Dave Ramsey’s Baby Steps Are Too Rigid

I’ve written before about some ways in which Dave Ramsey may be misleading you.  For the most part, however, I think he gives great advice, especially with regards to the behavioral issues relating to getting out of debt and dealing with family and small business financial issues.  One of the pearls Dave has contributed to the personal finance lexicon are his “Baby-Steps.”  They seem aimed at the financially clueless, but they still have merit for the more knowledgeable.  I introduce them in this post.

 Step 1 – Build up a $1000 emergency fund

According to Bankrate, 30% of Americans have no money at all.  Literally there is no savings account, CD or anything like it.  Meanwhile, Americans have $785 billion in credit card debt.  Divide that by 114 million households, and you’re left with $6886 in credit card debt per household.  With the median household income being $51,400, that suggests that the typical American has an emergency fund of NEGATIVE 1.6 months.  Getting $1000 in a bank account is a vast improvement.  It allows the household to avoid racking up more debt for relatively minor emergencies- small medical bills, broken appliances, car repairs, minor home repairs, airplane ticket to a funeral etc.

Step 2 – Pay off all debt (except mortgage) using the debt snowball

I don’t know if Dave Ramsey is the originator of the “debt snowball” idea, but he is certainly most responsible for popularizing it.  The idea behind the debt snowball is that you pay your debts off in order from smallest to largest, without regard to the terms or interest rates of the loan.  This is a purely behavioral approach to the problem, and Dave has been appropriately criticized for making an incredibly gray issue seem black and white.  He advocates that this approach helps the debtor “feel success” and “gain momentum” so he is more likely to complete the process and get out of debt.  If you examine the numbers from a mathematical perspective, you quickly realize that if you put the same amount toward debt repayment each month, you’ll be out of debt sooner by paying down the highest interest loan first.  Sometimes, especially with low-interest debt, you may be better off not paying the debt down any faster than you have to and using that money to invest in risky or even low-risk investments.


You can also argue that despite interest rates, some debt is worse than others.  For example, student loans can’t be discharged in bankruptcy.  That’s a good reason to get rid of them or exchange them for other types of debt whenever possible.  It also doesn’t consider the tax-deductibility of some types of interest.  At certain incomes (usually less than doctors make) student loan interest is deductible, even if you don’t itemize.  Mortgage interest is also tax deductible if you do itemize, lowering the effective interest rate owed.

But it’s pretty hard to argue that you should build up a larger emergency fund, save for retirement, or begin saving for college when you’re paying interest of 15-30% on credit card debt.  Even at rates well below 10% (think student loans), it might be worth forgoing tax-advantaged retirement savings in order to get the risk-free “return” that debt repayment provides.

Step 3 – Put 3-6 months worth of expenses in savings

This is a pretty standard piece of personal finance advice, but I confess I’ve never actually had a dedicated emergency fund with 3 months worth of expenses in it.  It seems every time I get close that I find something that I want to invest it in.  It just didn’t ever make sense to me to not max out a Roth IRA in order to fund an emergency fund.  I figure I can always withdraw the contribution tax and penalty-free if I really need it.  Likewise, I hated to pass up a significant tax break in order to put the money into an emergency fund.  Do I really want to pay an extra $5K in taxes in order to have $15K in an emergency fund instead of my 401K?  Not really. Our emergency fund gradually grows, but so do our expenses, so we’ve never actually hit the 3 month mark.  It doesn’t bother me much anymore.  At a certain point you don’t need an emergency fund.  A retiree living off his portfolio has the entire portfolio as an emergency fund.

Do I think you absolutely need 3-6 months of savings before investing anything?  No.  But you probably need a larger emergency fund than $1000.  It can take a very long time to acquire an emergency fund of 6 months expenses.  Imagine someone who pays 20% of their income in taxes, and is putting 15% toward an emergency fund, with plans to invest that toward retirement after the emergency fund is complete.  To make it easy, we’ll assume they make $100K a year.  So their emergency fund needs to be $100K*65%*0.5= $32,500.  Saving $15K a year means it’ll take 26 months to fill that emergency fund. That’s a long time to put off investing.  I like the concept.  I don’t like the rigidity of having to complete one step before starting on the next one.

Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement

I generally recommend to readers on this site that they put 20% of their income toward retirement.  But 15% is in the ballpark and is probably plenty for someone who starts early and doesn’t plan to retire early.  Dave’s advice here doesn’t quite fit with what I’ve criticized before- namely Dave’s mistaken idea that “good growth stock mutual funds” reliably earn 12% a year on average.  If your investments REALLY earned that much, you could save far less than 15% a year.  (assuming 40 years of saving and guaranteed 12% nominal returns you could save as little as 1.3% per year thanks to compound interest.)  But they don’t, so you need to save 15%-20%.

