Archives For Dave Ramsey

This is a video from 2014 in which Dave Ramsey addresses yet another question about his use of 12% as a benchmark rate of return.

Looking at the 30-year rolling return spreadsheet I put together, we can see that 12% or greater returns are possible. They occurred 19 out of 60 times.

When we take the average of all 60 of those 30-year annualized returns, we get 11.21%. You might think 11.21% is close enough, but over 30-years it’s a big difference. A person who received an 11.21% annualized return over 30 years would end up with a portfolio about 80% of the size of the person who achieved a 12% return.

What’s even more important to note is that these are index returns, NOT what a person could get in the real world. After fees (and don’t forget about inflation), the actual returns would most certainly be lower than published index returns.

I would respect Dave a lot more if he would come out and admit the error of his ways, but as you can tell from the above video, that’s not going to happen.

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?

Dave Ramsey has a program where he refers people to Endorsed Local Providers. An ELP is someone who has submitted an application to get on his list. I’m not sure how stringent the application process is. However, I have read that applicants must pay a fee to get on Dave’s list.

To all us Dave Ramsey skeptics, that brings up a question:

Is it a conflict of interest to pay to become one of Dave’s Endorsed Local Providers?

I say it is UNLESS they inform prospects that they did in fact pay a fee to be on the list.

I first learned of this in this article that Dylan posted in the comments section of this post.

Anyway, what are your thoughts?

My old Dave Ramsey posts regarding comparisons between the 15-year and 30-year mortgage still receive comments from time to time. This afternoon I noticed the following comment (on this post) that I want to address:

In the comparison above the amount in savings is only listed for the 30 year mortgage. Where does this number come from? Multiplying $458 times 180 (months) come to $82440. Nonetheless, one really important peice is missing. If I am in the 15 year category, and I just paid off my last payment of $1696. How’s about I save $1696/mo for 15 years and then let’s compare savings accounts. At the end of 15 years of saving $1696 (as I paid off my mortgge after 15 years), my savings account reads a sweet $305,280. Did I miss something?

His comment refers to this graphic:

Mortgage Comparison Snapshot

Let’s look at this reader’s questions, one at a time:

In the comparison above the amount in savings is only listed for the 30 year mortgage. Where does this number come from? Multiplying $458 times 180 (months) come to $82440.

The savings is the difference in payment amounts between the 30-year and 15-year mortgages. I went on the assumption that the person could afford either mortgage and that the payment difference would be saved and invested.

Simply multiplying $458 by 180 ignores the potential investment growth. In the example, I used an 8% growth rate. Granted that rate has turned out to be high given the bad markets we have had recently. But the 8% number is well within reach over the long-term.

The reader then goes on to say…

Nonetheless, one really important peice is missing. If I am in the 15 year category, and I just paid off my last payment of $1696. How’s about I save $1696/mo for 15 years and then let’s compare savings accounts. At the end of 15 years of saving $1696 (as I paid off my mortgge after 15 years), my savings account reads a sweet $305,280. Did I miss something?

Yes, he missed something. If you look at the graphic, you’ll see that I do in fact assume that after the 15-year mortgage is paid off the payment ($1,696) is invested at an 8% rate of return for the next 15 years. That’s why the savings account balance at the end of 30 years is $587.009 rather than the $305,280 that the commenter mentions ($1,696 x 180 months).

Anyway, I won’t go into all the details of that post. You can read it here along with all the very thoughtful comments that followed.

My church participated in Dave Ramsey’s “The Total Money Makeover Live!” event a couple of weeks ago. I did not attend the event but did pick up a copy of the workbook that went along with the event.

I have never counted myself among the Dave Ramsey fans. Sure, his advice is better than racking up lots of debt and not saving for the future. But, he also generalizes and has a one-size-fits-all approach to the advice he offers his listeners.

What bugs me most is the math behind his assumptions.

For example…

On page 3 of the above-mentioned workbook, is this:

The American Dream

Imagine if…
A 30-year old couple made $48,000 a year and saved 15% ($7,200 per year or $600 per month) in a 401(k) at 12% growth.

At 70 years old, they will have…
$7,058,863.50 in the 401(k)”

How did Dave arrive at that number? Here’s the math:

FV = $600 × (1 + .01)480

FV = $7,058,863.51

That’s a lot of money!

But, how would this look in the real world? I summarized Dave’s information into the following graphic and used 2009″s numbers from the IRS to calculate income taxes.

