Believe it or not, I have had multiple conversations about Dave Ramsey over the past couple weeks.
Dave Ramsey appears to be the introduction to personal finance for a lot of people out in the real world. While there are hundreds of great personal finance blogs, people are much more likely to stumble across the best selling personal finance book or the radio host that wrote it.
And that’s great. Any introduction to personal finance is better than no introduction to personal finance. If the options are Dave Ramsey or blind consumerism, then put me in the Dave Ramsey camp.
The problem is that people that find Dave Ramsey (at least in my experience) have had a tendency to preach Ramseyism as if it were The One True Word of personal finance.
So in response, here are the reasons that I am ignoring Dave Ramsey’s Seven Baby Steps (the central core of his personal finance prescription) and why you might want to as well.
1. $1,000 to Start an Emergency Fund
Dave Ramsey is virulently anti-debt. Like, sell all of your stuff to pay it off, anti-debt. Like, there’s no such thing as responsible credit card use, anti-debt.
Which makes it so surprising that he advocates building a $1,000 emergency fund before paying off your credit card debt. This doesn’t make sense from a numbers perspective. I have, in fact, previously advocated getting rid of your emergency fund if you have high interest credit card debt. As I said back then:
“Money is money is money. You have a positive balance in your savings account earning you 0.06%. You have a negative balance in your credit card account costing you 17.55%. Every month that you keep a spare $1,000 in your savings account rather than paying down your credit card, you are throwing away money.”
Ramsey’s argument is that, “When a car battery goes out or a baseball meets a window in your house, you won’t have to go into debt to fix it. You don’t want to dig a deeper hole while you’re trying to work your way out.”
But this doesn’t make sense. If you are already in debt, then the emergency fund doesn’t save you from going into debt like he claims.
Instead, you are saving $1,000 in case you have an emergency so that you can pay it in cash rather than putting it on your credit card. But you can put that $1,000 directly towards your credit card instead and end up better off.
If an emergency comes up, you can put it on your credit card. It will suck to see your balance bounce back up, but it will have already been lowered by the $1,000 from your emergency fund, so you will still be better off by the numbers.
Here, Ramsey is trying to protect you from the psychological hit of seeing the credit card balance go back up. However, the psychological protection will cost you in cold hard cash. If you feel that you need that psychological boost, then follow his advice. If you would rather keep your money for yourself rather than paying unnecessary interest, then feel free to ignore it.
2. Pay Off All Debt but the House
An important sub-part to this is his snowball method of debt repayment. “The smallest balance should be your number one priority. Don’t worry about interest rates unless two debts have similar payoffs.”
So if you have an $800 balance on a 0% interest car loan and a $2,000 balance on a 20% interest credit card, then Dave Ramsey wants you to pay off the car loan first.
This is a waste of money.
Paying off the highest interest debt first, regardless of the balance, means that you will pay less interest. This means that you will spend less money getting out of debt.
Dave Ramsey is advocating voluntarily paying extra money to credit card companies.
There is a rationale behind this position, of course. The idea is that it is easier to pay off lower balances and it will feel good to see that bill be completely paid off. This good feeling will motivate you to keep going.
If you are at risk for giving up on paying off your debt quickly because it feels insurmountable, then follow Ramsey’s advice. But like with Step 1, if you don’t need the psychological boost to keep you going and would rather keep as much of your money as possible, then ignore it.
There is also a third option when it comes to some debt: learn about forgiveness options. This is a tack that I am taking with my student loan debt. After taking on a significant six-figure student loan debt to pay for law school, I have dedicated myself to public service. Part of the deal with public service is that your loans can be forgiven after ten years. Because of that, it makes no sense for me to pay this off as quickly as possible.
3. 3 to 6 Months of Expenses in Savings
I actually don’t have a problem with this advice as a rule of thumb. I do have a problem with this being applied as a hard and fast rule for everybody. And I have a problem with it being placed above 401(k) contributions with an employer match.
An employer match is a 100% return on your investment. Or, depending on the terms, a 50% return if your employer matches 50% of your contribution. Either way, it is much more than you would be paying in credit card interest and much much more than you would be making in savings account interest.
It is also a limited time offer. If you do not get your employer match for 2017, you can’t go back and get it in 2018. If you choose not to get your employer match, then you are throwing away a guaranteed 100% return on your money.
As for the use of the 3 to 6 months of expenses as a benchmark, just think through how it applies to you and your income.
