If you have a few minutes, watch this slide show from Dave Ramsey: Drive Free. Retire Rich.

According to the video, a third of car buyers finance their cars for 6 years at 9.6% interest, making their monthly payment about \$475.

He then presents an idea…

You want a new car. Your current car is worth \$1,500. Instead of spending \$475 per month on a new car note, why not save that car note amount for 10 months and add that \$4,750 to your \$1,500 car and buy a \$6,250 car?

Of course, this requires some assumptions:

1. That your current \$1,500 car can hold out for 10 months.

2. That you’ll be able to get \$1,500 for your old car.

Assuming that both assumptions work out, you’ll be driving a \$6,250 car that you don’t owe any money on.

The illustration then assumes that you continue to save your \$475 for the next 10 months. At that point, you take your \$4,750 in savings, add it to your \$6,250 car (that hasn’t depreciated, btw), and purchase an \$11,000 car.

So far I like the idea. It’s past this point where Dave loses me.

Why?

Because he starts talking about investing that \$475 into a mutual fund that earns a “stock market average of 12%.” YEAH! TWELVE PERCENT! This is just wrong on two fronts:

1. Where you going to find a mutual fund that earns 12% in this environment? I’m not saying that a mutual fund can’t earn 12% but where does one find such a fund?

2. There’s a HUGE different between a stock market average return and an actual (geometric) return. Using a linear 12% annual rate of return on a monthly basis, overstates the actual return.

I would have respected Dave had he used the return for the S&P 500 Index rather than just some number he pulled out of thin air. According to my numbers, the geometric average return for the S&P 500 Index (going back to 1926) is .76% per month. Subtracting off .02% for expenses, we get .74% per month. That’s a far cry from the 1% per month Ramsey assumes in his illustration.

How much difference does it make? A lot. Here’s a nice little graphic for comparison’s sake (assuming a return of .74% per month and NOTHING taken out for future car purchases):

The Bottom Line…

Ramsey’s plan isn’t necessarily bad. I just don’t understand why he feels the need to use such a high expected rate of return. It seems to be a disservice to his followers because it’s not based in any sort of reality.

I think Dave should stick to his “get out of credit debt” message and leave the investment stuff to people who know what they are talking about.

Thoughts?

20 responses to Analyzing Dave Ramsey’s “Drive Free. Retire Rich.” Program

1. In my province this strategy would be expensive. We pay harmonized sales tax (HST) to the tune of 13% on any used car purchases, so to keep trading up would be an expensive venture!

2. I am a big fan of Dave Ramsey as I love his mantra of get out of debt and stay out of debt. I like to listen to him to keep me animated about not over indulging; which for me can be hard.

However, as you pointed out I always get lost when he says you can get a return of 12% every year. Another sticky point is his idea of 100% in equities.

Great article thanks

3. Dave should refrain from discussing investing. His lack of knowledge is embarrassing.

Otherwise I do enjoy his show occasionally.

4. I think that Dave needs to update his numbers. I remember a few years back when everywhere you read about an almost guaranteed 10 to 12 percent annual return on an S&P 500 index fund. But not these days. By the way, my wife and I will be teaching a Financial Peace class at our church this fall, so we are believers in Dave Ramsay’s system. But he needs to stress the need to save and invest without throwing out obsolete returns.

5. Dave is great for debt and small business advice, but bad for everything else. I have heard him give blatantly wrong estate planning advice before, which would have cost the callers considerable amounts of dough if they followed his advice.

He needs to stick to what he does best.

6. I agree with you 100%! I bought a cheap car for \$3000 in December and didn’t like it. I know that sounds bad, but it’s true. It was an older Infiniti in awesome condition, so it’s not like I was driving a beater. I went back to the lot I bought it from, and they offered me \$1500 in trade towards another vehicle! Ok, I got lucky, I sold it myself for \$3500 and bought exactly what I wanted for \$2500. I had to do some repairs and I probably have \$3000 in it. I bought a “brand new” car with 80 miles on it back in 2002 (the infiniti was our second car). My payments were \$220/month at 5% and I didn’t have the best credit back then either. I don’t have \$400-500/month to put towards a car or retirement. I could sell my (brand new in 2002) toyota for half of what I paid for it so I don’t feel too bad about buying “new”.

