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The Dave Ramsey Baby Step You Can Skip
12

The Dave Ramsey Baby Step You Can Skip

Aug 17, 2014

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Economy & Finance

The Motley Fool

Personal finance guru and radio talk show host Dave Ramsey uses a series of seven steps -- what he calls the "baby steps" -- to help people get in control of their financial lives. This slide show talks about the one step in the group that you may be able to successfully skip -- paying off your home quicker.
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Transcript
Page 1: The Dave Ramsey Baby Step You Can Skip

The Dave Ramsey Baby Step You Can Skip

Page 2: The Dave Ramsey Baby Step You Can Skip

Dave Ramsey’s Baby Steps are a great framework

• They’re simple

• They help you set decent priorities for your money

• You’ll usually see benefits quickly by following them

Page 3: The Dave Ramsey Baby Step You Can Skip

One of those steps can be skipped

• Baby Step 6 is “Pay Off Your House Early”

• That sounds like a nice goal:• It gets rid of a huge payment• It ends the bank’s claim on your home• It substantially lowers your out-of-pocket costs

• But is it really a good move?

Page 4: The Dave Ramsey Baby Step You Can Skip

What’s wrong with paying off your house early?

• It’s hard to get the money out in an emergency• Choices are: take out a loan or sell the house• How do you get a loan if you lose your job?

• It ties a tremendous chunk of your net worth to one particular asset class: real estate

• Most mortgages are low-cost debts whose rates can often be beaten by investing in the stock market

Page 5: The Dave Ramsey Baby Step You Can Skip

Can you beat your mortgage rate?• Imagine you’ve reached Baby Step 6 and are now

prepared to make a serious dent in your mortgage.

• You find yourself in this situation:• 15 years remaining on your mortgage• 4% interest rate• $1,000 Principal and Interest payment• $135,192.15 mortgage balance• $500 per month in available cash flow

Page 6: The Dave Ramsey Baby Step You Can Skip

• If you put that ‘extra’ $500 per month towards your mortgage, it will take you 8.95 years to pay it off. Call it an even 9 years.

• If you paid your mortgage on schedule, at the end of 9 years, you’d still owe $63,917.44 and have 6 years of payments left.

• Clearly, baby step 6 beats “doing nothing”

What you do get from “Baby Step 6”

Page 7: The Dave Ramsey Baby Step You Can Skip

What’s your real alternative?• There are no guarantees in the market. Still, there is

an opportunity to likely beat that 4% hurdle rate through diversified, market-based investments

• $500 per month invested for 9 years turns into• $71,369.95 at 6% annually• $78,714.77 at 8% annually• $87,026.86 at 10% annually

• Any of which, if you earn it, beats the $63,917.44 benefit you’d get by paying off your mortgage early.

Page 8: The Dave Ramsey Baby Step You Can Skip

Are those rates of return real?• Over the past 9 years, with dividends reinvested:• The Vanguard Total Stock Market (NYSEMKT: VTI)

delivered 8.4% annualized returns. The ETF tracks the broad US stock market.

• The SPDR S&P 500 (NYSEMKT: SPY) delivered 7.7% annualized returns. The ETF tracks the S&P 500, which contains 500 large-cap US stocks.

• The iShares MSCI EAFE (NYSEMKT: EFA) delivered 6.2% annualized returns. The ETF offers broad exposure to developed markets outside of North America.

Page 9: The Dave Ramsey Baby Step You Can Skip

But what about ending the mortgage payment?• Once your investment account is larger than your

mortgage balance• You can pay off the mortgage if you still want, or• You can keep your investments compounding

• Either way, you’re likely to be better off than you would have been by simply adding $500 to your mortgage payment each month to get rid of the mortgage sooner.

Page 10: The Dave Ramsey Baby Step You Can Skip

What would Dave Ramsey say?

Dave doesn’t necessarily agree. To quote him:• “Motivation is more important than math… If we were

doing math, you wouldn’t have credit card debt.”

• “It is a great thing to have a paid for house.”

• “The borrower is slave to the lender.”

Page 11: The Dave Ramsey Baby Step You Can Skip

By the time you’ve reached this baby step:• You’re out of credit card debt• You’ve shown yourself capable of sustaining a

lifestyle well within your means• You’re already in the habit of investing

At this point in your plan, you’ve earned the right to start thinking in “money and math” terms, rather than motivation terms.

Why it’s still okay to skip this baby step