Dave Ramsey's debt Snow Ball Method - how good is it?

Dave Ramsey recommends using the Debt Snowball Method. 


That means to knock out the debts one by one starting with the smallest without worrying about the interest rates (unless there are two debts with similar payoffs, then you take the highest interest first). 

You are supposed to attack the smallest debt and keep paying the minimum payments on all other debts. After the first debt is payed off, you apply the additional payments to the next one. 

This method will definitely work - at some point you will pay off the debt if you stick with the payments. But is it the best method? 

The trade off will be some $ versus increased motivation. This would work best for people with multiple debts who start to lose overview and motivation and are about to give up. 

For anyone with enough motivation and who is less prone to panicking, it would make sense to go with the highest interest debt first. Since it is a trade of $ versus increased motivation, for those people the $ will be more useful than additional motivation. 


I made calculations to illustrate the difference between the two methods: the Snow Ball Method and the method where you pay the highest % debt first. 
I used multiple calculators. The calculations  are not extremely exact, but good enough to get the picture. 

Debts:
$1,000 at 4%
$10,000 at 10%
$20,000 at 18%
Minimum payments are approximately 2% of the loan (that is what the credit card companies are using for their minimum payment calculations).


Snow Ball Method

1. We start with the smallest debt, disregarding the interest rates. 

Starting with $1,000 at 4%. Minimum payment is $18.42 (approximately 2% of the loan). 
We apply extra payments of $100 per month. 
Total payed for this loan: $1,016.
Time it took to pay it off: 9 months. 


After 9 months, the first $1,000 loan is paid off. The extra payment of $100 can now be added as extra payment for the second loan of $10,000 at 10%. 

During those 9 months the minimum payments were still paid on the other two loans. 
After 9 months the $10,000 loan at 10% shrank to $8,997 and the payments plus interest amounted to $1,718 for that time.
The third loan of $20,000 and 18% shrank to $19,117 and the minimum payments plus interest were $3,528.

After 9 months the total paid for all loans is $6,262.

2. Now we start to add extra payments to the second loan which is now $8,997. 
We can add $118 of extra payments (extra payment of $100 for the first loan and the minimum monthly payment of the first loan of $18). 
The time to pay it off is 36 months. 
The total payment will be $10,347, including $1,350 in interest. 

During those 36 months the last $20,000 loan was still needing minimum payments and it shrunk now to $15,961. 
Now after 45 months (9 months for the first loan and 36 months for the second loan) the total payments are $16,154. 

3. Now  we start paying off the last loan, originally $20,000 at 18% which is now $15,961.
The extra payments are now $310. The time to pay it off is 28 months. 
The total amount paid in these 28 months is $19,580. 

Totals for the Snow Ball Method:
$1,000 loan: $1,016, 9 months
$10,000 loan: $1,717 and $10,347, additional 36 months
$20,000 loan: $3,528, $16,154 and $19,580, additional 28 months
Total payments: $52,342
Total time to pay off: 73 months or 6.08 years


Highest Interest First Method 

1. The highest interest loan will be paid off first. 

That is the $20,000 at 18%.
With $100, extra monthly payments it will take 58 months and the total payment is $30,032.

During those 58 months the other two loans required minimum payments. 

The smallest loan of $1,000: only $203 are left to pay and $913 were payed in total.
The second loan of $10,000: it shrunk to $5,062.
The total paid during those 58 months was $8,463.

2. Now we focus on the second loan with 10% interest. 
The second loan already shrunk to $5,062. 
While paying off the second loan, the smallest loan took care of itself. There were only $203 left to pay. It was completed in a few months. 

It took 9 months and the total payments for the second loan were $5,262.

Totals for the Highest Interest First Method 
:
$20,000 loan: $30,032, 58 months
$10,000 loan: $8,260, and 5,262, additional 9 months
$1,000 loan: $1,126, 0 extra months, it was paid off with minimum payments only wile paying of the other two loans
Total payments: $44,680
Total time to pay off: 67 months or 5.6 years

So it is $52,342 versus $44,680. The Highest Interest First Method wins. 

Dave Ramsey's philosophy on debt - are you his target audience?

M. asked me: Dave Ramsey's philosophy on debt - do you agree? He recommends to delay any retirement contributions or filling up the emergency fund until all debt is paid off. He also doesn't recommend to use credit cards. I don't understand what speaks against using them, collecting the rewards but paying them off each months? 


I heard of Dave Ramsey a bit on some of the FIRE blogs, but I didn't look up his philosophies before.
So who is Dave Ramsey? Per wikipedia, he was in the real estate business and after some successes and failures he started counseling couples at his local church and developed a set materials based partially on his own experience and partially others. He published books and has significant presence in the media.


Here are his 7 Baby Steps to financial freedom, which you can read in their completion on his website here.

Dave Ramsey's 7 Baby Steps:

Baby Step 1 – $1,000 to start an Emergency Fund

Baby Step 2 – Pay off all debt using the Debt Snowball
Baby Step 3 – 3 to 6 months of expenses in savings
Baby Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement

Baby Step 5 – College funding for children
Baby Step 6 – Pay off home early
Baby Step 7 – Build wealth and give!


M. has the impression that Dave Ramsey suggests to follow the steps one after another. And she doubts that it would make sense. 

Let's see what would make sense. 

Imagine yourself giving recommendations to someone. Any recommendations. The structure of your recommendations will depend on if you are talking to a child or to an adult.  

The more background knowledge and resources the person has, the more nuanced will be your recommendations. In addition, it will also be limited by the amount of your own knowledge. 

For example if you talk to someone who just starts his first job, with very limited knowledge about finances and who maybe never heard of emergency fund, Dave Ramsey's steps could be great. They sound simple to follow and they are not too many. 

