Popular debt elimination evangelist Dave Ramsey teaches that, after setting aside $1,000 for emergencies, your only financial priority should be paying off all debt except your home mortgage. Everything else, including saving for retirement, should be put on hold until your debts are paid.
Ramsey uses the term “gazelle intensity” to describe the level of commitment you should have in escaping debt. The term comes from the image of a gazelle on the African Savannah being chased by a cheetah. The gazelle doesn’t think about anything else until it is free from danger.
Ramsey views debt as the cheetah and teaches that you should not pursue any other financial goals until you have escaped debt. All your resources should be thrown into getting out of debt as quickly as possible. Ramsey teaches that with that kind of commitment most people can get out of debt in two to three years.
One of my favorite financial writers, John C. Bogle, founder of Vanguard Mutual Funds, often writes about “the relentless rules of humble arithmetic”. Bogle borrowed the phrase from Supreme Court Justice Louis D. Brandeis. The phrase reminds us that the financial reality of a situation, in dollars and cents, should be considered before making decisions.
So, when deciding how to divide your resources between escaping debt and saving for retirement, which philosophy wins? Gazelle intensity or the relentless rules of humble arithmetic?
Let’s look at an example. Mr. Average earns $50,000 dollars per year, which is close to the median income in the United States. His employer will match his 401k contributions up to 5 percent of his income.
Not counting his home mortgage Mr. Average owes $25,000 in debt. About half of his debt is student loans and the other half is a car loan. He has taken advantage of current low interest rates and pays an average of 5 percent interest on his debts.
With gazelle intensity Mr. Average can throw $1,100 dollars a month into debt elimination. At that rate it would take him 2 years to pay off the $25,000 and be debt free.
What if, instead, Mr. Average took advantage of his employer match and put 5 percent of his income into retirement savings. He would contribute $2,500 a year (matched by $2,500 contributed by his employer), or about $208 per month, meaning he could only put $892 ($1,100 less $208) into eliminating debt.
Paying $892 per month, at the end of two years Mr. Average would still owe $5,158 in debt, and it would take him an additional 6 months to be debt free. However, with the employer match he would be saving $5,000 per year towards retirement. At the end of two years, even if we assume he only earned 5% a year on his investments, he would have $10,477 in retirement savings.
The relentless rules of humble arithmetic show that Mr. Average would come out $5,319 ahead ($10,477 less $5,158) by taking advantage of his employer’s match and saving for retirement at the same time he is eliminating debt. This does not even take into account the tax savings he would achieve by saving for retirement, which, if he were in the 25 percent tax bracket, would provide an additional $1,250 in tax savings over the two years.
As evidence of the success of his method Ramsey points to the many people who call his radio show to scream “We’re debt free!” He admits the numbers don’t add up if you forgo employer matches but believes that the commitment of being “gazelle intent” is more important than mere numbers.
I fear that Ramsey’s method has created an army of invisible victims. These are people who started the debt elimination plan with enthusiasm, commitment, and gazelle intensity. However, either through circumstances beyond their control, or simple human weakness, two or three years pass and they have not succeeded in getting out of debt, and they have nothing saved for retirement. They have given up years of employer matches and compounding that they can never get back and have still not reached their goal of being debt free.
These people don’t call the radio show because no one likes to admit failure, but they are out there. Remember, absence of evidence is not evidence of absence.
I dislike debt as much as anyone and believe becoming debt free should be everyone’s goal. So go ahead and be as gazelle intent as you want to be when attacking debt, but only after giving the relentless rules of humble arithmetic their due by taking advantage of employer 401K matches first.