7. Even if you assume you CAN get 12% in the stock market…when I financed a car (paid it off early in 2008, still driving it) my monthly payment was HALF of that.

8. I’m not going to be Dave’s apologist, he can handle that himself. He has a pretty good track record of successful investing and guiding people. His Endorsed Local Providers are pretty strong.

Having said all that, I used the same scenario he did in my book, but used a ‘more common’ 10% number.

Dave’s numbers might look like a ‘perfect world’ scenario, but the principle is sound.

Thanks for the post. We always need to be reminded to think for ourselves and to keep thinking.

9. Where did YOU get the “S&P 500 Index (going back to 1926)” that you used to compute the 0.74% figure?

10. I have a spreadsheet with the monthly total returns for the S&P 500 and its precurser, the S&P 90 going back to 1926. I got the numbers from standardandpoors.com and the appendix to Ken Fisher’s The Only Three Questions That Count: Investing by Knowing What Others Don’t (Fisher Investments Press)*.

11. I’ve got the total returns from Jan 1970 to April 2010. (Haven’t updated it in a couple of months).

Those data show a 0.8128% monthly return over those 40 years. To get the figure you quote (0.76% per month), the returns from 1926 through 1970 would have been 0.7118% per month.

The obvious break at that point is the loos of the gold standard, so perhaps it would be better to compare the total returns to inflation.

I’d love to get a copy of your data. I could not find monthly data earlier than 1970.

12. I agree that Ramsey pulled this 12% figure out of thin air. He makes ridiculous statements sometimes in order to illustrate his point. That’s where his credibility erodes.

Where did he account for the taxes paid on these unrealistic returns on investment?

Another point is that while driving these first few clunker cars, who’s paying for the repairs? Is that money paid out in addition to the \$475 being put in the bank toward the next car?

And the most obvious delusion – how is putting \$475 a month in to a ‘car fund’ driving ‘free’? Is Dave Ramsey putting that \$475 each month in all of our accounts for us?

Sometimes it’s tough to take this guy seriously.

13. Ramsey is a joke with no formal financial education/credentials last time I looked. Why people listen to him so much I’ll never know.

I was curious, so I did a search for one of his endorsed local partners. He recommended a commissions-based advisor with no finance degree, no series 7 license, and no CFP designation.

Oh, did I mention Ramsey gets paid handsomely for making this crappy recommendation?

This guy is laughing all the way to the bank while touting his Christian status symbol.

14. I am with Travis here. He has no financial credentials, yet he gives advice that is often dangerous. Imagine a 65 year old listening to his show in 2007 and putting all his money into growth funds.

The only thing Dave is helpful for are math-challenged people who are in debt and who need some common sense advice about living within their means. Also who really aren’t able to get satisfaction for having their net worth increased or their total debt decreased and need to get satisfaction from having one more tiny debt paid.

It’s not just investing. I’ve not taken loans for cars for quite a while, his number of \$475 a month sounds awfully high. Also when I paid for my new car for cash, I didn’t think of it as “driving free”. If I had I would’ve bought a more expensive car for cash (after all it’s “free” if you use your savings, right?), but I was thinking about spending a whole lot of money. It doesn’t matter if it was a special account you marked for the car or just “savings”, it’s still money. Additionally, repair costs have to be factored in. Also, how important is reliability for you – can you live with your car stopping in the middle of the road while you are driving to work, would you have a ride to work if you need to leave your car in a repair shop, can you do stuff yourself, etc.; these things need to factor in a decision.

His generic “all debt is bad” message regardless of interest rate is very simplilstic, but this is a different subject.

@Sam Burton #8 “He has a pretty good track record of successful investing and guiding people. His Endorsed Local Providers are pretty strong.

Having said all that, I used the same scenario he did in my book, but used a â€˜more commonâ€™ 10% number.”

He has no track record of successful investing at all. He made money on his business and his book, not on stocks. His own money are invested in his business not “growth mutual fund”.
Have no clue about his local providers, can’t comment there.

I wish you luck with your 10% estimate….

15. Seems like many people here feel the 12% return number is impossible or that DR is stating ALL mutual funds will make this kind of return every year.

