What is your opinion on Dave Ramsey
An ode to all the good things Dave Ramsey does
Dave Ramsey is the heavyweight of all personal finance heavyweights. He's been helping people get their personal finances in order for decades. His daily radio show is the third most listened to in the United States.
Ramsey can also be a magnet for criticism. Case Study: In 2013 I wrote an article criticizing his assumptions about investments (with 12% annual return) and his proposals for retirement (a "safe withdrawal rate" of 8%). That led to an appearance on his radio show that was controversial to say the least.
Hence, most assume that I am against everything from Ramsey. The point was taken up again this week when a college friend posted a link to a Guardian article, "The Man Who Wants to Get You Out of Debt - At Any Cost." After reading it, there is one thing to be clear about: It is possible to vehemently disagree with Ramsey’s investment advice while giving him all the credit in the world for his personal financial advice.
If we confuse the two - or suggest that it is morally reprehensible to help people out of debt - everyone in the financial community is losing.
The nuts and bolts of Ramsey’s "Baby Steps"
Ramsey put in place a system of seven simple steps to help people get their finances in order. It contains:
- Save $ 1,000 on an emergency fund.
- Pay off all debts (except your home) using the debt snowball method (more on this below).
- Save three to six months on the cost of living for a full emergency fund.
- Investing 15% of your household income for retirement.
- Saving for your child's college fund.
- Paying off your house early.
- Build up wealth and give away (something).
You would have a hard time finding financial professionals who have a problem with these priorities. You are rock solid.
Some have a problem with the "debt snowball method" as it encourages you to pay off your debts "in order, from smallest to largest regardless of the interest rate." By focusing on the smallest of debts rather than interest rates, some argue, Ramsey supporters may grow their debt even faster than it needs to be. This, according to the theory, leads to suboptimal debt repayment.
But here's the catch: Ramsey tries to help real people in the real world, not abstract people in a hypothetical world. Real people have emotions, feelings, and levels of motivation that go up and down. The snowball method offers a psychological boost (“Yeah, I paid that debt back!”) That can generate the momentum needed to pay off larger debts. There is significant peer-reviewed evidence from top universities in support of Ramsey.
This is a brief introduction to Ramsey's framework, but it doesn't get to the big issues worth tackling.
Who is to blame for your money problem?
The crux of the Guardian article was that some felt Ramsey's finger-pointing was unfair: "As Ramsey sees it, America's debt crisis is a drug addiction epidemic and its roots lie in individual behavior," it says. "The only way to escape its stifling weight is to stop and go on cold rehab: live on rice and beans, find a second job, sell your money-guzzling car."
He goes on to quote experts who generally agree with the seven steps but loathe the context in which they are given. I just think the most useful thing is to throw value judgments completely overboard and ask, does this work?
According to Ramsey, over 5 million people have graduated from Financial Peace University, tens of millions listen daily, and if the "debt free screams" are to be believed (and I see no reason why they shouldn't) the answer is for a large number of people clearly: YES!
I am not going to argue that there are no structurally unfair reasons why some people find it harder to make ends meet than others. But as my wife keeps reminding me - and as I learned as an inner-city middle school teacher - you mustn't neglect the "and".
By that I mean, you can acknowledge that there are structural issues that need attention, and that it is hugely helpful to help people focus on the things that they can control. These things are not mutually exclusive. In this context, Ramsey’s show could - in a sense - be seen as a structural answer to a major problem facing American society today: the lack of basic financial education.
If Ramsey were an elected official, another perspective might be warranted. But it is not, and no one will offer a service that will be loved by everyone. Still, Ramsey's program is clearly helping a lot of people, and we're all better at it.
To the advice on investing ...
Only a small part of Ramsey’s message is about the process of investing. For one reason or another, he suggests:
- He assumes that the stock markets are returning 12% every year. The truth that dates back to 1871 (and ended last year) is that compound interest averaged 9.2%. In the last 100 years it was 10.5%. In the past 50 years it was 10.2%. 6.7% in the last 20 years. That may sound like small differences, but compound interest is the eighth wonder of the world, and small percentage point differences are a big thing. Ramsey backs it up by saying, "Don't let your opinion on whether you believe a 12% return is possible or not stop you from investing." I couldn't agree more.
- Safe withdrawal of 8% of your pension fund in the first year and then adjustment for inflation. I have already pointed out the risks with this very aggressive assumption.
- Investing in mutual funds with high fees. Ramsey suggests investing through mutual funds in four areas: international, growth, growth and income, and aggressive growth.
While there's nothing wrong with mutual funds as such, the fees that are charged and the rules by which they must be run make it difficult (though admittedly not impossible) for any fund to consistently track market performance approximate.
But I don't think these three pieces of advice nullify the value of Ramsey’s message. Maybe they just need to be offset by some of our core beliefs about investing here at The Motley Fool:
- You can get 12% just don't rely on it. It is definitely possible to get 12% or more every year. Many of our best investors here have a track record to prove it. However, if you expect to get those returns, then you are setting your expectations higher than history clearly shows they should be.
- It is far safer to take 3% to 5% of your pension fund in the first year and then adjust it for inflation.
- It is entirely possible to beat the market by investing individually. But if that doesn't interest you, investing in a diversified basket of (very cheap) index funds makes perfect sense.
When you combine these timeless lessons - both personal and investment - the results can give you the financial peace that Ramsey promises and has given so many.
The post An ode to all the good things Dave Ramsey does appeared first on The Motley Fool Germany.
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Brian Stoffel has no position in any of the stocks mentioned. It has been translated so that our German readers can take part in the discussion.
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