It seems I write a post about Dave Ramsey every couple of years. They're popular posts, both for regular readers and for people later finding the site on the internet. Dave and his teachings can be a bit of a lightning rod, where people either become unabashed disciples or spew venom upon hearing the mere mention of his name. Despite Dave blocking me on Twitter (for criticizing his PSLF related advice I think), I like his show and for the most part his advice. I even make my kids listen to it. Plus, he is a very talented radio host I can't help but admire for his entrepreneurial success. The dude can market like a boss.
At any rate, let's take a quick look at what he gets both right and wrong.
14 Things Dave Ramsey Gets Right
# 1 Personal Finance is Mostly About Behavior
One of Dave's biggest contributions to the personal finance space is his relentless focus on behavior. He is absolutely right that getting into debt is caused by bad behavior and so getting out of debt cannot be accomplished until the behavior changes. Behavior also makes a significant contribution to investing. It turns out the investor matters a lot more than the investment. The math matters too, but only once you get the behavior right.
# 2 When Debt Is The Problem, Paying Off Debt Is The Solution
Dave's 7 Baby Steps put a heavy focus on paying off all of your debt except a reasonable mortgage. In fact, the only thing he wants you to do before beginning the debt pay-off is to save up a $1,000 “baby emergency fund.” He doesn't even care if you don't get a match and miss out on all the tax deductions available in retirement accounts. For someone with a serious debt problem, like many of his callers, readers, and show attendees, that is exactly the right approach. Their financial problem is debt, and when debt is the problem, paying it off is the solution.
# 3 Focus Matters
Dave not only focuses on debt, but he focuses on one debt (the smallest debt) at a time. The power of focus is very real. If you try to spread yourself out over multiple financial goals, especially in the beginning of your financial journey when your personal finance “muscles” are weak, you are likely to not accomplish any of them.
# 4 Momentum Matters
Likewise, momentum matters. Dave recommends a “snowball” approach to paying off debt. So instead of paying off the highest interest rate debt first, you pay off the smallest debt. This allows you to feel early success and that you have momentum and have accomplished something. Mathematically, that's not the correct thing to do. But math didn't get you into debt and it is unlikely to get you out. If math ruled your world, you wouldn't be in debt in the first place. The snowball works because behavior matters more than math in personal finance.
# 5 Most People Would Benefit From Financial Advice
Lots of do-it-yourselfers just can't figure out why anyone would need financial advice. After you interact with many of your peers, you will understand. There is a huge percentage of the population, even otherwise intelligent and hardworking people, who should not, can not, and will not function as their own financial planner or asset manager. The best thing that can be done for them is to get them to someone who offers good advice at a fair price. So I don't object to Dave sending people who need help investing to a recommended and vetted financial advisor. I have a serious issue with his vetting process, which I'll get to later, but not with the fact that he is sending people to financial advisors.
# 6 Enabling Others Is Not Helping
Some of Dave's best calls are those where there is an interaction between family members. He is quite talented at helping them to see the root problem behind the financial issue. He is excellent at pointing out and discouraging enabling behavior. An important lesson to learn is that while enabling someone feels like you are helping them, you really aren't. This is an important lesson for doctors, who spent their life trying to help people to learn. I'm not talking about paying your 93 year old grandma's rent. I'm talking about funding your brother-in-laws fourth doomed start-up. I'm talking about the economic outpatient care for your children. I'm talking about letting your non-disabled sister live in your house while you go to work to buy her food for years on end.
# 7 You Can Probably Spend More Than 4%
Dave isn't afraid to recommend absurdly high withdrawal rates from your investments. But his overall message–that you can probably spend more than the 2-4% that hyper-conservative people recommend as a safe withdrawal rate, especially with a very aggressive portfolio like Dave recommends–is correct. In the past, on average after 30 years if you follow a “standard” 4% withdrawal rate with increases each year with inflation, you will have 2.9 times what you retired with. What that means is that if you don't hit some terrible market conditions in your first years of retirement, you can spend MORE than 4% without running out of money. Even Dave's 8% rate when combined with a 100% stock portfolio and a 30 year period works 44% of the time.
