[Skeptical Saturday] So What’s the Story With All Those “Turn Your Debt Into Wealth” Type Programs?

Money isn't necessarily the root of all evil, but it certainly is the root of a lot of self-help nonsense...

I don’t listen to the radio often, but when I do, I generally hear a commercial where someone is offering a “proven system” that will help people turn their debt into wealth, no matter how much debt they have. I’ve always wondered what sort of program could take a negative balance and turn it into a positive balance through some sort of financial magic, and I’ve always been annoyed to find that, when I look into these systems, their websites don’t provide ANY information — just a bunch of promises and testimonials.

So, in the spirit of skepticism, it’s time to take a look at these debt-elimination systems, and find out what they’re really all about.

I’ll start with John Cummuta, and his “Transforming Debt Into Wealth” system, because I hear his ads on the radio all the time. Now, I don’t have anything against Mr. Cummuta, and from what I have been able to find out about his system, I don’t have any grounds to say that it doesn’t work. (I’m actually fairly certain that it will work if you follow it.) But what I will tell you is that I can give you much of the same advice here, in this article, for free, if you hang on until the end. That’s not because I’ve bought Mr. Cummata’s book or bought into his system; it’s because his system is something that debt experts have been preaching for decades.

Let’s start with the claims, though. Here’s an excerpt from John Cummuta’s website, at http://www.johncummuta.com:

A typical $60,000 annual income household with $151,639 in total debt, including their mortgage, could be completely debt-free, owning their home, two cars, and everything else in their lives in just 5 years 9 months. They would save $142,444 in interest payments, and could build up $1,646,312 in retirement savings in just 20 years using their newfound monthly cash flow.

Wow! Sounds amazing, huh? Who wouldn’t want to buy into a system like this? Well, me, for one, since it costs $349. For your money, you get a bunch of audio CDs, some junky-looking software, a 200 page workbook, and a phone coaching session, so at least you’re getting a product out of the deal. From what I can tell, without having actually heard the CDs or read the workbook, you’re going to learn about three things:

• The debt-snowball method: A means of paying down debt which I’ll describe in a moment. It’s ridiculously simple, and there’s no reason you should pay money to learn about it.
• Compounding interest: Guys like Cummuta tell you how to make it work for you. But chances are good, if you’re in debt, that it’s already working against you.
• Investing in IRAs: Income Retirement Accounts (IRAs) are nice because the money you put into them never gets taxed. The catch is that you have to wait until you’re 65 years old to get your money out without penalty.

So, what does that leave Mr. Cummata’s system with? A bunch of personal stories and some tips and tricks about saving money. From what I’ve read, it’s mostly common sense stuff about keeping track of expenses, not continuing to charge up credit cards, making meals at home, selling things you don’t need, and other ideas that anyone who’s ever had his or her back against the wall already knows.

This is why I couldn't have a piggy bank when I was a kid... it was always getting smashed open so I could buy junk.

In fact, that’s what you get with a lot of these systems. The only money that’s really being generated here is from the sale of overpriced products featuring old ideas with a new look. I hate to single out Mr. Cummata, because he’s only one of many people who are in this game not because they want to help people, but because they’re selling something. And from what I can see online, people are buying into it because they don’t know how to manage their money and do like the idea of spending more of it to get themselves out of trouble.

And then, you have the financial “gurus” like Mary Hunt, Dave Ramsey and Suze Orman who give advice so they can promote their various books, speaking tours, and workshops. The problem is that whenever people are selling products, you have to question not only their motives, but their behavior. Many of the people in the self-help and acualization movement don’t follow their own advice very well. In fact, just this week, one of the UK’s biggest financial gurus, Lorne Spicer (from Cash in the Attic), declared bankruptcy. This doesn’t mean that every financial guru is bad, but you have to consider that they’re not using their advice to make themselves rich; they’re selling books and seminars. That means that they don’t have to practice what they preach, because they have far more income than most people ever will.

So, how about some free advice, from which I’ll make nothing? Here goes.

Debt-snowball: First, make a personal budget, and try to eliminate extra costs wherever possible, such as magazine subscriptions, premium cable channels, and so forth. Get rid of the costs you can live without, and free up as much money as possible. Then, apply that money towards your savings account each month and build it up to $1000 plus three to six months of your salary. This is your emergency money — just leave it in savings unless you absolutely have to spend it.

Next, take all of your debts and write them down — credit cards, mortgages, car payments, student loans, and so forth. Next to them, write the time you have to pay them off, the minimum payment and the interest rate. Rank them from lowest amount owed to highest amount owed. Then, calculate the minimum amount you have to pay each month to keep your accounts current. Write this down. Next, consult your personal budget and write down the maximum amount you can be spending on debt each month. Take the difference of your minumum and your maximum, and write it down. That’s the extra money you’ll be applying towards debt each month.

So, now that you have your debt ranked, continue to pay your minimums every month, but apply that extra money to your lowest debt. The minimum on this debt will decrease, but continue to pay the same amount on it each month until it’s paid off. Once you pay it off, take the extra money you were applying to the lowest debt plus the money you were spending on its minumum and apply that to your next lowest debt. Do it again, and again, and again, until you have no debt left. Then, take the money you were spending on debt and apply it towards investments, savings, and IRAs.

The reason this is called the “debt-snowball” is because of the psychological impact it has on you as you continue to roll your money into debt and build momentum. You watch the minimum payments and the balances drop every month, and you watch the money you’re putting into it reduce your debt. If you stick to it, you can generally get rid of debt in a matter of years, especially if you can keep your expenses low.

