Exploring Dave Ramsey’s Financial Advice
Financial advice guru Dave Ramsey is one of the country’s best-known commentators on strategies for saving, investing, and getting out of debt. He has been widely quoted in the media for his strong views on how people should manage their finances.
From his ‘Money Makeover’ advice to his ‘Baby Step’ approach and his sponsorship of Financial Peace University classes, his views have attracted wide interest from the public as well as controversy among financial experts as to how realistic they are.
Ramsey uses experience from his own life to inform his recommendations. He built a $4 million real estate portfolio and was earning $250,000 a year by age 26, only to file for bankruptcy two years later when the bank called for early repayment of his property loans.
He rebounded from that setback to become a leading source of financial advice for millions of people through “The Dave Ramsey Show,” a top-rated talk show, that according to his website, is heard by 13 million listeners on a weekly basis on over 600 radio stations.
A devout Christian, Ramsey cites biblical injunctions against debt in advising his listeners to pay off their debts and remain debt free. However, his advice isn’t preachy – his focus is on helping people improve their financial situation, not on proselytizing.
With a net worth said to be in excess of $50 million, Ramsey can certainly point to his own financial success when pitching the benefits of his program.
In this article, we will take an in-depth look at Ramsey’s advice and analyze whether it makes sense or not. From the 30,000-foot level, his advice to focus on saving money, avoiding debt, and not living beyond your means is solid.
For more sophisticated investors, however, his advice could be seen as unduly restrictive and perhaps even counterproductive in some cases.
Debt, for instance, if used wisely can be a useful financial tool at times and should be differentiated from bad debt, such as high interest credit cards.
We’ll take a detailed look at the logic behind Ramsey’s advice with an eye towards evaluating where it seems on target and where it may fall short.
Total Money Makeover
Ramsey covers a wide range of financial topics in his writing and on his radio program. He also offers an educational program using his principles called Financial Peace University.
In his book Total Money Makeover, a number of the concepts central to his approach to personal financial planning are discussed. He uses the analogy that saving money is similar to losing weight in that to lose weight you need to eat fewer calories than you burn.
Similarly, to increase your savings you need to spend less than you make. This is a commonsense approach and Ramsey stresses that nothing he says in the book will be too complicated to understand.
You see, he believes that success in personal finance, as with other endeavors in life, is 80% behavior and 20% knowledge.
It is hard to dispute his insight here, as the admonition to control spending to improve your financial position could be said to fall into the class of things that, while good for you, are easier said than done.
The book touches on the denial that often accompanies poor financial behavior, equating it to the commonly heard protestation of an out-of-shape individual that he or she is “not that out of shape.”
From there, he lays out the case against debt and why he believes you should get out of it if you’re in it.
Even before you completely pay off your debt, Ramsey advocates building up an emergency fund using ‘baby steps.’
To accomplish that he recommends what he calls the ‘debt snowball’ method for paying off your debts.
Given his distaste for debt, Ramsey is not a fan of credit cards, equating having a credit card to being in debt.
He believes there is no shortcut to building wealth – it requires hard work and discipline.
He also warns against judging yourself against others when it comes to your spending habits, as this can lead to wasteful expenditures.
Total Money Makeover covers methods for maximizing retirement investing, saving for your kids’ college education, and paying off your home mortgage.
The final two chapters explain how the use of the techniques discussed in the book can build significant wealth and allow you to live the type of life you want to live.
All in all, Total Money Makeover provides a comprehensive accounting of Ramsey’s approach to personal financial management.
We take a closer look at some of the financial advice Ramsey provides in the book, his articles, and his talks below.
Debt and Credit Cards
Ramsey believes that it is a myth to think that debt creates wealth. He doesn’t think debt should ever be used to leverage wealth.
As you might imagine, he is also no fan of credit cards. He believes that using debt is considered customary in American society, with those who refrain from taking on debt thought of as outside of the norm.
He recommends learning to differentiate between what you want and what you need and avoiding debt by delaying gratification. He also opposes debt consolidation as it doesn’t solve the problem of overspending.
While Ramsey is absolutely correct in his depiction of our society as one in which debt is commonly used to finance a whole host of goods, his strict prohibition of debt doesn’t take into account situations where taking on debt can be useful.
Certainly, if you are prone to overspending and are using debt as a means of financing an unsustainable lifestyle, taking on debt is not likely to be helpful, and can even prove to be disastrous.