# 8 People Need To Take Significant Risk With Their Investments
Dave's recommended portfolio looks like this:
- 25% Growth and Income Funds (Large Cap Stock Funds)
- 25% Growth Funds (Mid Cap Stock Funds)
- 25% Aggressive Growth Funds (Small Cap Stock Funds)
- 25% International Funds
- +/- Some paid off income properties
With no bonds, cash, CDs, or whole life insurance, that's a pretty aggressive portfolio with a sizeable small tilt. Obviously it can always be more aggressive, but what Dave gets right is that people need to take some significant risk in their portfolios. Without a ridiculously high savings rate and a long career, we simply cannot save our way to a comfy retirement.
# 9 Celebrate the Milestones
Since personal finance is 90% personal (i.e. behavior) and 10% finance (i.e. math), it is important you do all you can to reinforce the behavioral aspects. As Jonathan Clements has said, “If financial education was all that was needed to improve behavior, we’d be a nation of avid savers, hardcore indexers and early retirees.” Celebrating the milestones, especially if the celebration is planned ahead, paid for ahead, and anticipated, will make it easier to reach your larger goals. This is something I wish we had done more as we progressed toward financial independence. The first $10K, the first $100K, and the first million are the hardest. Celebrate your first $10K in your portfolio. Celebrate each $100K in student loans you pay off. Celebrate getting back to a net worth of zero. Celebrate every net worth milestone. Celebrate your financial independence. Thanks to the success WCI, LLC has seen financially, we blew past a bunch of milestones without even noticing or recognizing them. It made me wish we'd celebrated the earlier ones (that we really had to work hard and sacrifice for) better.
# 10 People Spend More When Using Credit Cards
The studies are very clear that when you use a credit card to spend you spend more. Cash hurts the most, then debit cards and checks, and finally credit cards, especially if they are not paid off each month. If you don't have a 20%+ savings rate, or if you've ever carried a balance on a credit card, credit cards aren't for you.
# 11 Anyone Can Pay For College Without Debt
Dave is also a big fan of working your way through undergraduate. Having worked my way through undergraduate, I agree. There are four pillars of paying for your child's undergraduate education, and none of the pillars has “Debt” written on it.
- School Selection
- Child's Contribution (Scholarships, summer work, in-school work)
- Savings (529 etc.)
- Cash Flow
If the child's contribution, previously saved money, and the parent's cash flow is not enough to pay for the school, choose a less expensive school. They are out there. Value and your financial status simply have to be considered when choosing a school. In fact, there are schools so inexpensive that they can be cash flowed by the student herself. Better to have more than one pillar under your house, but it can be done.
# 12 No Sense in Carrying Debt and A Big Emergency Fund
Dave's Baby Steps, as noted above, instruct you to only carry a $1,000 emergency fund while you are paying off all of your debts but your mortgage. I'm amazed how many people owe $100K or more in student loans charging 7% interest while leaving $30K sitting in a savings account earning 0.1%. That's not a winning formula. One purpose of an emergency fund is to keep you out of debt. If you're already in debt, YOU ALREADY HAD THE EMERGENCY. Take that cash and pay down the debt. Does that make you feel uncomfortable? Good. You should be uncomfortable. But not because you no longer have $30K in the bank. Because you owe $70K at 7%!
# 13 Fixed His PSLF Advice
At one point, Dave didn't seem to understand the Public Service Loan Forgiveness (PSLF) program. Several times I heard him recommend to someone to leave the PSLF program even though the person could not possibly pay off the debt prior to the time they would receive forgiveness. I even sent him an unanswered letter about it. I don't know if he read it, but he eventually started giving the correct advice, which is to enroll in PSLF and comply with it, but save up the “regular payments” in an investment account on the side in case the program or your career plans change.