Sounds easy, huh? Well, it is… provided that you’re disciplined about spending. It also assumes that you have enough money coming in to allow you to have extra money in the first place. Many people who get mired in credit card debt don’t have extra money to apply to savings. They’ve living beyond their means. Those people, sadly, are going to have to either declare bankruptcy or find ways of increasing their income to get themselves out of trouble.

Compounding interest is a marvelous thing... if it's not working against you!

Compounding interest: There’s an urban legend that Albert Einstein said that compounding interest was the most powerful force in the universe, or the most powerful invention of mankind, or something like that. He probably never said that, but it sounds really good because compounding interest can be a really powerful way to make money over the long term. The rule of 72, a quick way of doing mental calculations for compounding interest, says that if you take the number 72 and divide it by the annual interest rate (expressed as a whole number, not a decimal), you’ll get the number of years required to double an investment. So, take 72 and divide it by 12% APR and you’ll find that it takes around 6 years for a credit card company to double its money on what you’ve borrowed if you pay back the debt plus interest during the entire period. That’s not so bad if you’ve borrowed, say, $25, but if you’ve borrowed $25,000, it can carry some serious personal repercussions.

So, how do you make compounding interest work for you? First, you have to stop it from continuing to work against you. That means getting rid of high-interest credit card debt and keeping yourself away from variable-rate loans that start with low teaser rates. It also means avoiding things like payday loans, title loans, and other predatory lending institutions. The smartest thing to do is to get yourself a low-interest credit card, transfer your balances to it, and put all the money you can into paying that balance off. That way, you’re not spending extra money on multiple sources of compound interest… and you’re giving yourself an ability to pay off a single debt’s principal much more easily.

The next way to make compounding interest work is:

Putting your money into an IRA:  Roth IRAs are special accounts where you can deposit money you’ve already been taxed on and pull it out when you’re retired, tax-free. While the money’s in the account, compound interest works its magic. So, if a 25-year-old builds up his or her account to $15,000 by the time he or she is 30, earns $5,000 in interest and then doesn’t invest another dime, the $20,000 that was in the person’s account when he or she was 30 turns in to $1,280,000 by the time they’re 72. Not too bad, huh?

The problem is, who has $3000 to invest per year into a Roth IRA when they’re 25? Most people don’t. Those who do are typically taking advantage of their employer’s 401k plan since they can put money into a 401k before their income is taxed, their employer will match their contributions, and they won’t have to worry about taxes until they withdrawal. There are ways to roll 401(k) funds into a Roth IRA, but there are limits on what you can do with it.

So, setting up an IRA is really one of those scenarios that benefits those who aren’t saddled with a lot of debt and that is unreachable for those who haven’t been as careful or as lucky with their money. Plus, the closer you get to retirement, the less an IRA can do for you since compounding interest is only really effective at high rates or with a high number of years. If you get a 10% rate of return on an IRA and you invest $3,000 a year when you’re 40 (the maximum amount), you’ll have $325,000 when you’re 65 and ready to retire. That’s not terrible, since you only chipped in $96,000, but it’s still not going to make you fantastically wealthy.

A penny saved is a penny earned: I’ll give you one more piece of financial advice that’s so ancient that it really should be common knowledge. For some reason, though, people don’t think about money this way.

Many people complain that they don’t make enough money. They’re probably right, but most don’t really sit down and examine their spending habits. If you’re able to save $200 a month, you’re actually better off than if you make $200 more per month. Why? It’s because of taxes. The more you make, the more the government takes. The money you have is post-tax, which means that the only tax you’ll have to continue to pay on it is if you make any capital gains (such as investing it and getting a positive return). But the money that’s coming from your salary begins as pre-tax, and you have to pay a chunk of it to the government in order to take it home.

Think about it this way. If you’re only making $24,000 a year in take-home pay, saving $2,400 of it might seem like a big deal, but the reality is that if you keep it up, you’ll have $12,000 in five years — half a year’s salary that you won’t have to pay any tax on. By contrast, if you worked hard, spent everything you made and made a $2,400 bonus each year that you instead put into savings, you’d have to give at least 20% of that to the government before you even got to touch it.  That would leave you with $9,600 in bonus money at the end of five years. Getting extra money isn’t as beneficial as saving it in the first place. That line of Benjamin Franklin’s describes reality well.

How can you avoid people selling systems? It’s very simple. If they are offering some miracle cure for your finances, but make claims that seem too good to be true or that are bolstered by a bunch of testimonials, they don’t have any real answers for you — just something to buy into. Think about it this way — it was really so easy to get wealthy, they wouldn’t have to sell books, CDs and workshops to tell you how to do it. They could help you for free, out of the kindness of their hearts. What would it matter to them, since they’d already made their money?

Speaking of which… want more great free advice? I’m a fan of Get Rich Slowly, a blog that has a lot of information, but that isn’t selling anything. MasterYourCard offers a different take on the debt-Snowball method. I also like Clark Howard’s radio show, since Clark seems dedicated to busting scams and not to pushing a bunch of junky products.

2 Comments

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  By Mike Harmon, January 17, 2009 @ 1:15 am

  I just stopped by your blog and thought I would say hello. I like your site design. Looking forward to reading more down the road.

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  By Allen Taylor, January 17, 2009 @ 1:15 am

  Nice writing. You are on my RSS reader now so I can read more from you down the road.

  Allen Taylor

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