However, in some cases a person who understands how to use debt properly can benefit from taking out a loan from time to time.
For instance, if your income is expected to grow strongly, using debt to purchase assets that will enable that growth, or increase it, can be productive.
As long as you don’t take on so much debt that an unexpected event can easily result in bankruptcy, use of debt for such a purpose has long been considered a smart way of using other people’s money to improve your financial position.
The idea of leverage by using other people’s money (OPM) is a foundational principle to building true wealth.
The caveat would be to be careful of overextending, which can leave you vulnerable to the same fate that Dave suffered, leading to bankruptcy.
In the same way any follower of Dave’s baby steps program will take small steps that incrementally result in large benefits, taking small steps with other people’s money to experience the benefits of leverage, without overextending, can bring about tremendous financial gains long term.
When it comes to improving your financial situation, Ramsey believes in taking ‘baby steps.’ Baby steps enables you to build on small successes, rather than getting discouraged by first trying to attain more difficult goals and giving up on the process altogether.
Dave Ramsey’s seven baby steps to financial success are:
Baby Step 1: Set aside $1,000 cash in an emergency fund for unexpected expenditures.
Baby Step 2: Utilize what he calls the debt snowball, in which you get current on all your debts and then focus on paying off one debt at a time, (with the exception of a home loan), starting with the smallest debt and working your way up to the biggest debt.
Baby Step 3: Fully fund your emergency slush fund with between 3 and 6 months’ worth of living expenses, i.e. groceries, gas, auto insurance, utilities, etc.
Baby Step 4: Place 15% of your household income into retirement investments.
Baby Step 5: Start a college savings fund.
Baby Step 6: Pay off your home mortgage early.
Baby Step 7: Build your wealth, live the life you want to live, give generously, and create a legacy for future generations.
Ramsey stresses writing down your goals as a means of improving your chances of achieving them.
He advocates focusing intently on one goal at a time and only moving your focus to the next one when the prior objective has been fulfilled.
He advises exerting maximum effort to become current with all your creditors, which is certainly good advice.
Overall, his seven baby steps make good general sense, but may not necessarily be appropriate for every investor.
We agree with Dave that setting aside a six-month emergency fund is prudent. Being prepared for the unexpected is a smart money decision but also provides peace of mind against the unknowable future.
A debt snowball is a great concept for getting rid of debt. The idea is that you pay down you smaller balances, which can then go towards your next smallest balance. You continue to grow your monthly dollar amount that can attack your debt, with the final goal being paying down your larger debts with your accumulated debt snowball money.
However, paying off your home mortgage might not be the most prudent choice. If your home mortgage is at a very low interest rate, it may be better to keep paying on the mortgage than to pay it off early, given the tax deductibility of mortgage interest for all but the most expensive homes.
Another point to make is that the equity in your home is not liquid. If your home is your most valuable asset you are missing out on opportunity costs elsewhere. Paying off your mortgage early, particularly if your interest rate is low, may result in hundreds of thousands of dollars in missed opportunity costs.
Ramsey makes a point of advocating the use of a budget that assigns a purpose for every dollar you bring in.
This approach, known as zero-based budgeting, helps cut down on unnecessary spending by assigning every dollar a task.
In a traditional budget, where any dollars not needed to pay expenses are classified as excess or unassigned funds, there is always the danger that you may be tempted to spend this money unproductively.
Zero-based budgeting enables you to assess the best use for these funds and place them in the appropriate bucket.
For instance, building an emergency reserve fund, or investing for retirement.
The disciplined spending approach zero-based budgeting promotes can be helpful to individuals of all income levels.
As the saying goes, it’s not how much you make, it’s how much you keep.
By deciding in advance how each dollar you make will be spent, you significantly reduce your chances of falling into the trap of making impulsive purchases that detract from your efforts to build wealth.
More great advice from Dave Ramsey here. Paying close to attention to where your money is going is important. Tracking your inflow and outflow will give you a better understanding of where your money is going.
For example, suppose you stop by Starbucks daily for a $3.50 latte. If that is part of your morning ritual, you probably go to Starbucks 20 times a month on average. Over the course of a year, you would be spending $840 on coffee.
The question then becomes, is my daily cup of Starbucks worth $840 a year or is there something else I’d rather use that money for?