Step 5 – College funding for children

I think Dave got this one right on.  You need to take care of yourself first before worrying about your kids.  Eliminating the burden of supporting you in your old age is far more valuable than providing a few thousand toward their college costs.  I’m surprised how many people make this mistake.  You can’t get loans for retirement, but it’s easy to get them for education.  Plus, if you’ve got retirement on track by the time the kids get into college (usually when you’re around 45-50), you can easily cut back a bit on retirement savings and help pay for their college with your monthly cash flow.  Compound interest and the time value of money make it far better to cut back on your retirement savings when you’re 50 than when you’re 35.

Step 6 – Pay off home early


I don’t have a problem with this advice either.  Since mortgage rates are usually pretty low, and the interest is often completely tax deductible (my effective mortgage rate is 1.8%-below the rate of inflation), even a rabid anti-debter like Dave Ramsey recognizes that sometimes it may be smarter to invest rather than eliminate debt.  There are benefits to paying off a mortgage early, including the psychological feeling of being debt free, but also the financial freedom of lower fixed expenses and the elimination of the risk of losing your house to the bank in the event of misfortune.

Step 7 – Build wealth and give

I also agree with Dave that giving away money is important.  There is a lot of variability here.  Many people give away 10% or more of their income each year, even when they don’t make that much.  Yet there are also plenty of high-income people who give away little more than a few hundred dollars a year.  I’m always interested to see the percentages that presidential candidates give away when they publicize their tax returns.  There are also a lot of people who don’t give anything away until after their death.  They figure they’ll give away what they don’t need, and can’t know what they don’t need until they’re dead.  It really comes down to your values.

I’ve got two problems with Step 7.  First, what do you need to “build wealth” for if you’ve already got plenty of money for retirement and for college?  Building wealth for the purpose of building wealth seems a bit miserly to me.  I’d be happy to see Step 7 just be called “Give!”  Second, as mentioned before, I dislike the rigid order of the baby steps.  I guess I’ve completed Steps 1, 2, and 4, but I’m doing steps 3, 5, 6, and 7 simultaneously.  The world is much more gray than black and white.  I appreciate the structure provided by the Baby Steps (and suspect there are a lot of people who need it, especially the type that spends years on Step 2), but I think a more sophisticated view of personal finance is probably beneficial.

Image Credit: Alexis O’Toole, via wikimedia, CC-BY-SA

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Comments

Dave Ramsey’s Baby Steps Are Too Rigid — 38 Comments

  1. There is some ‘evidence’ that the debt snowball is better.
    see http://getrichquack.com/2012/08/23/snowball-or-avalanche/

    On a personal level, I did feel better ripping through smaller debts first.

    The trouble is, some young doctors rack up a mountain of bad debt and they need some guidance otherwise they keep their debt like favourite pets.

    In general saving 3-6 months expenses will cover the time the income insurance kicks in if you are unable to work in Australia.

    Perhaps the WC investor can come up with some paediatric steps for worldwide doctors to follow!

    • That article didnt sound like the subjects were doctors, but rather a slice of the population at large. That mindset should not apply to physicians who should be able to sit down, make a spreadsheet and make things obvious. The only evidence needed is the mathematical fact that paying down higher interest debt first saves more money. I could care less how fast a particular debt disappears, I focus on the servicing costs. You just shift what you’re rewarding, and its obvious how fast that applies itself to the remaining debt, its really a no brainer.

      That doesnt work for the public in general because they are largely in debt for different reasons than physicians in the first place, ie, not to pay for their schooling and future (investment) but because of behavioral problems. So that again makes sense. We cant take that kind of broad brush and then paint a small subset with it, or vice versa.

  2. You totally beat me to the punch! I wrote a book review on Dave’s book covering these baby steps a couple of weeks ago, but haven’t posted it yet. In short I think the underlying messages of live below your means, don’t take on debt, and be disciplined is great, but the “how to” recommendations are definitely not the most efficient path. You covered the wealth building and retirement issues in the Dave Ramsey might be misleading you article, but I truly think you were too nice because these recommendations are dangerous. I’ll get my review up, so you can take a look.

  3. Sure- the debt snowball is better “because people are more likely to stick with it.” It’s behavioral. Mathematically if you can be disciplined to pay the same amount either way, you’re better off with the “highest rate first” method.

    Oftentimes it’s the same thing though. People tend to have less credit card debt than student loan debt than mortgage debt. And reasonably intelligent people try to take on lower interest debt before higher interest debt, so often times there is little difference between the methods.

  4. Great article and advise for financially peaceful life. I wanted to share personal experience with Step 6 and why I feel it is better to pay off mortgage even when mortgage interest rate is low.

    A few years ago, we were discussing net worth with a friend. We were surprise to learn that their net worth was growing at 20-30% yearly compared to 10% or so for us. Only difference was that they had paid off their mortgage while we were still making monthly mortgage payments. Even though logically argument like “sometimes it may be smarter to invest rather than eliminate debt” make sense for low interest mortgage debt, they encouraged us to pay off mortgage and see the difference in net worth growth.

