Where I Differ From Dave Ramsey

Dave Ramsey is perhaps the most popular financial coach in the world.  His system has helped millions of people get out of debt and build wealth.  I personally have been listening to Dave Ramsey for over 10 years.  I have great respect for him and know that his work has had a profound influence on my life and my finances. I agree with Dave on much of his advice.  When it comes to paying off the mortgage we are in complete agreement.  There are a few areas in his teaching where I differ in professional opinion from Dave, here’s why:

1. The $1,000 Emergency Fund.

Dave Ramsey recommends keeping $1,000 in cash as a starter emergency fund before attacking your debt.  Since 2/3 of American’s can’t handle a $1,000 emergency, this step is pretty darn important.  Mrs. C. and I have always kept more than $1,000 in cash, even when we had debt.  While we were paying off the van loan, which started at around $13,000, we always had north of $5,000 in cash.  The only time we dipped down to around $1,000 total was when I was really stupid and bought a house at tax auction with virtually all of our money.  If you spend $3,000 a month on living expenses, then $1,000 is only 10 days of expenses.  Even if your income isn’t variable, I don’t think this is anywhere near enough of a cushion.  I would recommend having a 30 day emergency fund in place, which would be around $2,500 to $5,000 for most people. Once the “debt snowball” is complete increase this to 6 months of expenses as Dave recommends.

2. The Half Your Income On Cars Rule Of Thumb:

Dave suggests having no more than half your annual income in vehicles.  I know this is a limit, but this is WAY to high in my opinion.  I honestly believe the number should be 25% at a max, with a goal of under 10%.  As an example, A couple earning $50,000 a year would be driving 2 $12,500 cars under Dave’s suggested limit.  Under a 25% of income limit this would drop to $6,250 each and under my more rigid 10% goal, this would drop to $2,500 each.  The bottom line is you want something that is relatively reliable but you also want the least amount of money possible tied up in depreciating assets.  Vehicles as a whole are depreciating assets.  One nice thing about older less expensive vehicles is that they depreciate at a much slower rate than new vehicles. Unfortunately I know several people who drive vehicles that cost more than 1 years entire income. American’s love their cars and we spend far too much money on them as a percentage of our income.

3. The Roth First Mindset:

The Roth is not always superior to the traditional, in fact for most people who have little retirement savings, the Roth is a loser.  This is because in retirement when you withdrawal money you will fill the 0% tax bracket first, and you would want to do this with money that you had to pay no taxes on going in.  The 0% tax bracket for a married couple is around $20,000 a year.  Using a moderate 5% withdrawal strategy, this means you would want a minimum of $400,000 in traditional accounts before taking anything out of a Roth. A Roth is best when you are in the 0% tax bracket already, or are on track to amass over $400,000 in your traditional accounts. Overall it is good to have a mix of accounts with different tax treatment. I think everyone should strive to develop traditional IRA / 401K accounts, Roth accounts, Health Savings accounts, and taxable brokerage accounts.

4. 12% Expected Rate Of Return:

Expecting 12% returns is extremely optimistic, heck I get told all the time I’m optimistic for projected 7%-8% returns.  When looking at long time horizons this makes a very stark difference.  Investing $300 per month for 30 years at 8% nets $440,000, at 12% nets $973,000.  If you plan on 12% returns and get 8% returns you may be in for a very disappointing retirement.  I would caution people to plan for 7 – 8% returns and if they happen to get 12% returns over the long term be happy with the bonus.  Don’t use high expected rates of returns as an excuse to save less money now.

5. Investing Strategy:

Dave recommends using actively managed funds instead of index investing.  I personally believe that index investing is a safer route and will lead to higher returns on average over the long term.   Index investing has become cheaper and much easier to access over time.  When I first started investing you needed $3,000 to buy into a single index mutual fund.  Today, with firms like Betterment you can open an account in 10 minutes and start index investing with 10 bucks and instantly be invested in over a half dozen different index funds. Index funds have much lower costs because they aren’t paying stock pickers and they don’t generate nearly as many trade fees. For example the Vanguard Total Stock Market Index Fund has an expense ratio of .16%, where the average managed fund costs 1.25%, with managed funds charging over 2% in fees.

Despite these disagreements, overall Dave Ramsey and I agree on much of the big picture. People need to work hard, make a plan and save money to get ahead.  Paying off the home mortgage is a goal to aspire to.  30 year mortgages are a ripoff.  Real Estate investing with CASH is a great way to build wealth.  Investing in stocks through mutual funds is a great way to build wealth.  FICO scores are a joke.  Life insurance, wills, and a long term plan for wealth management are all necessary.

What do you think of Dave Ramsey? Are there other areas you disagree with him on?  What about me?