Every business has a balance sheet. Tracking your assets and liabilities on a monthly basis will give you a handle on your finances and show you where you can shift your financial priorities to maximize your inflow and limit your outflow.
Investing for Retirement
After you’ve paid off your debt and finished funding your emergency reserve, Ramsey advises that you invest 15% of your income in retirement accounts such as 401k plans or IRAs.
He recommends against investing in bonds, instead suggesting you invest 25% in each of the following four growth-oriented stock mutual fund categories:
- Growth and Income
- Aggressive Growth
He advises that you make sure you understand the fees you are paying and that you work with a financial advisor to help you stick to the plan.
(Nowadays, maybe robo advisors would be the better approach under Dave’s recommendation due to the low fees vs traditional advisors).
While his investing suggestions may be a reasonable approach for some people, overall it is one of the weakest areas of Ramsey’s program.
A big reason for this is his contention that you can anticipate earning 12% per year on your retirement investments in growth-oriented mutual funds.
While it is true that there have been periods of time when such funds have earned that much per year, or even more, there have also been numerous periods of time when this has not been the case.
On average since 1926, according to numbers from Robert Shiller, a Yale economics professor, the S&P 500 has returned 9.9%. And according to Dalbar, mutual fund investors who try and time the market perform below half that rate, or roughly 4%.
It’s important to note that if you are retired during a period when the stock market returns less than its historical average, and you withdraw 8% a year from your retirement savings as Ramsey recommends, you can deplete your retirement funds to the point that it deals a severe blow to your standard of living.
As a result, relying on Ramsey’s likely overly optimistic assumptions of 12% compounded returns in mutual funds, and 8% annual withdrawals, may prove to be a bad approach to your retirement planning, particularly if you take into account taxes.
It should be noted that many financial experts recommend taking out an amount closer to 4% of your retirement savings each year to avoid running out of your retirement money too soon. That is half the amount that Ramsey recommends.
At I&E, we offer our own retirement planning blueprint that provides a stable, guaranteed return.
In addition, Dave Ramsey’s advice also flies in the face of traditional asset allocation wisdom that suggests owning a certain amount of bonds or bond mutual funds in a portfolio to diversify its risk profile, given that bonds and stocks are not perfectly correlated investments. Because they often move in opposite directions, this helps reduce portfolio volatility.
Additionally, Ramsey advises against investing in REITs and fixed annuities, which a number of advisors believe to be viable choices for diversifying a portfolio.
Further, we at I&E believe that there are many alternative investments available that can yield higher returns, with less risk, such as investing in primary assets like real estate, oil, etc.
Also, his advice to set aside 15% of your yearly income in retirement accounts has also been criticized as being a one-size-fits-all number, which may or may not be appropriate for a given individual.
However, he at least recognizes the importance of setting aside a significant portion of your earnings each year for future use, so even if you decide on contributing a different amount, his advice is more or less on target in this regard.
That being said, by suggesting a relatively high-risk approach to retirement investing he exposes his followers to more market risk than many advisors might deem appropriate, especially for those who are just about to retire or have already retired.
The Envelope System
To help you exercise spending discipline, Ramsey recommends the use of the envelope system for spending cash.
The envelope system method, in his view, helps people avoid the temptation to spend wildly or frivolously that is encouraged by today’s debit and credit card culture.
Instead of concentrating all of your spending on one or two cards, he suggests filling envelopes with the cash needed for each budget category each budget period.
Once you have spent all the cash allotted for a particular category, clothing, for example, you can’t spend any more on that category until the next budget period.
Ramsey feels using cash provides a greater brake on uncontrolled spending, given that the physical experience of spending cash is, to him, more impactful than simply running up expenses on a credit or debit card.
Using the system may require a bit of getting used to, but it can serve as a simple but powerful method for encouraging you to control your spending.
In the modern economy, certain bills may have to be paid electronically, but there are still many categories of spending, such as food, gas, clothing, entertainment, etc. that can be paid for with cash, making them good targets for the envelope system.
For someone who spends impulsively, and currently lacks the discipline to refrain from reckless spending, the envelope system has its place.
However, for anyone who has attained to a certain level of financial discipline, using such an inconvenient method may cause many people to reject it.
In addition, carrying around large quantities of cash is probably not the best route to take.
Buy Term Insurance and Invest the Difference
Because he feels there are better places to invest your money than with an insurance company, he recommends buying term life insurance which, because it has no cash value component, is cheaper than whole life, and investing the difference in mutual funds.