# 14 Debt Doesn't Make Rich People Rich
Dave is very adamant that wealthy people didn't get that way by borrowing their way to wealth. He correctly points out that the way to get out of debt is to pay off debt, not play with it by refinancing or moving it from one card to another. He even has millionaire theme hours where he trots out “Millionaire Next Door” types and asks them how much of an effect borrowing had on their wealth accumulation. They almost always say there was no or little effect. It isn't that Dave or these rich folks don't understand that borrowing at 1% and earning at 8% is a mathematically winning strategy. It's that they got the behavior right.
Those who are likely to save enough to build wealth are also likely to pay off their debt to build wealth. The problem is that most of us simply don't invest the difference. We spend it. On stuff like wakeboats and heli-skiing. Sure, paying off my mortgage only gives me a return about the same as inflation. But that's still a better financial return than I got on all that helicopter gas and better than what my Ally Bank savings account is paying me. Medical and dental students in particular are almost all entirely too comfortable with debt. Borrowing all that monopoly money in school makes us numb to it, and the numbness lasts a lot longer than bupivacaine. If you're not careful, it can last your entire career and keep you from ever building wealth.
8 Things Dave Ramsey Gets Wrong
#1 You Won't Get 12% Returns
Dave throws out this “12% return figure” all the time in calculations and conversations. I've heard lots of justifications for it, but you really can't justify this. If you are planning for your money to compound at 12%, you're going to be very disappointed. Even if we see good economic times over the course of your investing career. Even if you use an aggressive portfolio like Dave recommends. I would not use a number higher than 7% real if I were you, and even that is a stretch. It is especially a stretch if you are not 100% stock, don't have a small value tilt in your portfolio, don't invest in real estate aside from REITs, and are paying a financial advisor an AUM fee.
# 2 You Can't Spend 8% a Year
I'm a big fan of adjusting as you go as far as your retirement withdrawal rate. But Ramsey's 8% number is probably way too far on the high side, especially if it is the figure you start with and especially if you are not very aggressive with your portfolio in retirement. Historically, 8% only lasts 15 years 71% of the time with a 50/50 portfolio. It only lasts 30 years 9% of the time. I'm fairly comfortable with many types of risk, but I wouldn't be with that one.
# 3 Picking Actively Managed Mutual Funds is a Losing Strategy
Dave is a big advocate of actively managed mutual funds. He is so adamant about this it is embarrassing. The data in favor of an index approach is overwhelming. The best actively managed funds are the ones that are most index-like (low costs, low turnover, stable strategy.) Why not just buy the real thing?
# 4 Past Performance Does Not Predict Future Performance
The worst part about Dave's advocacy for actively managed mutual funds it that he doesn't tell you how to pick a good actively managed fund. He just tells you to look for the one with the best past performance. There is a reason that the prospectus is required by law to tell you that “Past Performance Does Not Predict Future Performance.” That's because it is true.
# 5 A Commissioned Salesman Is Not A Real Financial Advisor
A cynic would argue that points 3, 4, and 5 are all connected. Dave recommends you invest with a “Smartvestor Pro.” These are reportedly vetted financial advisors with “the heart of a teacher.” The problem is that even someone with “the heart of a teacher” cannot overcome the poor incentive structure they all face. They only get paid (and can thus feed their own children) if you buy an investment with a commission. The worst investments pay the highest commissions. Therefore their incentive is to sell you the worst investments and have you trade them as often as possible. That's not the incentive structure you want for your financial advisor. If you're going to use an advisor, you want a fee-only advisor. Now don't get me wrong. There are some conflicts of interest there too. For example, an advisor paid an Asset Under Management fee is incentivized to recommend against paying off your student loans, paying off your mortgage, or buying the rental house down the street. An hourly rate financial advisor is incentivized to work slowly and bring you back often. A flat-fee (annual retainer) advisor is incentivized to do as little for you as possible and put you into a “cookie-cutter” portfolio. But those mal incentives pale in comparison to that which a commissioned salesman masquerading as an advisor faces. To make matters worse, in my experience someone paid on a commission basis has a far greater ratio of sales knowledge to financial knowledge than a fee-only advisor. Less real experience. Less real education. It's just a bad idea to hire a “financial advisor” paid on commission.
