I'm in a situation where I need to work my way out of some debt.
When I was a Christian I looked to a guy named Dave Ramsey for advice.[...]
As a newbie skeptic and nonbeliever I now want to look at debt elimination through the eyes of critical thinking and reason. [...]
I've heard Ramsey's radio progs on long drives a few times. His advice is IMO not dramatically different from the Suze Ormand or others who leave there religious views out of the picture; OTOH he is more focussed on complete debt elimination. So as a step toward critical thinking, you should challenge yourself to question his suggestions.
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One thing to realize at the start is that any advice (like Ramsey's 'steps') can only be evaluates in terms of goals, and that all goal selection is purely subjective and emotional - not based on reason or logic. Most ppl may agree that eating food is better than starving or that living in a nice house is better than living in a homeless shelter; but these valuations are purely emotional. If some Gahndi chooses to starve or someone choose to live in inferior dwellings than they could afford - we cannot criticize their logic. We can ask about their choice of goals.
Looking down his list ...
Ramsey suggests this order of execution apparently ....
1: $1,000 Emergency Fund
2: Pay off all debt using the Debt Snowball
Ramsey's 'snowball' involves paying off the smallest debt amount first.
3: Accumulate 3 to 6 months of expenses in savings
4: Invest 15% of household income into Roth IRAs and pre-tax retirement
5: College funding for children
6: Pay off your house early
7: Build wealth and give!
I don't know what "Roth IRAs" are.
Roth IRA is a government sponsored retirement savings account where a limited amount of after-tax income can accumulate in an account with no cap-gains, dividends or interest tax. There are restrictions & requirements on it's withdrawal.
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I would differ w/ Ramsey's advice in several respects.
1: Ramsey suggest an initial $1k cushion to offset unexpected expenses, but that seems far too low to me. We all have unexpected expenses that might range from requiring a new roof or a new car, medical expenses to a new pair of shoes or a new suit - all these expenses recur, often w/o warning and these expenses likely occur with considerable statistical independence (your failed roof does not improve the chance your car or liver won't fail too).
Ramsey's main goal seems to be to remain fiscally solvent despite these potential & variable costs/losse. This sort of risk amortization screams "insurance". when you have risk of cost you cannot manage then it's very sensible to carry insurance against these. Medical insurance, car insurance, homeowners insurance, and the deductible amounts should be low corresponding to the actual assets one can afford to pay out. Of course if you can afford the loss out of savings (like a pair of shoes) then you don't need insurance.
My advice would be to get low deductible (more expensive) insurance plans on everything critical and to immediately build up assets that can cover several deductibles plus a couple uninsured costs. $1k is not unreasonable BUT you need to insure the heck out of other critical risks (and this costs money).
2: Ramsey's 'snowball' involves repaying the smallest debt amounts first, instead of the fiscally rational approach of repaying the debt with the highest interest rates. One should also consider the cost of defaults if your loans are in arrears. If you lack the discipline to pay down bigger but higher-interest loans first, then you need psychological help (I am serious). Maybe some self-help book or some debtors-anonymous group can help. Trying to trick yourself psychologically while paying extra on high-interest loans seems ineffective toward the implied goal.
3: The 3-6 months of expenses in a fairly liquid form is a good rule of thumb to cover risks including a brief job layoff, but this amount is clearly meant to cover more of the risk-expenses you've insured against. As this safety-net accumulates some insurance deductibles can be increased (decreasing the costs). At some point certain insurance coverage can be dropped (e.g. your homeowners does not need to cover water heater replacement if you can readily afford the cost).
4: Roth IRAs and other pre-tax retirement savings are useful, and 15% of household income is a reasonable MINIMUM saving amount IMO. However the non Roth pre-tax savings accounts are only an advantage if you believe that future (retirement) tax rates will be lower than current tax rates. That's a topic where reasonable ppl can disagree, and future tax policy is fundamentally unpredictable.