He suggests buying enough term life insurance to replace 10-12 times your annual salary. Your insurance coverage should last at least long enough for your kids to head to college or leave your home to live on their own.
While whole life insurance is priced to provide you with lifelong insurance coverage, Ramsey doesn’t see the need for such coverage later in life if you have followed his plan and built yourself a solid retirement investment portfolio.
Buy term and invest the difference works, according to Ramsey, because your mutual fund investments should be enough to provide for your spouse or other dependents if you die, because the money you would have spent to purchase whole life insurance will have had enough time to grow in value if invested wisely.
Ramsey is not alone in advising people to buy term life and invest the difference, AKA BTID. The phrase BTID was first used by Primerica’s founder, Arthur L. Williams, Jr., who talked many people into choosing term life vs whole life insurance. Today, most financial entertainers, such as Suze Orman, offer the same advice.
Now, anytime you have a consensus recommending one thing it usually pays to ask a simple question—why?
Truly, Wall St and Main Stream Media love the idea of buy term and invest the difference. And since money flowing into Wall St comes from 401k plans invested in mutual funds, do you blame them?
At I&E, we believe that any sound financial blueprint requires a “safe bucket” as a foundation. We have found, through extensive research and personal experience, that blended whole life insurance with paid-up additions, through a mutual insurance company, is the best savings vehicle one can use for a variety of reasons that we expand on in numerous blog posts throughout our website.
One last point, when we design a strategic banking policy, we use term insurance to help lower the premium and increase the initial death benefit. That way, you get both term life AND whole life, instead of having to choose one or the other.
Real Estate Investing
Even though Ramsey decries the use of debt for financial leveraging purposes, he still feels that real estate can be a part of an investor’s investment portfolio.
He recommends sticking to the following rules when investing in real estate: Don’t invest until you are ready to do so.
Ramsey suggests that you only invest in rental real estate properties after you have solidified your finances.
If you are finding it difficult to meet your expenses already, he does not believe adding the expenses associated with owning real estate to your plate is a good idea.
He advises that you make sure you have paid off any commercial debt before making a real estate investment and that you have the cash flow to help you deal with any setbacks that occur after you purchase property.
Here are Dave Ramsey’s four guidelines for real estate investing:
- Stay away from both discount and highly priced property:
He recommends buying moderately priced property to avoid the difficulties you can run into with tenants of both low-end and high-end property.
At the low-end, your renters are not as likely to have respect for the property because of its discount nature, making it harder to find tenants who will treat your property well.
At the high end, your tenants, according to Ramsey, are more likely to behave as if you work for them and demand that you accommodate their every whim, resulting in an excessive amount of work on such properties.
- Be ready to do basic repair work:
Owners of rental property, according to Ramsey, should be aware that repair work will be required from time to time. To keep costs down, ideally you are prepared to do some of the easier repair work yourself.
- Don’t purchase out-of-state rental property:
Ramsey believes that the difficulty in monitoring rental property you own in another state makes it unwise to hold this type of property. Because you can’t keep a close watch on how your tenants are treating the property, you run the risk of its value eroding due to poor maintenance by the renters.
- Use the services of a real-estate professional:
Ramsey thinks it is wise to seek out local real estate experts for advice when it comes to finding acceptable properties for purchase. He recommends that you find a real estate agent who shares your values in regard to the criteria you have established for buying properties.
All in all, Ramsey’s approach to purchasing rental real estate is a sound one. It doesn’t rely on the leverage recommended by some real estate gurus, so it is more likely to appeal to conservative investors who don’t care for the risks involved in using debt to buy real estate.
It should be noted that there are alternatives that might limit your cash flow but free up your valuable time. Turnkey real estate opportunities can help take the time burden off of you and place it on the turnkey real estate provider.
Further, you should consider using other people’s money when purchasing a cash flow property. You don’t want to “buy” cash flow, that is, put such a large down payment on the property that it cash flows.
Rather, find solid cash flow properties that cash flow with only a 20% down payment. Now, instead of having all your money tied up in that one property, you can put the remainder in a safe place for emergencies. Better yet, you might even consider buying a separate property to get additional cash flow.
Prudence is key, particularly when you are just starting out. But once you get cash flow you can then take a portion and place it into a tax favored savings vehicle, a properly designed strategic banking policy.
