During the month of July, I conducted a very detailed discussion of Dave Ramsey's The Total Money Makeover. During the process, I realized that on most issues, I agreed fully with Dave.
To a degree, this put a damper on the book club. It's always interesting when there's disagreement, after all, if everyone conducts themselves in a mature fashion.
(Perhaps this means I should have a book club on Rich Dad, Poor Dad...)
Anyway, after the book club finished, a reader wrote in and asked me that very question. You agree with Dave Ramsey so much. Where do you disagree with him?
I spent some time thinking about that question and came up with five strong principles where my perspective on personal finance disagrees with Dave's. It's worth nothing that these are merely five points in comparison to dozens where I do agree with him - there's a lot more that he says that's spot on than things I disagree with.
Let's dig in.
A 12% annual rate of return in stocks is not realistic.
If you look at the amazing run of the stock market from 1980 to 2000 - the years when Dave was actually figuring out his financial state - it's easy to see where his concept of a 12% annual rate of return comes from. The stock market actually did return 12% or so a year.
During that timeframe, the baby boomers were putting tons of money into the stock market - an unprecedented flood of new investors. And as with any market, if demand goes up, so do prices.
Today, though, boomers are starting to retire and many others have moved - or are moving - their investments into something more conservative than stocks. The demand is slipping a little bit, so prices are adjusting accordingly. They'll still go up (because more investors all over the globe are getting in than getting out), but the people getting out is going from a trickle to a big stream - and will gradually become a flood.
The 1980 to 2000 bull market is gone and is not going to return any time soon. Sure, you can still earn a nice, healthy return in stocks, but a much more reasonable estimate is Warren Buffett's long term prediction that stocks will return about 7% annually.
So what's the big deal? Much of Ramsey's investing advice revolves around the idea that investing in stocks will return you 12% annually. It won't. You can still build up the kind of nest egg he talks about, but you have to invest more yourself. The market won't do that much work for you any more - and if you expect the market to return 12% for you on average over a very long period, you're in for a very nasty surprise down the road.
Personal responsibility is the problem, not credit cards.
Dave is pretty much a credit card absolutist - cut 'em up and get rid of 'em. For people who have problems with credit cards, it's not bad advice.
However, he goes too far, stating unequivocally that credit cards are bad and that people should live without them. This flies in the face of his usual message, which is that personal responsibility is what really matters.
A personally responsible person - one who does not carry a balance on their cards - can use credit cards as tools. Over the past three years, my wife and I have saved about $500 using our Target Visa without buying a frivolous thing with it - just food and household supplies, which we could easily buy with cash. Instead, each month the statement comes in and we just send out a check. Then, every few months, we get a 10% off card, which enables us to take a shopping trip at Target and get 10% off our total bill. We make an effort to save larger purchases until we have such a discount.
I could tell a very similar story about our Citi Driver's Edge card, which provided us with about $700 cash to help with a recent auto repair. All we did is use the card on gas and minor auto expenses and pay off the balance each month.
If you're personally responsible, you can handle your urges and keep the spending on such cards down to the staples. That means you're never carrying a balance - no interest payments - while also building up a strong credit rating, which helps with your insurance rates.
Credit cards aren't the problem when it comes to credit card debt - personal responsibility is.
A $1,000 emergency fund is enough if you're paying off credit card debt.
One of the big parts of the Dave Ramsey plan is that one should save up a $1,000 emergency fund, then turn all extra money towards paying off debts. This is a great way to get rid of those debts as fast as possible, of course.
Dave's argument is that the $1,000 emergency fund is more than enough to take care of most of life's problems and that you can negotiate your way out of the rest. I disagree with that - many events that would require me to turn to my emergency fund would go far beyond that $1,000 level.
How exactly, pray tell, can one negotiate themselves out of a job loss in a tight job market, or barter when it comes to a broken arm?
Instead of just stopping when hitting that $1,000 emergency fund, I suggest setting up an automatic savings plan, dumping $25 a week into the emergency fund (or $50 if you can swing it), then forgetting about it. Use everything else that's left to hit the debt hard and let that emergency fund slowly build.
Why do this? Here's an example. Let's say you set up that savings plan to sock away $50 a week, then you start whacking at your debt as hard as you can. Six months later, you lose your job. You turn to your emergency fund. Thanks to your savings, you have $2,300 there, enough to keep the bills paid for two months or so. Without that plan, you only have $1,000 - things aren't going to go nearly as well.
If everything goes perfectly, Dave's plan is better.
But when in life does everything go perfectly? That's the point of an emergency fund. Fund it appropriately, and you'll always be glad you did.
"Growth" mutual funds are not the be-all end-all of investments.
Whenever Dave talks about specific stock investments, he always mentions putting his money into a "growth" mutual fund. There are two problems with this.
One, it's not diversified. Buying nothing but growth stocks makes your investments less diverse. Quite often, growth stock funds are very heavy into a few specific "hot" sectors - and when those sectors go cold, ouch. Growth mutual funds didn't do very well in 2001 after the dot-com bubble burst, for example.
Two, an ordinary "mutual fund" charges a lot of fees. Invest instead in a low-cost index fund. An index fund is basically an automatically-managed mutual fund, one that operates according to some publicly-defined easy-to-follow rules instead of relying on the research of a team of fund managers. You can get similar returns with an index fund without the huge fees (which many mutual funds take to pay the salaries of the fund managers and pay for advertising).
What's a better solution? If you're investing in stocks, buy a very broadly based low cost index fund. You won't ride the bull markets quite as strongly, but you won't fall nearly as far during down markets or changing market conditions. More importantly, you won't be paying huge fees to ride the roller coaster - index funds are pretty cost-effective.
Before you put big money into the stock market, at the very least, read more than one voice on stock investing. In fact, read as many voices as possible. You'll find that diversity is good and low costs are even better.
Do not cut your retirement savings during the initial push to pay off debt.
One final piece of Dave's advice that really bothers me is that he suggests people trim their retirement savings during their initial push to pay off their debt, even if it means foregoing matching from employers.
To me, this is simply throwing money away. No matter how bad your situation, refusing to get an immediate 50% or 100% return on your money - risk free - is a bad idea.
No matter what, if your employer offers matching funds on your retirement accounts, invest at least enough to get all of the matching they're offering. You'll never, ever regret it - it's basically free money that enables your retirement savings to grow much more quickly than if you turned away.
Sure, it means that you'll pay off debt a little more slowly. What you'll gain, though, is a lot of free money for retirement from your employer. Never turn that down, no matter what.