Why does Dave send people there? A few reasons probably. First, he's been doing this for a long time. It wasn't that long ago that you couldn't get a real advisor because almost all of them were paid on commission. Just like nobody who is up to date talks about “growth and income” and “aggressive growth” funds any more, it's like Dave is still operating out of the 90s. It would be very tough, both intellectually and financially, to cut ties with all of these guys he has paying him now who were apparently just fine a decade or two ago. And it gets harder every year. He probably figures better to just keep the empire marching along. Second, his typical listener is investing a four or five figure amount (or less.) That person can't afford a flat annual retainer. Nobody charging a straight AUM fee is going to take him as a client for decades. There aren't enough hourly advisors out there to service all those who need advice, and even those guys charge $100-500 an hour, which is dramatically more than you might pay in loads even on a $10K investment. The reason roboadvisors have done so well is simply that financial advice is expensive stuff and lots of people simply choose not to pay for it, for better or for worse. Maybe a lot of those people will be better off with a commissioned salesman with the heart of a teacher than nobody. At least they'll be investing. But I wish he'd at least point out the issues.
# 6 You Can't Pay For Medical School Without Debt
Dave's advice for undergrads is reasonable. However, he never seems to distinguish between an undergraduate education and a professional education. Nobody is going to work their way through medical or dental school or law school. It's not going to happen. If you're lucky, your parents can help out. If you're not, then it's loans for you. For most physicians, some dentists, and attorneys who can get a good job afterward, it's still a good investment even when paid for with borrowed money at 6-8%, as long as you get that debt paid off within just a few years afterward. I'd like to see some more subtlety in Dave's discussions with these folks.
# 7 You Don't Need A Big Emergency Fund Before Investing
Dave's Baby Step 3 is way too rigid. He advocates you save up an entire 3 months of expenses before investing anything. The problem with that is it requires you to leave some money on the table. That might be the match from your employer. It might be the tax-deduction from contributing to your 401(k). It might be tax-free space in a Roth IRA that you can never get back. I think it is probably okay to make some compromises in this department. I think having a 3 month emergency fund is a good idea. But there's no reason it can't sit in a conservative investment in a Roth IRA, from which it can be withdrawn tax and penalty free at any time. If a $1,000 emergency fund was good enough to pay off a 3% debt, it surely ought to be good enough to get your match. I understand the benefits of keeping the baby steps simple, but I think they're a little too rigid. Maybe it's just a behavior vs math thing and I'll change my mind in a few years, but I think it's at least worth pointing out the issues.
# 8 All Debt Does Not Have To Be Eliminated Before Investing
While we're on the subject of rigid baby steps, I disagree that you have to get rid of all non-mortgage debt before investing. As Dr. Cory S. Fawcett has said regarding paying debt versus investing:
“It depends on how the debt compares to the present and the future. If you are drowning in debt and struggling each month to get by, then the first step must be to restore a reasonable balance….If, on the other hand, debt is not overwhelming your finances, then you can take a more balanced approach. You may be able to pay down debt ahead of schedule and at the same time make this year's maximum retirement plan contribution. Most doctors are in a position to do both, if their lifestyle spending (present) is also in balance.”
There you go. Dave Ramsey's show is great, and he gets most stuff right. If you follow it, you'll do well. Tweak it just a little, however, and you'll do even better.
What do you think? What parts of Ramsey's philosophy and advice do you agree or disagree with? Comment below!