Total Money Makeover - critical summary review

There’s only one way to eat an elephant: one bite at a time. The tortoise beat the hare in that famous fable because it knew this age-old wisdom better than its fearsome rival: small, steady steps work much better than haphazard jumping. When you are hasty or ambitious, or you simply try to do everything at once, progress can be very slow or nonexistent. It’s the other way around when you focus on a single task and do it with vigor to completion; then, and only then, you should move to the next step.

This has always been the framework of Dave Ramsey’s fiscal philosophy that he sums up in a simple motto: “we can do anything financially if we do it one little step at a time.” In “Total Money Makeover,” he presents his readers with seven such steps – baby steps, he calls them. “Make them,” he says, “and you’ll retire as a rich, debt-free American with a house of your own and enough money to enjoy every day until the last one.”

So, get ready to design a sure-fire step-by-step plan to pay off your debts and prepare to secure “a big, fat nest egg for emergencies and retirement.”

Ваby step No. 1: save $1,000 cash as a starter emergency fund

According to Money magazine, 78% of Americans will experience a major negative event with severe financial consequences in any given 10-year period. So, that’s 4 out of 5 readers. 

The event we’re talking about can be absolutely anything. Your job might be “downsized, rightsized, reorganized” – or you might just get fired. Even though you might not have planned to have kids just yet, an unexpected pregnancy might happen this very year. On the subject of kids – who knows: maybe your grown daughter will divorce her husband and come back to live with you. Your car might blow up. Your loved ones might die. 

We tend to describe these events as surprising, but – actually – they are not: sooner or later, they will happen to almost everyone. So, you have to be ready in advance to tackle them when they come. And what better way to do this than with “an old-fashioned Grandma’s rainy-day fund”? After all, if the weather forecast says that it is going to rain in the afternoon, you take your umbrella with you when you leave your house for work in the morning. An emergency fund works precisely in this manner – which is why it is the first to your Total Money Makeover.

If you earn more than $20,000, get together $1,000 – and get it fast! You can do that: it is more than achievable. And if your household income is under $20,000 per year, then use $500 for your beginner fund. But remember: this emergency fund is not for vacation, for buying things or for Christmas; it is for emergencies only. So, no cheating.

Baby step No. 2: start the debt snowball

Creating an emergency fund is the best way to prepare yourself for baby step No. 2: dumping your debt. Ramsey uses the perfect analogy to link the first two steps of his Total Money Makeover plan, comparing your rainy-day fund to a light protein shake you need to drink to fortify your body so you can work out, which eventually should enable you to lose weight.

And the best way to “lose weight” – that is, to pay off your debts – is the Debt Snowball method, a technique that might seem simple to understand but also requires truckloads of effort. 

In essence, this method requires from you nothing more but to list all your debts – except your home – in order of smallest payoff balance to largest. Don’t forget anything – even loans from your parents or medical debts that have zero interest. Use a simple spreadsheet (nothing fancy) and be sure to include these six columns: item, total payoff, minimum payment, new payment, payments remaining, and cumulative payments. 

And that’s it! Now all you need to do is start paying off your debts from the one listed at No. 1 to the last one, whatever its number turns out to be. Yes, that’s right: contrary to common opinion, you’ll start paying off your debts from the smallest one. The idea is to build momentum by gaining a few quick wins. Paying the little debts off first gives you quick feedback, and that feedback should fire you up and give you just enough willpower to stay with your plan. Personal finance is 80% behavior and 20% head knowledge – which is why the Debt Snowball works better than intricate interest-based math calculations.

“The only time to pay off a larger debt sooner than a smaller one,” writes Ramsey, “is some kind of big-time emergency such as owing the IRS and having them come after you, or in situations where there will be a foreclosure if you don’t pay it off. Otherwise, don’t argue about it; just list the debts smallest to largest.” And pay them – with gazelle-intensity!

Baby step No. 3: finish the emergency fund

In about a year and a half or two – 18 to 20 months – you should succeed in moving from baby step 2 to baby step 3. By now, except for your mortgage, you should be free from all other debts and still have at least $1,000 in cash in your emergency fund. Moreover, you have momentum on your side.

Now, it’s time to use that momentum to fully fund your rainy-day account. A recent study found that every second American (49% of us, to be precise) could cover less than one month’s expenses if they lost their income. You don’t need Ramsey to tell you that this is pretty much insane – if not irresponsible. What is the opposite?

Well, as a rule of thumb, a fully-funded emergency reserve is the one that covers three to six months of expenses. So, ask yourself what would it take for you to live three to six months if you lost your income. Depending on your needs and lifestyle, this number will usually range between $5,000 and $25,000. A typical family – living on $3,000 per month – might need a $10,000 emergency fund as a minimum.

However, since the purpose of this fund, by definition, is to absorb risk, “the more risky your situation, the greater the emergency fund you should have.” And don’t forget that it’s an emergency fund, designed to turn crises into inconveniencies: don’t use it for something else. Even if that something else is buying a house.