Consider this rough estimation - in a typical life-cycle you are dependent consumer from 0yo-~18yo, are perhaps on average self-sufficient from ~18-25yo, productive from ~25-65yo, and again dependent from ~65-77yo. So in those ~40 productive years you must throw off enough excess value to provide for the ~30yr of non-productive years. So 70 yrs of consumption and 40 years of production implies you need to consume only 4/7ths or 57% of your typical productive era value and transfer the remaining 43% by paying for child-rearing, education & retirement. The government in the US snacks on 15.4% of your gross income as SocialSecurity & Medicare transfers nominally for retirement, but you generally need to apply another (43-15) 28% toward savings and child-rearing/education expenses. If you aren't paying college loans or for kids [and we all to to some extent by school taxes], you really should bank ~25% of gross ! {Yes, really}
5: College funding ... Ramsey suggest avoiding bonds for their (5-8%) low yield, but those stated rates are actually extremely high at this time. Investing in stocks and volatile investments IF you'll need the funds w/in a few years is genuinely "not smart". But less volatile investments like bonds naturally have lower yield. IOW I discount that Ramsey's specific investment advice.
Note that money is the only true commodity - it's perfectly fungible. You should not make a fetish of the distinctions between various categories of savings (college, vacation, retirement, car, home). You have one pool of assets, and you have a semi-predictable set of dates on which you'll need/want to draw on these. You need to invest based on those expected future needs. Sadly some government programs (IRAs, Roths) encourage misguided thinking.
6: 'Pay off your house early' - may or may not be good advice. If I had a 3.2% mortgage rate (available last year) and can currently get ~4.7% return as dividends from power utility company stocks (and I do) - then it's smarter to invest in stocks. It's not common, but in some time periods you can safely borrow and invest.
7: Ramsey's "giving" is not fiscal advice, it's religious/social advice.
I think Ramsey's steps gloss over several fundamental issues (maybe he covers these elsewhere).
Most ppl, gainful employed, should be saving or applying to debts a minimum of 15% of gross income (and 20-25% is a better target) and this necessarily means keeping a cost/standard of living that is lower than if you lived hand-to-mouth spending every dollar you receive. Being frugal is a main means to become wealthy and it requires a certain attitude toward spending - frugality - that you only pay for real tangible value. Read 'The Millionaire Next Door' for example. The self-made wealthy really do shop at WalMart and drive 10yo Toyotas. You should always be looking for real value bargains, and looking for added sources of income (including eventually investment). The attitude that you deserve some pricey-luxury before you've assured your LT financial goals is the signature of the bottom-scrapers.
House maintenance costs, property taxes, insurance, periodic auto replacement are all things that must be accounted for in ST savings but won't help your LT goals like college or retirement. Budget & plan for these.
Ramsey *seems* too debt-phobic. The value of debt involves an estimate of the return on the debt. For example may well be a long term value to trade rent for a mortgage at today's low interest rates. Of course this means qualifying for a low rate, and having an expectation of staying in the house for a significant number of years. Borrowing to start or expand business is also a good reason to accumulate debt *assuming* you rationally expect a real return on the amount borrowed. Bad/terrible debts are in assets that are overpriced for value. For example a Toyota and a BMW 5 series will both get you from A to B and last a good long time, but the BMW will cost you an extra $35k while performing the identical functional job. If you are borrowing (incl leasing) for the BMW and you haven't safely achieved all your other financial goals - then you are a fool (relative to the goals of wealth accumulation and risk reductions). Ppl really should be paying cash for cars, since these are a rapidly declining assets.
Everyone should recognize the time-value of money. If for example you spend an extra $35k on the BMW and then recoup en extra $20k when you sell it, you've not only lost the $15k delta, but you've also lost all the income you could have earned on a a $35k investment for N years. Tying up assets costs money.
The point is you can use debt to your financial advantage, but most ppl use it as a means to squander future earnings on wasteful non-necessities and assets with negative returns. We want one sort of debt, but not the other. [Same for Federal spending, but that's for another thread].
I don’t know why you would now have a problem with him. He learned his financial lessons the hard way going into bankruptcy several times. Why can’t you follow his advice and just ignore his proselytizing like tithing?
I agree - but I'd rather have a financial advisor who was smart enough to generally avoid the school of hard knocks training. Don't look for safety training from the 3 fingered carpenter.