Dave's Math

For my example, I assumed that this couple does not have children. If that were the case, it would probably be possible for them to sock away $7,200 per year. Their budget would be tight unless they economized.

Then comes my next question:

WHERE ARE THEY GOING TO GET A 12% RATE OF RETURN FOR 40 YEARS?

Seriously, WHO assumes a 12% rate of return for 40 years? Later on in the book, Dave stresses diversification. There’s not a properly diversified portfolio on earth that is going to average a 12% rate of return on a consistent basis. The ONLY way you’re going to get that kind of return is to invest ALL YOUR MONEY in small cap stocks, which are highly volatile.

I think the word “imagine” was the proper word to use for his scenario because the only way he’s going to get those numbers is with IMAGINATION!

To bring us back to REALITY, I reran Dave’s numbers using a much more conservative .77% monthly rate of return, which happens to be the geometric average return for the S&P going back to 1926. Take a wild guess at what the 401(k)’s expected value becomes with that number?

$3,017,106

And that number’s even somewhat inflated because it assumes 100% of the money is invested in the S&P for all 40 years.

And…

Neither of those numbers include inflation, which would eat up at least half of those accounts.

So why does Dave use such a high number for an assumed rate of return? I would have to say it’s to give people hope (a false sense of hope, but hope nonetheless). When people look at those numbers, they go, “WOW! I can do that? I had no idea!” I will admit, that those numbers are eye-popping.

But,…

THEY AREN’T BASED IN REALITY

Thoughts?

Jesse over at You Need a Budget sent me an email this evening asking my opinion of Dave Ramsey’s 3-step plan for fixing the credit crisis. Here’s the plan (which you can also download as a PDF here):

Years of bad decisions and stupid mistakes have created an economic nightmare in this country, but $700 billion in new debt is not the answer. As a tax-paying American citizen, I will not support any congressperson who votes to implement such a policy. Instead, I submit the following three steps:

Common Sense Plan.

I. INSURANCE

A. Insure the subprime bonds/mortgages with an underlying FHA-type insurance. Government-insured and backed loans would have an instant market all over the world, creating immediate and needed liquidity.

B. In order for a company to accept the government-backed insurance, they must do two things:

1. Rewrite any mortgage that is more than three months delinquent to a 6% fixed-rate mortgage.

a. Roll all back payments with no late fees or legal costs into the balance. This brings homeowners current and allows them a chance to keep their homes.

b. Cancel all prepayment penalties to encourage refinancing or the sale of the property to pay off the bad loan. In the event of foreclosure or short sale, the borrower will not be held liable for any deficit balance. FHA does this now, and that encourages mortgage companies to go the extra mile while working with the borrower—again limiting foreclosures and ruined lives.

2. Cancel ALL golden parachutes of EXISTING and FUTURE CEOs and executive team members as long as the company holds these government-insured bonds/mortgages. This keeps underperforming executives from being paid when they don’t do their jobs.

C. This backstop will cost less than $50 billion—a small fraction of the current proposal.

II. MARK TO MARKET

A. Remove mark to market accounting rules for two years on only subprime Tier III bonds/mortgages. This keeps companies from being forced to artificially mark down bonds/mortgages below the value of the underlying mortgages and real estate.

B. This move creates patience in the market and has an immediate stabilizing effect on failing and ailing banks—and it costs the taxpayer nothing.

III. CAPITAL GAINS TAX

A. Remove the capital gains tax completely. Investors will flood the real estate and stock market in search of tax-free profits, creating tremendous—and immediate—liquidity in the markets. Again, this costs the taxpayer nothing.

B. This move will be seen as a lightning rod politically because many will say it is helping the rich. The truth is the rich will benefit, but it will be their money that stimulates the economy. This will enable all Americans to have more stable jobs and retirement investments that go up instead of down. This is not a time for envy, and it’s not a time for politics. It’s time for all of us, as Americans, to
stand up, speak out, and fix this mess.

I think think this plan makes sense. Still, even under this plan we’re still going to see a lot of foreclosures. Those who purchased homes using interest-only mortgages and then only paid the interest-portion of the payment will never be able to afford a regular mortgage payment.

Dave’s also not quite clear on how we pay for the insurance program. Is this something paid for with tax dollars or is it something charged to the homeowner? I’m assuming it is taxpayer-funded. Regardless, I think this is a lot more tolerable than the massive $700 billion bailout that’s being discussed. What do you think?

If you like Dave’s plan, go check out his website to learn how you can help spread the word.