Here we find yet another instance where Ramsey and I disagree. But on this topic, my disagreement is ... well, relative.
What's that mean?
It means that if someone wants to delay retirement contributions until they've paid off their high (read: double-digit) rate debts, then I can go along with that pretty easily. This assumes, of course, that all extra money does, in fact, go toward debts, and not toward more dining out or a bigger home theater system or whatever.
Sure, missing out on an employer match is yucky. But I do understand when Dave talks about the "power of focus." It's real, and it matters. Postponing retirement contributions with, say, an initial fifty-percent return (supposing the employer matches @ fifty percent) so you can rocketship your way out of twenty-plus-percent interest-rate credit card debt may not make sense in strict mathematical terms, but I can understand doing it. The benefits of paying off high-interest credit-card debt, I would suggest, go beyond strict mathematics.
On the Other Hand...
However, Dave's response to a caller's question this last week — a question very pertinent to what I'm discussing here — about sent me out of my chair.
The call went something like this, as I remember:
Female Caller: Dave, my daughter just graduated from college with a degree in medicine, and she's doing her internship now. She's living at home with her father and I, and honestly, she's been very frugal with her money. Her only debt is student loans, but she has over $100,000 of them. She's earning just under $80,000 per year right now. She has a pretax retirement plan at work, and her employer matches her contributions at fifty percent. She's not yet started putting money in it. Our financial advisor says she should start contributing to it right away, but we've told her that she needs to pay off her loans first. What do you say?
DR: Your advisor is stupid. You know that?
Female Caller: (Laughs) Right. Well, we were thinking—
DR: No, look. She needs to pay the debts. Focus on the debts. Pay them off now. She's making great money; she's living at home with you guys; she needs to get those debts eliminated. At her age — earning that much cash with no expenses, really — forget the retirement plan and the matching. Make her pay off the student loans.
Okay. Deep breaths. Deep breaths.
I don't believe the woman ever told us what rates her daughter is paying on those student loans. But I bet you it's less than ten percent — maybe a lot less. Because the daughter's income is so high, the loan interest probably isn't tax deductible. Let's say she's paying eight percent on those loans.
So Dave's telling her to give up a guaranteed initial fifty-percent return on her investment via her retirement plan in order to speed up the payoff of a sub-ten-percent student loan.
I say this with all due respect:
My Thoughts on "Stupid"
First off, our young graduate's income puts her in (at least) a 25 percent tax bracket. So every $100 that she keeps out of her pretax retirement plan gives her, after taxes, only $75 to put toward her debt.
In the realm of net worth, that's a twenty-five percent haircut right there. "Thanks much!" says Uncle Sam.
Utilize the retirement plan, though, and she gets to keep that money ... and her employer ladles on the gravy, kicking in another $50. This brings her investable, plan-to-retire-with-dignity total to $150.
And keep in mind: For our young graduate, every missed contribution is a guaranteed fifty-percent return on her money which she cannot get back.
It isn't like saying, "Boy, I sure wish I could time-warp back to the late 1980s and invest in Microsoft stock!" Yes, that would've provided a fantastic return on your money. But in the late 80s, Microsoft's stock's meteoric rise was no guarantee — unless, of course, you could read the future.
With an employer match, there's no fortune-telling necessary. The fabulous return — just for setting aside some money — is written in stone.
Here's what I'd tell the caller: Your daughter needs to contribute enough to get the maximum match from her employer. After that, throw everything else at the debt.
At eighty grand a year, Young Grad is making roughly $6,666 per month. She could probably (legally) set aside up to fifteen percent of that, or $1,000 per month, in a pretax retirement plan. Her employer matches her contributions at a rate of fifty percent (up to six percent of income), so she'd need to invest twelve percent ($800) in order to get the maximum match ($400).
Here, in essence, are her choices:
- Save $1,200 bucks for the future, or ...
- Get $640 bucks to pay for the past.
Tell me again, Dave, since you're so fond of using the analogy: What's that about driving down the road, throwing hundred-dollar bills out your car window?
In my opinion, it isn't the financial advisor here who's "stupid."
Am I way off-base on this?