Financial Peace University
Ramsey’s Financial Peace University offers people the chance to attend workshops or receive a boxed set containing the material for the courses, which are based on the financial expert’s seven baby steps for getting out of debt, building retirement income, and creating a financial legacy for future generations.
Financial Peace University’s membership kit contains a variety of materials including lesson CDs, a holder for the envelope budgeting system, a progress chart, a copy of Ramsey’s book Complete Guide to Money and a Financial Peace University workbook.
Most of these materials can be used when attending class in person, or when following along with the lesson CDs. Purchase of the membership kit gives you the option of attending a series of nine sessions whenever you like.
If you prefer to follow along in the comfort of your own home, the CDs consist of audio versions of the lectures given during live classes. The membership number that comes with the kit allows you to register for access to worksheets, bonus articles, and class videos if you have chosen to sign up to attend live classes. The budget worksheet that comes with the kit provides a handy tool for working out a detailed budgeting plan and sticking to it. A membership kit can be purchased on Ramsey’s website.
Financial Peace University is taught at churches throughout the country. For various reasons, churches have welcomed Dave Ramsey’s financial advice with open arms. But we have one main issue with Dave’s approach:
Dave Ramsey’s teachings about finances seem to come from a fear based mindset that focuses on scarcity, rather than abundance. His advice to pinch every penny and avoid debt at all costs is truly limiting. Worse yet, his advice to stick your savings into government plans and mutual funds is risky, at best.
At I&E, we believe in cultivating an abundant mindset. There are many additional steps you can take once you graduate from Financial Peace University. If you are wondering what to do next, we can help provide you with a financial blueprint to go beyond the scarcity mindset and into true abundant living.
How Dave Ramsey Makes His Money
In addition to his own investing activity, Ramsey makes money from referral fees paid to him by financial advisors who are listed on his site. The advisors he recommends are commissioned salespeople, rather than investment advisors who charge a fee based on the value of your portfolio.
Ramsey claims it is better to pay a one-time up-front fee of 5.75% or thereabouts on the value of your mutual fund investment rather than pay an ongoing fee to a financial advisor. These fees vary, but typically range from 1% to 1.5% or so a year.
While this may be the case if you don’t want to actively manage your investments, or have someone do it for you, given the tremendous volatility of today’s markets, a case could be made that it is worth it to pay a financial advisor to offer ongoing advice about portfolio allocation.
To go one step further, you may want to speak to a strategic planner at I&E and see what we can offer to help take you beyond financial peace and into financial abundance.
It also seems likely that he receives some sort of fees from Zander Insurance Company, the firm he recommends his followers turn to if they want to purchase insurance coverage.
Dave can make money anyway he chooses. With a net worth estimated to be above $50,000,000 he is obviously making some good personal financial decisions.
Dave Ramsey has earned his fame for financial acumen by working hard to deliver his message that by using disciplined budgeting to save money while avoiding debt and setting aside a sufficient portion of your income you can build a satisfactory retirement income.
His program, while by no means perfect, delivers the positive message that by focusing on fiscal rectitude and working hard you can achieve financial success and live the life you want to live while building a legacy to leave to future generations.
The most powerful messages he delivers are, in our opinion, first, his warning of the dangerous allure of using debt to boost your consumption power and the threat excessive debt can pose to your lifestyle both in the present and the future.
And second, his support of a rigorous budgeting process you can use to reduce the temptation to spend money frivolously and to help you set aside enough funds today to create an enjoyable financial future for yourself down the road.
On the minus side, his blanket proscription of debt fails to take into account that people with rising incomes can use debt productively if they do so within reason.
Ramsey also provides what may turn out to be truly bad advice to those who are closing in on retirement or already in it when he advises them to invest 100% of their retirement funds in stock mutual funds. If a significant market downturn occurs, especially one that lasts multiple years, it can severely erode the value of retirement accounts invested in the stock market via mutual funds.
For this reason, investors have traditionally been advised to invest more conservatively as they get older to avoid risking their standard of living in retirement by allocating an excessive portion of their portfolio to the stock market.
Overall, Ramsey’s advice is well worth looking into. As long as you realize that there is no one-size-fits-all approach to investing and that in certain areas his advice is highly questionable, there are a number of helpful techniques you can learn from his teachings.
This is no small thing as, given the topsy-turvy nature of modern financial markets and the significant volatility they are prone to, investors can use all the help they can get when it comes to building wealth over the long-term.