Are you a freelancer? Are you at a start-up or in a particularly volatile field? Then maybe keep a larger emergency fund to offset the variability or volatility of your income.
Are you in a government job? A union job? Are you from a two-income household where the incomes are from different employers and fields? Then you could probably keep a smaller emergency fund because the risk of job loss is lower.
4. Invest 15% of Household Income Into Retirement
The average American savings rate is 5.7%. That means that following Ramsey’s advice here would put most people in a much better position.
But is it enough?
Looking at the chart from The Shockingly Simple Math Behind Early Retirement, we can see that a 15% savings rate leads to a working career of 43 years. This means that if you want to live a comfortable retirement, you can save 15% of your income from your college graduation at around age 22 until your retirement at age 65.
Assuming you actually start saving at 22. And assuming you have a steady income. And you don’t lose your job at any point. And you don’t want the option to retire early. And health issues don’t force you to retire early.
15% is a great starter goal for your retirement savings. Hit it and then set a new, higher goal.
5. College Funding for Children
My wife and I don’t have kids at this point and so college funding for those non-existent children is not a part of our current financial plan. Because of that, I can’t really weigh in on where this should fall in the list of priorities.
What I can do is give you some common-sense wisdom that has been floating around the personal finance blogosphere: Your kids can borrow money for college. You cannot borrow money for retirement.
Just running the numbers, it looks like you should be saving more than 15% towards your retirement before you move on to college funding.
Beyond that, this comes down to a matter of your personal priorities. Do you want to give your kids some support? Pay for their full way? Pay for grad school?
Where do those different levels of support fall in your list of other priorities?
I have no problem with people placing college funding for their children next in their financial to do list. But do it because you made a conscious decision that it was your priority, not because you were told that it is the correct answer by someone that has never met you.
6. Pay Off Home Early
Sure. Why not? If this is what you want to do.
From a pure numbers perspective, when you accelerate payments on your home should be based on the interest rate on your mortgage. Is it higher or lower than the expected return on an index fund?
But whether or not to pay off your home early often comes down to more than numbers. There is a level of comfort in not having to worry about your ability to make mortgage payments if you lose your income. There is a level of comfort in having more flexibility with your future income.
I don’t have a problem with making a mathematically inefficient decision here. Especially because you will then have lower expenses in retirement and the option to downsize to a smaller house and cash out the difference.
As with college savings, however, where this falls in your priority list is a very personal decision and there is no one-size-fits-all approach.
7. Build Wealth and Give
Under the final step, Ramsey says to “Build wealth, become insanely generous, and leave an inheritance for future generations.” As far as tactics, he states that “Now you can max out your 401k and IRA so you can continue to live and give like no one else in retirement.”
Why is this last? Why wait to build wealth until your house is fully paid off and college is fully funded?
And you can probably guess that I am against waiting to max out your retirement accounts until this step. Even ignoring the idea of financial independence or early retirement, think of the tax savings you’re giving up by ignoring this in steps 1 through 6! That’s big money and big growth that you are choosing to miss out on.
More importantly, though, why wait until this step to give money away?
First, giving money away makes you happier. It is, in fact, one of the most cost-effective ways to improve your own happiness. Even from a selfish perspective, why would you horde all of your money until this last step if you can use it to buy happiness? We want to be financially successful, but we cannot give up our happiness on the way there. The journey is at least as important as the destination.
Second, even a small amount of money can make a big difference. As of 2013, there were 767 million people in the world living on under $2 per day. You could change a family’s life trajectory for less than you spend on coffee or fast food. There are also many easily curable diseases that we just don’t have the funding to eradicate. You could save lives for cheap.
Even if you can’t donate much, you can still make a massive difference in the world.
Third, if you don’t build a habit and mindset of giving and generosity before you become wealthy, how giving and generous do you think you will be when you become wealthy? Maybe you can hit a certain net worth number and flip a switch, but that doesn’t feel very realistic to me.
If your mindset is “I’ll give when I have more,” it will be very hard to switch your mindset once you have “enough.” It will be difficult ever to feel like you have “enough.”
I am very much against tacking giving on to the very end of a financial plan. It’s always a good time to help others.
I don’t want this to come off as an anti-Dave Ramsey screed. He can be a great introduction to personal finance. If you are an average American with no idea where to start, go ahead and start with Ramsey’s Baby Steps. But once you get started, do a little more research. Create a plan that fits your life and your needs.
Personal finance is personal. Don’t let a guru (or his rabid followers) convince you that there is only one answer.