Dave Ramsey’s Total Money Makeover
Dave Ramsey’s Total Money Makeover is probably the most famous personal finance book on the market today. In fact, the top 7 of the top 10 personal finance books on Amazon are all written by Dave Ramsey. If you’ve been trying to get out of debt and doing some research on the internet, it is impossible to not come across him. He has thousands of loyal followers. A lot of his books are clearly aimed at an American audience, but there are great take-away messages in his work for all audiences. Walk through his book with me and let’s take a look at what is useful, also exploring through my commentaries below, Australian style.
Dave describes obtaining financial freedom in 7 Steps:
Step One: Save $1,000 cash as an emergency fund.
Before you can work on getting debt free, you need to have something to fall back on in case of emergencies, so you don’t use your credit cards again. Importantly, keep your emergency fund for EMERGENCIES! E.g. the car blowing up or the dog getting hit by a bus. If an expense is not more than $100, it’s not an emergency and you should just pay for it out of your regular budget by temporarily cutting back on other expenses.
Commentary: For years, I thought that this emergency fund idea was ridiculous. Mathematically if you had $1000 in savings the best use is to pay down your credit card, and if an emergency came up, well, just use the credit card. I’ve come to realise that the $1000 fund enables you to never use your credit cards again, which is really important psychologically if you’ve decided to be debt free.
Step Two: The debt snowball.
Dave wants you to pay off your debt with the smallest balance first. You list all you debts from smallest to largest and pay any extra money you have onto the smallest one. Once your clear one debt, you put the repayment from that one onto the next biggest and so on. This is the quickest method for reducing the total number of debts you have, which is good for motivation.
Commentary: This step is controversial. It gives accountants (including myself) an involuntary twitch. Paying off the debt with the highest interest is the quickest way to become debt free, but I accept his point in that becoming debt free is 80% motivation and 20% math.
Step Three: Finish building the emergency fund.
Dave recommends that after you pay off your debts, you save 3–6 months of living expenses.
Commentary: It’s hard to argue with this. I’ve seen many people’s otherwise sound finances crash and burn due to an illness or redundancy.
Step Four: Invest 15% of your income towards retirement.
Commentary: This is one of those steps aimed at American readers. Australians have their employers compulsorily contributing 9% (soon to be 12%) of their income into superannuation. If you earn less than $46,700, the government offers a 50% co-contribution up to a maximum of $500. So if you contribute an extra $1000 to superannuation, the government will put in $500. That’s a phenomenal 50% return on your investment! For those under the income threshold it is definitely worth contributing an extra $1000, but after that, you should be putting extra towards paying off your home loan.
Step Five: Save for college
Commentary: This is another step for the American readers. Your children can use the HELP scheme to pay for their education. The scheme adds interest but only at the present rate of inflation. If you want to pay for your children’s university education, great, but pay off your home and fund your retirement first.
Step Six: Pay off your home mortgage
Commentary: For Australians, we can actually accomplish this and step three (above) at the same time through a mortgage offset account. A mortgage offset account allows money in a savings account to offset the balance of your mortgage while still being accessible for everyday use. E.g if you have a mortgage of $200,000 and $20,000 in an offset account you would only pay interest on $180,000. If you put your emergency fund into a mortgage offset, then start making extra payments into your mortgage offset.
Step Seven: Build wealth
After you’ve cleared up all of your debt, you can then focus on investing.
I think there should be another three steps for serious consideration and focus: (1) committing to being debt free, (2) budgeting and (3) expense reduction. Dave’s steps are also a bit light on practical advice, such as specifying what accounts to use in simplifying your finances.
If you’ve got debt, you’re making all the payments and you just want something better for yourself, then Dave’s book is a great read. I get the impression that it is aimed at an audience who accumulated some debt in “college” and has a car loan, but who has reasonable income and some extra money with which they can pay off their debts. It’s not really aimed at people who are struggling just to make their debt payments or have fallen behind. Debt Mediators has solutions for people who do not have extra money available to pay off their debts.
If you are struggling to make payments give Debt Mediators a call and one of our consultants can help provide you with a solution.
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