Our second question of the month comes in from a new listener named Erik!
Erik here. I'm a new listener on the Marriage, Kids and Money Podcast. I appreciate all you're doing to help families achieve financial independence.
When you originally started out with Dave Ramsey doing the Total Money Makeover, did you stop continuing saving for retirement during Baby Step 2?
I'm curious about your approach with the Debt Snowball and retirement investing.
Great question Erik!
This is one that comes up a lot in our Financial Peace University classes.
There are three approaches to this question that I'd like you to consider:
- Stop all retirement investing
- Don't invest until high-interest credit card debt is paid off
- Invest immediately regardless of debt type
Let's review these options and I'll tell you what I did as well as what I would do today.
Option 1: Stop all retirement investing
This is the path that Dave Ramsey advises for people who go through his course, read his book or listen to his radio show. He recommends that you stop investing in your retirement so you can go “gazelle intense” on your debt. Take it from me, it works.
When I was die-hard into Dave, I went explicitly through his steps. During baby step 2, we completely pay off our $48,032 of debt in 12 months. Our family is happily debt-free and never looking back.
When we were paying off the debt, I stopped contributing to my workplace 401k and Roth IRA. I didn’t have much in there to begin with but I stopped either way.
Looking back, I wish I would have continued contributing to my workplace 401k because of the favorable company match. My debt was not the “high interest” kind. I had a student loan of around $30k at 7% and my wife had a car loan of about $20k at 4%.
- Eliminate your debt much faster
- Puts your sole focus in one area
- With high-interest credit card debt, you more than likely save more by paying it off than you'd make in the stock market
- Miss out on a potential employer match through a workplace 401k
- Delays your retirement plan so you need to invest longer to reach your retirement goals
- With lower interest debt (car loans, student debt, etc), you could potentially make more in the stock market
Related Article: Roth IRA Investing in 10 Simple Steps
Option 2: Don't invest until high-interest credit card debt is paid off
Another way to look at this is to pay off all of your high-interest credit debt first before investing for retirement. I like this approach a lot.
Having high-interest credit card debt is a major drain on your ability to build wealth or just to simply stop living paycheck to paycheck. If you're paying 20%+ interest each month, the game is stacked against you.
For this approach, you would hold off on investing and then throw all of your extra money at your credit card debt until you don't owe another penny. As soon as your credit card debt-free, then start investing again up to the match with your employer 401k.
- Eliminates your high-interest debt fast
- Gets you back into retirement investing faster
- You'll save more by paying it off than you would in the stock market
- For a period of time, you'll still miss out on an employer match through a workplace 401k
- Delays your retirement plan slightly
- Slows up your overall debt pay-down strategy if you have non-credit card debt like student loans, car loans, medical debt, etc.
Option 3: Invest immediately even with credit card debt
Another option is to continue investing during the debt pay-down process regardless of what type of debt you have. Fans of this approach like it because it lets you take advantage of the 401k employer match from the start.
I'm not as keen on this one because it ignores someone's high-interest credit card debt situation. Since you didn't share with me your personal debt story, I'm not exactly sure if you have high-interest debt right now.
- Grows your retirement portfolio earlier and faster
- Takes advantage of free money through your workplace 401k match
- If you only have lower interest debt, you may make more in the stock market this way
- You'll have debt for a much longer time in your life (added stress, payments and obligations)
- If you have high-interest credit card debt, you will more than likely make less interest in the stock market than you would if you just paid off your debt
- With an unexpected emergency, your debt may continue to rise if you're living paycheck to paycheck
Related Podcast: How We Eliminated $27,000 of Newlywed Credit Card Debt
What Would I Have Done Differently?
Although I'm very happy we paid off our debt very fast, I wish I would have taken advantage of the free money (my favorite kind of money) offered through my employer.
Now my situation may be different from yours so let’s think about this …
If you have credit card debt and you’re paying 20%+ interest, I would recommend you not invest in anything until that debt is gone. There’s a slim chance of you making 20% in the stock market.
But if you have a 4% car loan or a student loan you’ve refinanced down to 3%, it might not be a bad idea to keep investing in your 401k at least up to your employer match.
For me, I had a $30,000 student loan at 7% (which I wish I would have refinanced with SoFi, but I didn’t) and my wife had a $20,000 car loan at 4%. Based on that, I wish I would have refinanced the student loan down and then kept investing in my 401k up to the match.
You Know You Better Than Anyone
So, Erik, I don’t know all of the details of your situation, but before you make any decisions ask yourself a few questions:
- What type of debt do I have and how high are my interest rates?
- Is there any way I can get my interest rates lower?
- If I keep investing in my 401k at work, how much longer will I be living with my debt?
- Am I okay with that timeframe?
Do a little soul-searching and find out what feels right for you.
Related Article: 10 Steps to Young Family Wealth and Happiness
I love Dave Ramsey and he did A LOT for my family, but I realize that he’s making this program for the masses and he can’t know the specifics of everyone’s situation. Therefore he has to make big sweeping rules to help as many people as possible.
It’s black or white in the course, in his book, and with his radio show. I do think there’s a lot of gray area, but it’s up to us to discover it. Dave’s not going to prescribe a detailed plan for every one of his millions of listeners. It’s impossible. But he gives you the guidelines and then you design your life and your plan accordingly.
That’s something that took me a while to figure out. I thought there was one way and all other ways were wrong … nope. Not true at all. It’s just a book – it’s a really good book, but it’s just a book and someone’s opinion.
It’s up to us to take the next step. It’s up to us to dig a little deeper and find out what works best for our specific situation.
I hope that helps Erik.