners that really applies to everyone; young and old.
-Don’t pocket your entire raise: Spilt the increase in your salary between savings and fun money. Increase your retirement savings by a couple percentage points and/or add $500 to your monthly mortgage payment. Keep what remains as a benefit of your time and effort at your job. If you want to be a financial pro, put all of your raise into additional savings. After all, you were living without it before.
-Budget, Budget, Budget: Knowing the difference between your fixed, necessity costs and your variable expenses can often save you if an emergency comes along and help you save more in good times. Many people, even wealthy people, have no idea where their money goes. This is ground zero for any successful investment and financial plan. Please reach out if you are in search of a better budget method.
Failure: All Debt is Bad
Ramsey shouts to the high heavens in his book, his radio show, and his website that all debt is evil and getting rid of all debt is priority #1. Well…that may not always be the best idea.
Consumer debt (i.e. credit cards, car loans, lines of credit) with high interest rates and extremely long payoff terms, yes you should pay this off. But does this mean you should cut up your credit cards? No! If you are responsible enough to utilize credit cards for monthly spending and pay them off every month then they are a great resource.
What about mortgages and student loans? They aren’t entirely evil. These often have much lower interest rates and favorable tax treatment. For example, after the tax law changes in 2017, paying off your mortgage may not be the best use of extra cash. Pre-tax law changes, many people itemized their tax deductions to cut down their taxable income, but with the $10,000 limit on property tax deductions and the removal of miscellaneous deductions this is no longer the case. A major source of itemized deductions is the mortgage interest deduction. If your mortgage interest deduction along with other itemized deductions gets you over the 2019 standard deduction of $24,400 then redirecting your excess cash to a more beneficial area might be in your best interest.
Approved: Setting, and Sticking to, Goals
Ramsey’s 6 baby steps are one-size fits-all and not the right order for every person but they are a major factor in the success of his method. If you understand and agree to the goals you are setting and have a plan for getting there, you are much more likely to actually get there.
If you’ve been working with WealthPoint for a while, and have been listening closely, there is a common thread underlying a lot of our advice: stick to the plan. This is in the stocks vs bonds asset allocations that we agree to when you become a client, the retirement savings plans we establish when we explore your financial plan projections, and how we respond to minor and major market movement. Where we differ from Ramsey is in the crafting of those goals. If you are a high-income family with only one spouse working outside of the home, a $1,000 emergency fund isn’t going to cut it. If you are 10 years from retirement with not enough savings, taking an additional two years+ to payoff all debt including your mortgage won’t get you to retirement on your timeline. We work very closely with our clients to develop a plan to reach their goals that fits their situation, not just anyone.
Failure: Behavior is More Important than Math.
We agree with Ramsey’s main opening point: Personal Finance is 20% knowledge and 80% behavior. Financial professionals like ourselves can guide you on your way, but only you can make the necessary changes to reach your goals. Where Ramsey goes off the rails is his Debt Snowball method. This method instructs you to pay off your smallest debts first, regardless of the interest rate, and work up to your largest debts. Ramsey states that the quick sense of accomplishment you get from the small debt payoff will motivate you to stay on track and attack the big debts. This is not how we structure our client’s debt paydown schedule. Consider the following situation:
John Smith has multiple debts. Which should he pay off first?
-Car Loan: $5,000 at 0% interest
-Credit Card: $15,000 at 22% interest
-Student Loans: $10,000 at 4% interest.
Dave Ramsey would have John attack the car loan first, then student loans, and then the credit cards. Even if John could pay off the car loan and student loans within a few months, he would be racking up an additional $275 in pure interest every month!
WealthPoint would advise John to pay down the debts from highest interest rate to lowest interest rate first. Sticking to the paydown schedule is crucial but you always want to do it in a way that won’t add to your debt while you are trying to get in the black.
Exploring the world of Dave Ramsey has been a very thought-provoking exercise. There is no doubt that he has the power to help people turn around their financial lives. But his method isn’t perfect, and it certainly isn’t a replacement for a qualified professional. With WealthPoint’s help, we can build your plan to retirement and guide you through the behavior and mindset it takes to get there.