Tuesday, June 20, 2017

Why I Choose To Stay In Debt: A critique of the Dave Ramsey methodology

Besides my passion for minimalism and small house living, I feel deeply and profoundly the importance of financial independence, living within one's means and spending resourcefully and responsibly. Not so that I can be wealthy in a monetary sense, but so that I can experience the freedom from stress and worry and obligation that living large and in debt can bring.

As we downsized our belongings and our home over the past three years, we have also downsized our budget. It was pretty simple: we started spending less and saving more. 

I'm one of many small living enthusiasts who has checked out Dave Ramsey and his seven steps to financial freedom. It's a straightforward plan that anyone can follow:

  1. Baby Step 1: $1,000 cash in a beginner emergency fund
  2. Baby Step 2: Use the debt snowball to pay off all your debt but the house
  3. Baby Step 3: A fully funded emergency fund of 3 to 6 months of expenses
  4. Baby Step 4: Invest 15% of your household income into retirement
  5. Baby Step 5: Start saving for college
  6. Baby Step 6: Pay off your home early
  7. Baby Step 7: Build wealth and give generously
(from www.daveramsey.com/baby-steps)

We've been following this plan for almost two years now, but not the way Dave says to. It turns out I'm all for breaking the rules when you find a better way to do it. Here's why I am not a strict adherent to the Dave philosophy of money management, and what we're doing differently - and with success:

  • If I wait until all my debt is paid off to start saving for retirement (Step 4), I'm missing out on years of tax-free principal stashed away in my IRA or 401k earning me compounded interest, and employer matched funds too. (And any financial advisor will tell you that 20% of your income is the real savings target.)
  • If I get fully and completely out of all my debt, with $1,000 in the bank, and then lose my job, I'm going to be in BIG trouble! $1,000 for a family of four is a great emergency fund when there's money coming in, but it's not a lot to live on during hard times.
  • I think it's important to build in myself and my family a habit of giving now (Step 7), even when we have bills and debt - and maybe even no nest egg. Giving should be part of our lives when we have and when we don't have. It can be big or small: a few items to the local food pantry is a good way to start. I want my children to think of giving as something we do, all the time, with whatever we have. 
  • Don't wait to start paying off a mortgage early. Even $5 extra a month can cut years off of a loan and save hundreds in interest payments. 
  • I would rather have money in the bank than be completely debt free. Why? Say, worst case scenario, my husband and I both lose our jobs. We can negotiate down our debt payments, but we're going to need cold, hard cash to pay for essentials - like groceries, healthcare, and gas. And having money in the bank gives me a sense of security that lets me sleep at night, without worrying about what would happen to my family in times of crisis.
  • New debt is generally more expensive than old debt. I'd rather stay out of new debt by saving money for upcoming expenses - like a new(er) car - than get out of debt. Our car loan is at such a low interest rate that paying it off early will save us a mere $37. But I'd have to spend much more than that if we don't have enough money in the bank to buy our NEXT car with cash.

  • Step 2 involves paying off your loans in order of their outstanding balance, smallest to largest. I know why Dave advocates for this - because you get the easiest reward and are more likely to stick with the program. But if you have time to sit down and figure it out (or just take my word for it), you can save hundreds - maybe even thousands - of dollars by paying off your highest interest rate loans first, even if it takes you longer. 
So after a lot of figuring, calculating, and planning, our approach looks something like this: 

  1. Done! Baby Step 1: $1,000 cash in a beginner emergency fund
  2. Done! Baby Step 3: A fully funded emergency fund of 3 to 6 months of expenses
  3. In Progress: Baby Steps 2 and 4-7
  4. Use the debt snowball to pay off all your debt but the house, 
  5. AND Invest 15% 20% of your household income into retirement
  6. AND Start saving for college
  7. AND Pay off your home early
  8. AND Build wealth and give generously

We decided to split our debt payments to savings in a 3:2 ratio, both on a monthly basis and whenever we find ourselves with "extra" cash at the end of the month. So far it's worked brilliantly, and our debts are almost gone!

So follow the Dave Ramsey plan, or make your own like we did. Whatever way you do it, and wherever you are on the financial independence spectrum, keep at it!