    Earlier last year, we decided to pay off mortgage (our only debt) and guess what our net worth increased by almost 30%. In retrospect, I believe some of the following factors contributed to higher growth in net worth:

    1. The monthly mortgage payment that were almost 20% of monthly income were now directly going to bottom line (net worth) instead of making principal and interest payment on mortgage debt.

    2. The return on investment from a mortgage is tied to return on the house value appreciation (real estate component of your portfolio). You can’t take that mortgage amount (because you don’t have that money) and allocate similar to your total portfolio.

    3. The net worth contribution of a house = house value – mortgage amount (asset – liability) is an incorrect one for personal life. Actually, the net worth contribution of a house = house value – mortgage amount – total interest you plan to pay over the life of carrying remaining mortgage. Not only, you are paying penalty in terms of “total interest you plan to pay” but also this money is not generating return at the rate of your overall portfolio.

    Until I paid off mortgage and experienced the much higher growth in net worth, I also didn’t believe that carrying low interest debt is not a bad idea. But now I am a believer in that in personal life having no debt is the best. Borrowing at low interest rate only makes sense for businesses who can use low interest debt to generate higher returns that the interest rate.

    • I dont disagree with the point in general, and if you have the extra funds why not pay down the mortgage since the security is also a very nice benefit, and eliminating the long term accumulation of interest on a 30 year note. However, I dont see why you would let a simple net worth calculation drive that behavior, and how paying off the mortgage would change your net worth differently than taking those same funds and putting it into an index fund? Obviously, you could also mix these strategies. Agree that having no debt is the best.

      That said, a mortgage, especially a low interest one is an inflation hedge and a good one at that. Its likely the dollars you paid off the mortgage with are worth more now than in 5-10y. Depending on the remaining years on your mortgage and until your expected retirement, you may have discounted the future value of that invested cash. In the same way the mortgage payment today is more expensive than tomorrow, money invested today earns more than tomorrows. Get bit on both sides.

      I know there is some controversy about it, but I dont think you should use your home value in your net worth calculation. Its a consumptive item, you cant just sell it without having some sort of replacement which will cost you money in some way. Sure if you downsize or have another place already, but thats not how people typically compute the net worth when they discuss these things. You’ll have a much clearer picture of your net worth if you disregard home value.

  5. I completely agree with you about the emergency fund. I have never understood the concept that I have to have 3-6 months of living expenses sitting as cash to be financially secure. Especially when you are not maxing out all tax advantaged accounts. I use the Roth IRA for my emergency fund because I can withdraw the contributions tax and penalty free. I can get to this money within a few days and get the benefit of paying no taxes on earnings if I do not withdraw them. All of this being said, I put 25-30% of my income in other tax advantaged accounts so I do not need the Roth to have an adequate retirement savings rate. If I needed this space for an adequate retirement savings rate, I would be putting retirement savings in a taxable account. I also invest conservatively with the money in the Roth that is used as my “emergency fund.”

    As a physician with a stable job, I will be able to handle the vast majority of emergencies with a 1 month emergency fund and my monthly cash flow. Larger financial needs are uncommon and I can not justify earning a rate less than inflation in a taxable money market account for something that is very unlikely to happen. Insurance (which is what an emergency fund is) is for financial catastrophes. If an emergency happens to me, I will take that 3-6 months of living expenses out of a tax advantaged account, which will not be a catastrophe for me as I am saving at such a high rate now. Lastly, the IRS allows for penalty free withdrawals many retirement accounts if someone becomes disabled. So I just can not forsee a situation that will be a catastrophe that I will not be ok.

  6. Thanks for your comments Anil. I’m not sure I agree with all of them, but I don’t see anything wrong with living a debt free life. Yes, you may leave a little money on the table, but life isn’t necessarily about “maxing everything out.” I think your anecdote about net worth increasing faster with a paid off mortgage is just that. I find my net worth increasing by a smaller percentage each year (but a larger dollar amount) because my annual savings becomes a smaller fraction of my net worth each year. Plus, portfolio returns start having a big effect. For example, if your $1M portfolio dropped by 40%, you’d still have a negative net worth increase for the year even if you paid off a $300K mortgage.

    I also think you’re unnecessarily confusing the return from paying down a mortgage with the appreciation of your house. These should be kept quite separate in your mind. Your return on paying down the mortgage is exactly the mortgage rate (and perhaps less if all or part of your mortgage interest is tax deductible). The return on the house depends on the change in its value plus the value of the dividends (i.e. what it would rent for minus taxes, maintenance, and repairs.)

    Again, I have no problem with someone paying off their debts. There are good reasons to do so. But pretending there isn’t an arbitrage opportunity available by borrowing at a low rate and investing at a probably higher rate is just denying reality. Paying off debt is less risky and probably better from a behavioral perspective. Arbitraging low-interest debt is probably better from a mathematical perspective.

    Dwolf- I like your article. The thumbs up/thumbs down approach is nice. Sometimes I wish I could be that concise.

