Day 7: Building the Nest Egg

This post is part of a series on Dave Ramsey’s Financial Peace University (FPU). The following is my impression of small pieces of the class. For more, I highly recommend taking the class for yourself.

In the 7th class session, Dave Ramsey tackles investing, both from retirement  and college savings perspectives. As is common, he takes you just through a surface breeze of the topic, since each of these have been topics for entire books. Even though its the 7th class session, this lesson is only covering Baby Step 4 because there were a couple of lessons in there that didn’t correspond to a Baby Step, such as Relationships and Money. In Ramsey’s plan, you would first build a safety net of emergency fund, pay off all debts except the house, and then start in on Baby Step 4: Investing 15% of your income in retirement plans.

Ramsey does a good job of explaining basic financial concepts clearly. He adds several people’s money to a bowl to demonstrate a mutual fund, and then he also puts a coat over a cookie jar to show how IRAs are just the tax structure of the account, not the account itself. Even though they’re simple, the examples and imagery help many to connect with abstract concepts.

KISS Your Investments

Ramsey’s model is centered around simplicity. He has a few hard and fast rules that he wants you to follow, a simple Baby Step process to take you through the different phases of life, and basic principles to follow. This theme continues into the topic of investing: He says, “Keep It Simple, Stupid!” Ramsey is the first to admit to doing stupid stuff, and sometimes he is also the one to call others stupid, so he takes it just as he dishes it out.

By “Simple,” Ramsey is meaning for you to avoid all the fancy products and gimmicks of Wall Street. No market timing. No options trading. No Oil & Gas or foreign currency deals. No complex partnerships or get rich quick schemes. Just simple, boring, long term, regular investment. He demonstrates the power of this at the beginning of the lesson with a hypothetical 30 year old couple that invests in their 401(k) and in IRAs. Assuming a 12% return, they end up with $16.8 million at age 70.

Financial Security

This example at the beginning of the class session rubbed me the wrong way. I recently penned an article on jasoncutter.com about Financial Independence. Maybe that’s why. A whole other article could be written on this, so I won’t delve too deeply now, but it felt as if this $16.8 million was being held out like a carrot on a stick, leading me to think, “If only I could get to that point…” I think there’s something wrong with that. If we think of financial security as a certain asset amount, then we don’t understand what security really is. God holds us in his hand. No large amount of money can secure us. No small amount of money can destroy us. Granted, there is a balance to be struck here with our bank accounts and how we think about them. I think financial security has less to do with our bank accounts and more to do with how we think about them, but I digress…

Simple = Aggressive

When Ramsey says “Simple,” he means really simple. His recommendation for diversification is 25% in each of the following categories: Growth & Income, Growth, International, and Aggressive Growth. (Did I mention growth?)

Ramsey’s Recommended Asset Allocation http://www.daveramsey.com/elp/roth-ira-starter-guide?snid=tools.rothiraguide

Ironically, too simple, and you become stupid. As this article by Money magazine argues, Ramsey is overly optimistic about the stock market, thinking it will average 12% per year, so he has no hesitation to recommend entirely stocks. Elsewhere, I have heard Ramsey recommend the same investment set up to a near-retiree. If the market drops 40% like it has in the last decade, that could be catastrophic for someone nearing retirement.

Moving On

The lesson is about investing, and its easy to get caught in the weeds of retirement, but Ramsey moves on to funding college in Baby Step 5. This is an important move, as it communicates that investing is for more than simply retirement. Ramsey recommends both the Education Savings Account (often known as a “Coverdell”) and 529 Plans, in that order. His major concern about the 529 option is that they often don’t allow you to control the investments over time. He doesn’t like that “a computer” automatically shifts the assets as the child nears college age. However, I don’t understand how he sees this as a major problem in light of the flexibility that the 529 offers, especially in comparison to the Coverdell, which cannot be transferred to other beneficiaries as easily.

In addition to this advice, Ramsey also comments on some major pitfalls of college savings, like using bonds, insurance, or prepaid tuition plans. Ideally, Ramsey says, you shouldn’t go into debt for college. You and your college age kid can find other ways to pay for college, like getting a job, living off campus, or utilizing local community colleges.

The Takeaway

Simplicity is good. It makes the advice easy to follow, but again, a balance needs to be struck here. Too simplistic and formulaic, and you become inflexible and unable to deal with individual circumstances. This is the difficulty of financial planning. Make it complex, and you optimize the use of the money at the expense of not being able to follow through on the advice. Make it simple, and it is easy to follow at the expense of not being able to deal with a variety of life situations.