Maybe I can help clarify … Yes, 12% (or higher) annualized return is possible. You can research growth funds with at least a 10 year track record which are doing this here:
http://screen.morningstar.com/FundSearch/FundRank.html

Can you just take your money and leave it in the same fund forever and make 12% … No, and DR doesn’t teach this. DR suggest you educate yourself, watch you investments, and adjust when necessary. The rub … for many its simply a disagreement on what is plausible. Dave strongly recommends people invest in Roth IRA’s … is this bad? Dave recommends investing in your company’s 401K and taking advantage of the matching funds … is this bad? He likes and recommends a tool for this called Mutual Funds … He recommends diversifying over multiple types of growth funds, and suggest only investing in funds with substantial track records of success … is this bad?

Yes , DR makes money off his business, books, and endorsements (Great for him!)… but I’ve dealt with all of those entities and guess what …. I’ve been making and saving money too!

Just some thoughts from somebody who is currently successful using DR’s recommendations. Good luck to all no matter what your personal investment choices are 🙂

16. My primary commuter vehicle is a 1997 (I bought it in 1999) and is worth south of \$1,500 now. No way I’d ever sell it and I don’t want to trade up. It’s worth more to me, than to anyone else. I know it’s history, it’s quirks and maintenance performed.

It’s roulette to buy beaters in hopes of trading up. I’d rather someone purchase a cheap 2 year old vehicle (even if financed) and drive it for 15 years, than pay cash for beaters in hopes of trading up (you will realize losses on the maintenance/repairs unless you can do the work yourself).

As for DR’s 12% claim: it’s a worthless number. But the same case could be said of JLP 9% claim: just because we have seen a long-term historical rate of about 9% yearly (who invests for 84-years anyway), doesn’t mean that the market will perform considerably below 9% into the foreseeable future. Past performance IS NO GUARANTEE of future returns.

#11 Jack) yes, only the returns adjusted for inflation matters anyhow — so the entire argument over 9% or 12% is academic.

17. Chuck,
it’s easy to pick winners in hindsight. 80% of mutual fund managers will not outperform their benchmark over time. You have better odds in Vegas. All that matters is how the market (or mutual fund manager) performs once you’ve purchased the investment. So unless you have another investment strategy, most people’s options are buy and hold mutual funds with only a small chance (historically, at least) of outperforming their benchmark, or buying a portfolio of index-tracking ETF’s with low expenses. At least you won’t be trailing the market (assuming a tight tracking ratio). By the way, are Dave’s commission-based ELP’s going to sell you a low-cost investment where they don’t get paid much? Or will they prefer A-share mutual funds with higher commissions? P.S. Dave says on his website that even after adjusting for inflation, the market has returned 12% since 1926. Wrong–before inflation it’s about 9% and after inflation it’s around 6%. Of course, we haven’t touched taxes and expenses yet. 🙂

18. I am a DR fan. However I do agree that some of his message and credibility breaks down once you get out of debt and begin to look at either investing (outside of retirement) in the stock market or real estate. My question is, those of you that think DR is totally wrong with growth-stock mutual funds, where do you suggest invest? Is there another financial guru that caters toward the more ‘sophisticated’ investor and helps explain individual stock investing, real estate investments, etc.?

19. I like Dave Ramsey, but yes, there are many “assumptions” that he makes in his numbers. With that \$1500 car, he doesn’t take into account the constant repairs, reliability, etc. When you’re driving an older car you’re not making payments to a bank but you ARE making constant payments for repairs and new tires, wipers, brakes, valve covers, etc., etc., etc….

20. Dave’s plan worked fine for my wife and I. We drove our “beaters” (we really are spoiled here in America) for several years. On the rare occasion that one did break down I bought a haynes repair manual and went to youtube.com. Did things I never imagined I could. Over five years while we were paying off our house using the money we would’ve been throwing at car payments I made three repairs: fuel pump (\$100), alternator (\$100), thermostat (\$50). \$250 beats \$400 monthly car payments anyday. My truck still ran with over 300K miles when I finally retired her. Now my wife drives a nice car, I drive my dream car, our house & land are paid for, and we have \$500K set back for retirement. We averaged between 9-11%. You may not like Dave or you may fancy yourself smarter than him, but the advice is sound and the feeling is unparalleled. Just a view from the other side.