    Alan- Thanks for the support. I don’t see a physician income as being nearly as stable as you seem to, but the important thing is to have a plan in the event you have a major emergency. Withdrawing Roth contributions is a reasonable plan. Withdrawing 401K contributions isn’t nearly as reasonable given the taxes and penalties you pay. I expect I’ll eventually work my way up to a 3-6 month emergency fund, but a good chunk of it may be in I Bonds or something similar. It didn’t feel nearly so bad holding cash 5 years ago when Prime MMF was paying 5.25%.

  7. My point about being stable was that I will have a job and have an income. So I am not worried about being unemployed. If something ever happens to our salaries (which I agree that our salaries are not something I would call stable), I will change my plan then, but nobody knows what our salaries will be in ten years. I am not going to stress about if and when my salary might change.

    Withdrawing from a 401k might not be the best option, but I have a 457, which will have no penalty if I leave or lose my current job. And the IRS will not charge a penalty for withdrawal from most retirement accounts (401K included) if you take the money out for disability reasons. Yes, I will have to pay taxes on the money, but I will also have to pay taxes on it when I retire so I am not sure of your rationale here. I will need a larger amount because it is pretax, but isn’t the whole point of this discussion that the money is tax advantaged. Also, if I need the money early, I might take it out at my marginal rate now, but I am also putting it in at the same marginal rate so I do not see a loss here. And if the year I withdraw it I have less income because I am out of work, my effective rate will be lower than my marginal rate now so it will be an even better reason to use the 457 as my emergency fund.

  8. Dave’s advice is for those who are not very dedicated to financial security and need structure and emotional support. For those with better dedication other methods are more appropriate. The emergency fund might not be needed for folks who save a lot of their income, and the buffer for larger issues might not be as appropriate for folks with very secure careers.

    Otherwise Dave has done a lot of good and would be even more successful if more folks spent less and saved more.

  9. WCInvestor

    I think you have to remember that Dave Ramsey is not giving advice to doctors, he and most personal finance people are giving advice to people making 30K a year or less… or maybe a little more but with more obligations.

    The reason for that emergency fund is that they have no money, there is no roth ira or anything else.

    he’s trying to get them to have $1000 so that when their tire blows or their faucet breaks that it’s not just another thing going on their credit card.

    If you’re smart enough to find this website and are a semi or regular reader, you are probably well beyond Dave Ramsey’s baby steps…. to the point that I find the topic somewhat useless on this type of a site.

    Also I disagree strongly with paying your home off early unless:
    1) you haven’t refinanced down to some of these filthy rates… i have a 2.625 10 year – i can EASILY with low risk beat that in the market.

    2) You know nothing about investing and don’t intend to learn (this defines a HUGE number of people who don’t know an ETF from a R2D2)

    If you have a low rate and you’re comfortable with investing then it’s crazy to pay off your home early regardless of “net worth” baloney.

    Not sinking extra money into cash accomplishes:
    1) More money for my cash portfolio, which generates 5-6% fairly easily with little risk

    2) since i haven’t put the money into cash i can more easily take advantage of another opportunity if one arises…. maybe i need a car and if i’d sunk money into my home i couldn’t pay cash for the car and now have to borrow again.. that’s crazy… maybe an opportunity for buying into a business, a stock i really believe in, some real estate… cash plays with all those opportunities.. cash is king! I lose a lot of options when i sink the money into my home.

    • Z

      With all do respect, I think your first statement shows total ignorance towards Dave’s plan and
      That of financial planners. Doctors also need advice on how to build wealth. Making the money is only a small part of building wealth.

      I’ve have listened to Dave’s show for awhile now, and there have Ben countless numbers of doctors, lawyers, and others making well into 6 figures who call in to his show to do their debt free scream and or ask for some financial advice.

      Why go see a doctor if I’m not sick? Because Prevention is the best and cheapest way way to be healthy. Annual check ups do that.

      Why do I need a fininacial planner if I make $100k and already have a 401k etc…? Because that is the best way to prevent a costly mistakes in building my wealth.

      • Unfortunately, sometimes seeing the “financial planner” is one of those costly mistakes. There are so many mutual fund, annuity, and insurance salesmen out there masquerading as planners that I would bet most people would be better off not seeing most “planners”. Sad but true.

        Seeing a fee-only planner and paying a fair price for good advice is unfortunately rare, but becoming less and less rare all the time thankfully.

  10. Defending Dave Ramsey by saying his advice is not for high income families is fair, but I personally know many doctors who believe in the emergency fund. I have seen many defend it on this website. And lower income families have access to Roth IRAs as well. So why is putting money in a ROTH for an EF not a good idea for them as well? Obviously this money should be invested conservatively until it is large enough.

  11. I’m curious where you’re generating 5-6% on cash with little risk. I’m not seeing anything paying that without significant risk right now.

    I agree that you need an emergency fund, whether its in your local credit union or in your Roth IRA.

