We covered step 1, step 2, and step 3 in previous posts. If you actually followed the steps, you are now feeling pretty good about yourself. You have likely learned just how little you actually need, making frugal look like a luxury, and now have enough saved up that you could live comfortably for at least 3 months if you didn’t earn a single penny. This next phase is broken up into steps, but they represent more of a priority than they do separate steps. In fact, Dave teaches his audience to do these together until you run out of cashflow every month. They are to invest 15% of income for retirement (step 4), fund college for your kids (step 5), and pay off your home early (step6).
The 15% of income into retirement is new. You should have stopped doing this if you were investing prior to following Mr. Ramsey’s baby steps. At this point, the 15% is also a MINIMUM. If you are making $1,000 a month, you should be putting $150 into investments monthly….$10,000 should be a monthly $1,500 invested, and on and on. He gives some advice on wise ways to invest it, and again prepares his material for his audience. The basics are very solid advice like invest in what you know, find someone you trust, shelter it from taxes as much as possible…basically the same advice you would get from the large majority of investment brokers from any reputable firm.
If after that 15%, there is nothing left, Dave teaches that is it. You are done until you have freed up some more resources. In truth, at this point, his audience has far more cashflow than that. So his next focus is on college funding for kids. If you don’t have any, you just skip this step of the phase. If you do have some, he talks about reasonable budgeting. The Harvard undergraduate degree is meaningless in the long term. Evidence backs Dave up on this, that although Ivy league educated graduates might get better paying and more impressive jobs upon entry into the workforce, the difference in terms of pay or positions essentially disappears after a few years. It is better if your child learns hard work and can apply the information, not where their piece of parchment came from.
In any fashion, if you determine you want to help your children pay for college, he uses some pretty simple “back of the napkin” math to determine how much you should invest. He also suggests you base the first couple years on community college prices to get some basics and allow your student to better determine a path ahead, especially to avoid paying for unnecessary classes at more expensive prices, and then base the 2-3 years remaining on in-state tuition. Further, he offers other advice, like making it the student’s job to apply for any and every scholarship they qualify for, and to set expectations that the young man or woman will ultimately have to work while going through college to pay for anything more than the basics.
Certainly, if you are wealthy enough you can adjust expectations and potential as you would like, but we still need to remember who this plan is built for. Most of the audience are not doctors or CEOs of corporations, and those of his audience who do have large incomes, usually have even larger debt burdens. Dave is still teaching life lessons about not spending too much on things you don’t need. The degree from the in-state school that lets your kid be a doctor doesn’t make him any less of a doctor than the kid with a degree from Yale or Oxford…but your young adult won’t come into their new profession saddled with debt and you won’t have to spend your life-savings to send your kid to the local school.
Once you have determined where to send them and come up with an estimate for costs, you just figure out how much you need to save to be ready the day they pack their bags. If you think it is going to be $60,000 and it’s going to be 10 years before it starts, you need to come up with about $500 a month to set aside.
Now you are investing 15% for retirement, planning for college, and anything left over, Dave teaches to roll it into paying off the house early. Stipulations do apply. Never pay in advance, but pay on principle. This is also sound and repeated by everyone who talks about paying off debt early. It is the quickest way to build equity and pay off the mortgage.
This is also another point of contention with some other budget gurus.
Remember that one of the conflicts with the debt snowball from outsiders was that he paid off the smallest debt first and not the largest interest rate. A person’s mortgage often represents the absolute smallest interest rate of all their debts, and in the minds of many detractors, people would be best to invest more and ride their mortgage out for a while. Some even go so far as to recommend taking out lower interest rate lines of credit or second mortgages to be able to finance even more investing.
As was the case then, the inherent thing they are missing is risk. They are focused solely on the opportunity cost of missing potentially larger interest rate gains in investments against the lower interest rate losses in paying their mortgage. Lost in their entire calculation is the idea of risk.
There is really an underlying element of Great Depression Era wisdom in Dave Ramsey’s coaching. Spend less than you make, plan for the future, and go scorched earth in your attempt to reduce and remove risk from your life.
If you got into a smaller home in the earlier steps, then paying off your home early can happen faster. If you listen to his show, you hear their screams of joy and passion when they exclaim their debt free nature at the ripe old ages of 29 or 32.
Either way, once they have started along this path, it can become pretty redundant. This is also the stage when Dave talks a lot more about enjoying things. It is important to remember that he talks about whatever is left over going to pay the home off early. What is left over is largely determined by what you spend. This is the phase when many of his followers opt to save up for a month or two or three, and go on a cruise. They decide they want to take their family to Disney World or some other adventure on a long vacation. This is the point where their income is becoming a wealth building tool. They already have adequate savings and their money starts to work for them relatively free from risk, so they can sort of relax and enjoy.
Largely overlooked by his opponents in the finance realm, is also the fact that most of his audience uses this opportunity to engage in mission work, or to adopt children in need of homes. He tells stories shared from others in his community of Financial Peace that some will even pay to help others adopt when they feel they have grown too old or simply don’t feel adequate to have an additional child in their already full homes.
His audience is not comprised of a bunch of scared, selfish dummies. They simply were financial idiots, like me, who applied some very uncomplicated rules to their budgets and managed to secure themselves financially through hard work. They are grateful and they are loyal.
Many of the nerds, like myself, manage to spend some of their extra time, when their debt snowball is basically on auto-budget and they have learned how to communicate the importance of the budget to their wives, learning more about financing and investments. If they were fortunate, they stumbled onto a unique tool which I plan to address at the end of the next post on this topic when I discuss step 7.
Now, if you don’t understand it, you shouldn’t invest in it. If you think you understand something, and you are wrong, you will lose everything. So in light of that sage advice, if you are going to play any single stocks, try to hedge those investments by doing research and expose only a fraction of your entire portfolio to single stocks. Here is a good book on how to try and identify quality and undervalued stocks, but only do this if you are limiting exposure and understand the risks.
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