But the more people know, the more questions they will have and the more they will think for themselves. They will test the suggestions to agree or disagree with them. Those 7 simple steps may not be sufficient for people with more background knowledge.  

Target audience is the key.

You can check it if you are Dave's Ramsey's target audience. 
If some information in those steps is entirely new to you, you may be his target audience.

If you see nothing absolutely new, and if you start thinking and maybe questioning some of the mentioned strategies, you are not his target audience. You have grown beyond that.


You see that the Step 1 is about starting an emergency fund with $1,000. Yes, everyone has to start somewhere and that would be a good start. 

Trying to pay off all debt before putting anything into the 401k will not always be the smartest thing to do. If your employer contributes to your 401k too (many do that), you would not get that additional money if you don't contribute anything yourself (see my post here).

To me it looks like after the completion of Step 1, all other Steps can be taken care of at the same time. 
Paying off mortgage and other debt can go hand in hand with maxing out your retirement accounts. Unless your debt/income ratio very bad, which will require some special handling. 

Organizing your personal finances is not about winning in every area immediately. It is about optimizing it for your personal situation and sometimes trying to lose the minimum amount because sometimes losses are inevitable. 

Once you get used to the idea that it is not possible to win everywhere, the expectations will adjust to "realistic". Realistic expectations will reduce your decision making stress, especially the fear of missing out on something. 

By ranking your priorities - pay off all debt, max out 401k, or pay off your mortgage, if you miss out on something, that will be the area of your least priority. 

How to determine the priorities?

1. If paying off debt is your least priority, you can pay only the minimum payments for the rest of your life. It will not bother you very much that your debt will still be there when you die and it will be counted against the inheritance if there will be any. 

2. If you think that you will not live very long and don't want to die with a lot of unused money, retirement accounts may not be your first priority. But if you don't die early, you will have to work until you die or until you are so sick that you have to retire, hoping that the social security will be enough. 

3. If you are sure that your life will always go as planned and your salary situation will always stay stable to pay off your 30 year mortgage as scheduled, you can just go with regular payments without any extra principal payments.

Those descriptions are extreme and don't really apply to high income professionals. But they can help you to decide what would be the least comfortable option for you. If all of those scare you equally, you may attack all three of them at the same time equally.  

Your strongest fear will determine your highest priority. The others will follow in order of decreasing fear.   

You can work toward minimizing all three but at a different percentage for each. If mortgage bothers you most, allocate the majority of the additional payments toward the mortgage. If it is debt, allocate more toward debt. 

My priorities were 1. Debt, 2. Retirement funds, 3. Mortgage. 
According to that I started making extra payments to the mortgage only after retirement contributions were maxed out. 

I could shrink Dave Ramsey's 7 Steps to only 2 Steps:

1. Start an emergency fund (I had $2,000 in my emergency fund before even thinking about anything else).
2. Assess your debt, your retirement accounts and your mortgage. What is the highest priority for you? Allocate % accordingly. Re-evaluate every year.  


Regarding using credit cards: to me, nothing speaks against using them for cash back or points as long as you pay them off each month. The cards are not evil just by themselves. It is the lack of self-discipline and organization. If you can make sure to pay them off every months, there is no problem. It is like giving a little child a toy with small parts he can chock on. He doesn't understand. There is no danger to give anything with small parts to an adult who knows not to swallow them or to stuck them up the nose. 

All my credit cards give me cash back.  I don't want worry about missing a payment while traveling, so they are all on auto pay. 

But again, think of Dave Ramsey's target audience - people with limited knowledge in personal finance. 

Here is another interesting topic related to Dave Ramsey - his recommended Debt Snowball Method. He recommends to reduce the debts one by one starting with the smallest without worrying about the interest rates. Is it really a better way? I made my calculations, see my post about the Debt Snowball Method here. 

How I would pick a financial advisor

You should be able to trust your financial advisor. 
For me, since I trust almost nobody, it is very difficult. 


I have one financial advisor which comes for free together with my employer related 401k. Do I trust him? No. 

He didn't offer his additional services outside 401k yet. But if/when he asks, I will have a serious talk with him. 

Just imagine you are thinking about consulting a dietitian. You would definitely have to see how he looks like. To see with your own eyes if he is successful himself in the assumed area of his expertise of weight loss and weight maintenance. 
If he looks slim, you would interview him to see if his experience is real and he is not just someone 20 years old fresh out of a dietitians school and had never had any weight problems himself. 
You would like to see the real results of the strategies he can offer. 

The same is with the financial advisor for me. 
His financial strategies and results will not be as obvious as the body of the dietitian. 
So I would have to ask him to provide his own results for me before I can trust him. Especially I would focus on how the accounts were handled just before and during the last recession. 
Anyone can talk. I would ask to see the results. 

But I don't think he will go for it and show me the results. He probably would say that this information is too personal or something like that. 
And I probably wouldn't insist if he is still against it after I explain the example with the dietitian to him. 


I know, some would bring the arguments against it, such as: a doctor who is healing a particular disease doesn't have be sick with it himself. He can still heal it going with the treatment guidelines. I agree with that. 

A financial advisor can give you general "treatment guidelines" for your finances. But those guidelines are not very difficult. You can gather that information yourself. 

I would compare a personalized financial advise to a opinion of a medical expert. Like one on some specific topic where the general information is not sufficient anymore. 
What you usually get from financial advisers is the general information. If your financial situation is very complicated, that can be compared to some complicated disease where you need an expert medical advise. 

For that reason I will probably stay without a financial advisor, at least for now. My situation is not complicated and I already have sufficient general financial knowledge. 
Maybe my expectations of a financial advisor are too high.