  12. Preferred stocks mainly.

    You should check out the yieldhunter website.

    Obviously its not no risk like a cd, but you are basically buying the debt of investment grade companies. Its been great for me for years but most people just dont understand how to do it.

  13. RE: step 7
    I give way more than 10% of my income away every year, and I plan to give even more in 2013!
    39.6 federal marginal, plus state income tax, plus 20% capital gains tax, plus new deduction and personal exemption phaseouts, plus uncompensated medical care given away…. seems plenty to me.
    After all that I take $ and put it towards other steps and a hope of early retirement.

  14. Preferred stocks = “cash with little risk?” I think you underestimate the risk of your preferred stocks if you think about them as somewhat similar to cash.

  15. @WCI

    If on a risk scale… 0 was US Treasuries and CD’s, and 10 was Pink Sheet Penny Stocks

    Where would you rank the following:

    Large Cap US Stock Index Fund
    Mid Cap US Stock Index Fund
    Small Cap US Stock Index Fund
    Large Cap Foreign Stock Fund
    Bond Index Fund from Investment Grade US Companies
    Preferred Stock Index Fund from US Investment Grade Companies
    REIT Index Fund
    US Utility Index Fund
    MLP Index Fund

    Looking at a Chart, I think user “Z” really has a point that preferred stocks are fairly reliable income generators without a huge amount of risk.

    For instance, if Treasuries and Cd’s are a 0 risk, I can’t imagine a diversified preferred stock portfolio would be over a 2 or 3?… and given the spread of like 1% interest to more like 5-6-7%.. that seems like a pretty fair risk/reward trade off, no?

  16. Good questions. There is a fundamental difference between stocks and bonds and most stocks are much riskier than most bonds. Preferred stocks are a bit of a hybrid security, so perhaps halfway between the two. Less risk than stocks? Yes. More risk than bonds? Definitely.

    There is a risk:reward continuum. However, just because an investment is riskier, DOESN’T necessarily mean the expected rewards are higher. Penny stocks for instance. The risk is quite high, but the reward really isn’t. Using your scale:

    CDs (under $250K) and Treasuries: 0
    Large Cap US Stock Index Fund: 7
    Mid Cap US Stock Index Fund: 7.4
    Small Cap US Stock Index Fund: 7.8
    Large Cap Foreign Stock Fund: 7.3
    Bond Index Fund from Investment Grade US Companies: 2
    Preferred Stock Index Fund from US Investment Grade Companies: 5
    REIT Index Fund: 8
    US Utility Index Fund: 7.5
    MLP Index Fund: 8.5
    Penny Stocks: 10

    The issue with preferred stocks is that they are more complex than both stocks and bonds. Remember that complexity favors the issuer. The issuer in this case is the company issuing the security. The terms of the deal will favor the company. Larry Swedroe, in his Alternative Investments book , puts preferred stocks in the “flawed” category along with convertible bonds, junk bond, and private equity (as opposed to the good, bad, and ugly categories). His reasoning includes that the maturities are generally quite long (adding in interest rate risk), there is call risk, there is significant credit risk, dividends are easily suspended even if the company goes into bankruptcy, there is preferential treatment for the corporate buyer of these bonds (not you), there are no low-cost index funds of this asset class, buying individual issues involves trading costs, lack of diversification, and need to monitor credit ratings, and credit risk increases over time due to the long maturities. He convinced me that I don’t want to buy these things. I suggest you read his chapter and then make your own decision. But thinking they’re “bonds” just isn’t correct. They’re not.

  17. There are etfs of preferred stocks with pretty low expense ratios that follow an index.

    Thank you for that post wci. Very insightful.

    Also gave me a great insight into your risk tolerance.

    I think i learned today that my risk tolerance is higher than i thought.

  18. Z-

    A few things about risk, returns, and risk tolerance. First, always remember that investing is not a competition. It isn’t about beating the S&P 500 or your neighbor or whatever. The goal isn’t to have the highest return or the most risk tolerance. The goal is to achieve your financial goals with the minimum amount of risk.

    Risk tolerance is like The Price Is Right. You want to get as close to the right risk as possible without going over. Going over your risk tolerance is devastating- just ask my three partners (and millions of other individual investors) who sold out in the depths of 2008. The very best way to know your own risk tolerance is to assess your behavior in a bad bear market. I remember in Fall 2008 when my stocks were down 50%. I’d lost the equivalent of all the money I had saved in my first 4 years of investing. What was I doing? I was finding all the cash I could and stuffing it into stocks. My REITs, an asset class I’d just added in 2007, were down something like 75%. I wasn’t really keen on buying any more of those. I was wondering if they really could go to zero. I have to admit that while I didn’t sell them, I certainly didn’t feel like buying more. Luckily, I was smart enough to leave things on autopilot and I actually did buy some more on October 24, 2008 and again on January 7, 2009 according to my records. But by the first week of March 2009, at the very bottom of the bear market, I was certainly doubting myself. Take a look at what I posted that week on Bogleheads:
    http://www.bogleheads.org/forum/viewtopic.php?f=10&t=33849

    If you haven’t yet had the opportunity to go through a big bear market, I suggest you set your asset allocation on the conservative side of what you think you can handle. Better to underestimate your risk tolerance than overestimate it.