Baby step No. 4: invest 15% of your income in retirement

By the time you reach this step, you should have no payments but a house payment and about three to six months’ worth of expenses in savings – which is thousands of dollars. A good time as any to “get really serious about your wealth building.” 

And wealth-building is always a combination of three things: conscious spending, clever saving, and safe investments for retirement. It is the last one of these elements that baby step 4 of the Total Money Makeover program is all about. 

As far as investing in retirement funds is concerned, Ramsey’s rule is simple: “Invest 15% of before-tax gross income annually toward retirement.” Why not more? Because you’ll need some of your money for steps 5 and 6. Why not less? Because your altruistic desire to get your child through school or pay off your home faster will almost certainly leave you a bit poorer once you retire. “Kids’ college degrees won’t feed you at retirement,” writes Ramsey, and there are just “too many 75-year-olds with a paid-for house and no money.”

So, the number is 15%. As for the tool – it is mutual funds. “Why?” – you ask. Because the stock market has averaged just below a 12% return on investment throughout its history, and, naturally, growth-stock mutual funds take advantage of this trend. To make the most of your investments, “select mutual funds that have had a good track record of winning for more than five years, preferably for more than ten years.” And also spread your retirement money, investing evenly across four types of funds: 25% to growth and income (blue chip) funds, 25% to growth (equity) funds, 25% to international (overseas) funds, and 25% to aggressive (small cap) growth funds. And then – just watch your money grow.

Baby step No. 5: save for college

Even though everyone thinks that saving for college is important, hardly anyone saves money for the college education of their kids. According to both Money magazine and CBS Market Watch, 39% of Americans with kids – so more than 1 in 3 families – don’t save a dime toward college. To make matters worse, according to USA Today, the majority of those who do save for college – 37% of Americans overall – do so in a simple savings account yielding less than 3%. So, all in all, 2 out of 3 Americans raise kids that graduate from college with an average of $27,000 in debt!

Another study – conducted by SallieMae and Gallup – sounds even more staggering: only 9% of American families use college savings funds like Education Savings Accounts (ESA) and 529 plans. And that’s arguably the only way to actually save enough money for your kids’ college education! The math is simple: if you invested $2,000 a year from birth until the 18th-birthday of your child in prepaid tuition, it would purchase about $72,000 in tuition; through an ESA in mutual funds averaging 12%, you would end up with $126,000, tax-free. Let us translate that in even more optimistic terms: if your kid is under eight, and you start investing just $167 per month in an ESA, then you’ll have no problem getting your kid through college, debt-free.

This doesn’t mean that you shouldn’t encourage your children to apply for scholarships if they are talented to win one or to enroll in some state school if that seems like the best option. Quality neither justifies nor pays off debt – 9 out of 10 times.

Baby step No. 6: pay off your home mortgage

“Anytime I speak about paying off mortgages,” writes Ramsey, “people give me that special look. They think I’m crazy for two reasons. One, most people have lost their hope, and they don’t really believe there is any chance for them. Two, most people believe all the mortgage myths that have been spread.” Four, in particular, stand out:

• The first myth is that it is wise to keep your home mortgage to get the tax deduction. The truth is that tax deductions are no bargain: you’ll end up paying a lot more because of them.
• The second myth is that it is wise to borrow all you can on your home to have great interest rates; then you can invest the money. The truth is that, once you take all those stock market taxes and fees, borrowing against your home is too risky an endeavor for the prospect of winning just a few bucks.
• The third myth is that you should take out a 30-year mortgage and promise yourself to pay it like a 15-year one, so if something goes wrong, you’d still have some wiggle room. The truth is that, well, something will inevitably go wrong. Moreover, history is against you: the FDIC says that 97.3% of people don’t systematically pay extra on their mortgage.
• Finally, the fourth myth is that it is wise to use the lower rates offered by an ARM mortgage or balloon mortgage if you know you’ll be moving in a few years anyway. The truth is that ARM and the balloon mortgage were created to transfer the risk of higher interest rates to you – so you will be moving, yes – but after a foreclosure.

The solution? Nothing original here: just take a shorter mortgage and remain disciplined. Need an incentive? Take this into consideration: in comparison to a 30-year mortgage at 7%, a 15-year mortgage should earn you savings of $150,000 over its course! 

Baby step No. 7: build wealth

Not much to say here, right? Once you can – start building your wealth. Surround yourself with experts and stick to their advice. “When your money makes more than you do,” quips Ramsey, “you are officially wealthy.”

But don’t forget to spend some of it as well! There are three good uses for money: having fun, investing, and giving. Once you earn enough of it, you should do all of these things.

Final Notes

“Total Money Makeover” is the most popular of Dave Ramsey’s several financial bestsellers. 

Bearing in mind that Ramsey might be America’s “most trusted voice on money and business,” it is not an exaggeration to say that it might be the best book of its kind you’ll read this or any other year.

So, why wait?

12min Tip

Math won’t help you amass wealth: behavior modification will. So, quit making fancy spreadsheets: just start snowballing debts, saving money, and investing 15% of it in mutual funds.