The Tough Love School of Life…

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You have read the numbers. Half of all Americans do not have $1,000 to $2,000 in savings for an emergency. Forty percent of Americans do not have a retirement account and the same percentage, 40%, do not pay off their credit card every month. The balance on these cards not paid off monthly is about $9,000 and at an average interest rate of 18%, interest alone is $135 a month before you even make a dent in the principal.

You could sit down and rationally explain to people that they need a detailed budget and they need to stick to it. Its simple, spend less than you earn. Sounds sensible, sounds logical… but close to impossible for many. The thrill of spending and the persuasive power of American advertising is just too great. Some folks need a more radical, tough love approach. Dave Ramsey has made a career of preaching tough love in finance, both through his radio show and through books such as his “The Total Money Makeover” (2003) which has sold 5 million copies.

What’s his solution? It requires going cold turkey (see below), cutting up your credit cards, paying for everything in cash and if you don’t have cash, don’t buy. Focus immediately on building an emergency savings account of $1,000. Then start the ‘debt snowball’. List your debts in order from smallest to largest and attack the smallest first, making minimum payments on the rest. Then when the smallest balance is paid off you attack the next smallest debt. This is not conventional wisdom which recommends paying off the highest interest rate debt first, then the next, and so on. Ramsey argues that people need to see small victories to stay on course so going after the smallest balance first makes sense.

After your consumer debt has been paid off you build an emergency cushion equal to three to five months of expenses, you invest 15% of your gross salary in a retirement account (no compromising here) and finally move on to the longer-term issues on the list.

How effective is this program? Like losing weight and stopping smoking, it is tough. Some can do the Baby Steps on the first try but others will have to try again or try something completely different. Consumer debt (including college debt) is a real problem today. A significant number of Americans have not had an inflation adjusted pay raise in ten to fifteen years. Life is indeed tough. What’s your plan?