    Another consideration is to take risk as efficiently as possible. Swedroe, for instance, is a huge fan of taking risk “on the equity side.” He likes to keep his bonds very safe, and then tilt his stocks toward the riskier asset classes. Securities that combine bond and stock risk like preferred stocks, convertible bonds, and junk bonds tend to mix the risks, which trends toward not being as efficient.

    I’m not surprised to see there is now an investible index for preferreds. I guess that removes that argument against them. They still aren’t a cash equivalent, of course.

  19. Thank you for that posting.

    I started investing in 2002 during a bear market, but i didn’t have enough money in play to matter.

    I had a pretty good amount of dough (to me) in 2008 when things went downhill.

    At market 11,000 i truly saw the writing on the wall and went 100% cash.

    I did not get back in at the bottom, but around dow 9500 i went back into the market back to my normal ratios.

    Was i lucky? absolutely. Did i time it perfect? no way, best was dump at 14K, get back in at what.. 7? that would’ve been epic.

    but i know enough not to sell when the pain is at its worst.. the time is always quite a bit before that… or that when the pain gets unbearable to buy buy buy.

    I know a TON more about the markets now than i did in 2009… i will look forward to another buying opportunity like that in the next decade or so.

  20. We may not see another opportunity like that in our lifetimes. And if we do, it may not end the same way. That’s the risk of investing in equities I suppose. Sometimes, they don’t come back up. Consider the Russian stock market (St. Petersburg) in 1917. Or the Egyptian one in 1961. You could actually probably argue that all stocks eventually go to zero.

    At any rate, after 2000-2002 and 2008-2009, I’m sure you have a pretty good idea what your risk tolerance is.

  21. WCI and others

    I am a big Dave Ramsey fan but I do like that you are objectively criticizing Dave’s plan and not just bashing. Here are some issues I have with your arguments.

    Step 1 none really.
    One of the reasons for this step is just to have some padding to protect people against Murphy. Another reason is that for almost everyone, it is pretty easy to scrape together a grand by creating a strict budget and selling stuff. This is a quick win. Usually takes 4-6 weeks average. Because its quick and easy people get a since of accomplishment and gain confidence that the can actually achieve their ultimate goal of financial peace.

    Step 2. Eliminating debt mathematically or emotionally doesn’t matter. I’m not going to beat a dead horse. Although the difference financially is minimal in the long run.

    Step 3
    $32000 is an awful big EF. Most people can get away with $10000-20000 for an EF. That maybe 3 months expenses for some and 6 months for others. Depends on your comfort level. Remember, dave wants you out of debt in less than 2 years. It takes intense focus and a very tight budget to get to that. Take for instance my situation, I’m in step 2, I was able to loosen up enough money to pay about $3000/mth to eliminate my debt in about 12 mths. If you keep the intensity rolling into step 3. You can have your EF in another 3-4 mths. If $30000 is your comfort level, that would only take me 6 moths at my intensity. As far as using a Roth IRA for an EF, a lot of people won’t have one set up yet and therefore it would take too long to get 3-6 mths worth in there at a rate of the max contribution of $5500 per year. Remember an EF is insurance not an investment. And insurance cost money.

    Step 4
    I’m not going to argue with 15% or higher for investing. We do agree that it should be at least 15%. But you can get around a 12% return on good growth stock mutual funds. Look at the track record of the S&P 500 over the last 70 years. The average rate of return of that time frame is 11.9%. If you cannot at least equal the market, then you better fire your financial guy. Remember your not trying to make money fast. Sure over the last 5-7 years the market was terrible. Some years I only got an ROI 6% some 9%, Some negative. Last year my ROI was over 15% and I had a couple funds return 18%. In January and February of this year I have already got an ROI OF 6%. If that continued, my year end ROI would be36%. We know that wont happen though. Bottom line, 12% is possible. I’ve been investing since 99 and I’m averageing 10%. Now I will be doing better since I’m a little wiser. There’s a book that best describes investing and building wealth. “The Tortoise and the hare.” Slow and steady wins the race. Every time I read it, the tortoise wins.

    There is no rigidity on the baby step plans. It’s a plan not law. Plans can be adjusted and refined. 4,5,&6 are all done simultaneously. Actually starting at step one you are actually doing step 7.

    Step 6
    Paying off your house is financially sound. Even if you have a low interest rate, it’s still sound advice. All we are doing is minimizing risk and reducing stress. If I had a paid for house, the housing market crash in 08 would not have been so devastating to me. That is worth paying off my house. To keep a mortgage for the tax purpose is just ridiculous. Lets say you are in the 25% tax bracket, and you paid $10000 in interest last year. Why would I give the bank $10000 to save me from giving the government $2500? So if you didn’t have that tax break, you might be in the next tax bracket up and pay more taxes. Then take the $10000 that you are not paying to a bank because your house is paid off and give it to a charity. Same tax advantage and you are helping others instead of making the wealthy bank wealthier

    Step 7
    Arguing about what to title to give step 7 just seems like nit picking to me. Actually this step is about more than just giving. Yes please give we all agree to that. The rich rule the poor. This means that you cannot help people if you are broke. But if you build wealth approriately you can make huge impacts in people’s lives. In this step he teaches you not only to give, and by the way he instructs to give all through the steps, but To continue to save and spend your money also.

    When you can give away a lot of money, while still saving to leave an inheritance to you children’s children, and enjoying the fruits of your labor, THAT is the definition of wealth and is truly FINANCIAL PEACE.

    • Pacer Dude-

      Welcome to the site. I hope you stick around and read more of it. I’m glad Dave helped you get out of debt. He’s very good at that.

      You might be surprised to learn that the average investor couldn’t invest in the S&P 500 until 1976, when Vanguard introduced its 500 fund, the first retail index fund. It’s average annual return since that time is 10.74%. If it were annualized, it would be 0.5-1% less. That’s very different from 12%. Plus, that assumes a 100% stock portfolio, which most investors cannot handle emotionally, nor should they. So when you add in some less risky assets, your annualized returns will be even lower. Assuming your retirement portfolio will make 12% is simply folly. Dave’s wrong on that point, but I’ve noticed over the last few months that he doesn’t cite this statistic any more. Instead, he does what you did above and talks about the returns in the last year or two.

      You also seem to be under the impression that beating the stock market over the long run is easy, especially if you find the right “financial guy.” It turns out that not only is it not easy, when you look at it over the long run it is nearly impossible, especially if you’re using a “financial guy” who thinks he can do it. The literature on this point is quite robust, and really not debatable. Your ignorance of that literature does not change the fact that it is there.

      Paying off very low interest debt is not always the best financial move. I’ll tell you exactly why someone might decide to keep a mortgage and invest rather than pay off the mortgage.

      Let’s take my marginal tax bracket of 33% (28% federal, 5% state.) Assume the investment portfolio will make 8% (about what mine has made over the last decade) and the mortgage is 2.75% (incidentally, that’s what mine is.) So now I’m left with a choice. I’ve got $50K. Do I put the money into my 401K or do I send it to the bank to pay down my mortgage principal? If I pay down the principal, after a year I get an after-tax return of 2.75%*.67= 1.84%. If I put it in the 401K, I lower my tax bill by $50K*.33= $16,500. Let’s assume I eventually end up paying an effective rate of 20% on that money when I withdraw it in a few decades. 33-20% = 13% * $50K = $6500. I’ll get another $4K (8%) in earnings in that first year. So after one year, I have an extra $920 if I paid down the mortgage or I have an extra $10,500 if I invested it in my 401K instead. Over 15 or 30 years, that difference can be huge. Yes, the security of a paid-off home is nice, but you’d have to admit there’s a pretty good counterargument to paying off very low interest debt early, especially when it can be invested in a tax-protected (and asset-protected) account.

      I’m not sure what 2008 has to do with anything. The mortgage is quite different from the house and shouldn’t be confused. Paying off the mortgage early earns you exactly what your after-tax rate is on the mortgage. The fact that the house fluctuates in value is not relevant to the discussion unless you’re trying to get rid of PMI or are underwater and thus can’t sell or refinance etc. “Why pay $25K to get a $10K tax break” is a frequent Daveism. Obviously it’s not a good idea to pay $25K for a $10K tax break when looked at in isolation. But you have to look at the lost opportunities created when you use cash to pay off low interest rate debt instead of investing. Now I’m not talking about your credit cards, and auto loan, and non-deductible 6.8% student loans. I’m talking about a mortgage or student loans with a negative real (after-inflation) interest rate. There’s more discussion of this point here:
      http://whitecoatinvestor.com/student-loans-vs-investing/

      You also mention it takes too long to fund a Roth IRA. I don’t understand your argument. You say a $10-20K emergency fund is fine. For 3 1/2 months of the year a typical couple that hasn’t been investing can put $22K into Roth IRAs right now. For the other 8 1/2 months a year they can put in $11K right now and another $11K in a few months.

  22. We have been following his baby steps to the letter and could not be more happy. The most difficult step was paying off all of our debt which took us more than 4 years to achieve. I cannot tell you the how good we felt when we realized that we only had a manageable mortgage left to pay. We should have the home paid off by mid next year.

  23. I’ve just started reading Dave Ramsey’s “Total Money Makeover” book. I’m already past Baby Step 1 and need to work on my debt (roughly $11k on credit cards and <$2k truck loan). At age 48, I have less than $40k in 401k/traditional IRA/Roth IRA and need to pay for my college degree (which does need to be completed) along with continuing education to move forward in my career. All of that education can't be paid for in cash because it doesn't exist so we're talking student loans and credit card. Oh, if I get hired back into what I'm trained to do (aviation), I'll end up taking at 50% paycut for the first year and won't get back to my current income for another five years (I'll be 53). The logic of getting the college education is two-fold; one, it's a life accomplishment. Two, if I ever want to fly for a major airline, I need that degree.

    As for investing, I've already proved to myself that I suck at it. Every time I've attempted to invest in the stock market, I end up losing money. It's just not my strength so I need a financial advisor. Unfortunately, they cost money, which doesn't grow on trees.

    Many people say I should "suck it up" and continue working a desk job, even if I'm miserable. I disagree – life's too short to spend 2100 hours a year doing a job I detest. Sure, the money is good and will allow me to build on my retirement but why be miserable?

    I'll have to bookmark this website – maybe it'll help me in the same manner as Dave's book (already know about EF's, debt, and how to budget).

    • Your situation is very common among Americans, and even among high income professionals such as physicians. Dave Ramsey’s baby steps can be helpful in these types of situations. Being 48 with a net worth of essentially nothing and without a career option that you enjoy that also pays you well can be a depressing situation. However, there is definitely a balancing act to be made here. Few people ever get a job that they would do for free. Almost all of us at least detest our job a little at times. But you don’t want to take on big debts or time or money in hopes of getting a job you like a little more that will pay you less than what you’re doing now. I suggest a balanced approach. First, you need to spend a lot less of your income. Clearly if you keep doing what you’ve been doing for the last 3 decades (spending nearly everything you make) you’re going to end up with the same results and you’ll retire on nothing but Social Security in your late 60s or 70s, perhaps with some debt still hanging over your head. Second, get the education needed to maximize your earning potential. If the requirement is “a degree” that can be relatively easy to get through a community college or inexpensive state university. Just be sure there is actually an economic pay-off to doing so. You need to figure out a way to keep working while you get it. Lots of people go to school part or full time while working part of full time. It isn’t impossible. Third, read a few good books on investing and develop an investing plan. Stock market investing can be ridiculously simple. Just buy all the stocks at the lowest possible price. Vanguard offers a “Total Stock Market Index Fund” that allows you to own all the stocks in the US for a price so low it is basically free. Similar funds allow you to buy all the non-US stocks and all the bonds. Quit trying to pick stocks or time the market. Just buy them all, hold them forever, and concentrate on saving as much as you can. You may be surprised how quickly your money starts growing after a while.

    • Why are you conflicted? Even Dave Ramsey, an anti-debt zealot, suggests you put 15% toward retirement and save for college before throwing extra at the mortgage. Are you wondering if you should pay off your mortgage instead of putting 15% toward retirement? I think everyone agrees the answer to that is no. If you’re already putting 15% toward retirement and you’re good for college, then sure, deleverage yourself by paying off your mortgage. BTW, I usually recommend 20% to docs and similar high income earners because they get a late start and because SS will make up a smaller percentage of their retirement income.

  24. I personally don’t understand how people get so far into debt… my major money mistake was buying a car my excuse work was 2 miles away and while 3-5 months of the year i could easily walk.. during the winter -20 temps.. walking was not going to be fun. I spent 8k and could afford the payments until i was laid off… then i was screwed. I had been on track to pay off the car in 2.5 years instead of the 5. But the loss of a job set me back. I’ll never make the mistake of taking out a loan again. But to be 100k in debt? how is that even possible are people that dumb? My husband has 2 masters degrees and 0 debt. no one helped him. no loans just a job…. yup some people actually do that. work while in school Crazy i know! Our biggest money problem is wanting to buy a home. ideally with cash. we don’t want a mortgage, i like baby step 6 is it? lets just say that’s the step we where on ( use your imaginations) then following the steps we have $1000 a month to put toward a mortgage the average where we live is $1,300. btw my husband is a extremely frugal if its not spent on rent, food, heat we don’t spent it. you might think i am forgetting cloths but im not we might buy a new shirt or a pair of jeans if one pair is wore out but that amounts to maybe once a year

  25. There are a lot of who can benefit from the baby steps i think my dad got me the book total money makeover almost 10 years ago now.. but he was also always good about teaching us how to spend and save wisely. unfortunately with my youngest sibling it didn’t stick. 12k in debt with student loans no degree. dropped out. :s
    While she struggles to pay off the loans our biggest ‘problem’ is where to cut spending more do we can afford a home sooner. I was searching for more reasonable suggestions then ‘cut coffee once a week’ ‘bring lunch to work’ and the normal stupid suggestion most people give. we never eat out we always pack a sack lunch (even on road trips) and we never get coffee out side the home. anyway thats when i stumbled onto this site :) full of more great advice that will help my husband and i to stay out of debt :D

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