Dave Ramsey, like many conventional minded financial advisers revered for their knowledge, may be out of touch when it comes to giving advice in today’s bewildering economy. As most people have learned after the economic recession, there are some conventional investing methods that may work and others that no longer hold water. The key is to understand how the relevant parts still apply. Many financial advisers around the country suggest that Ramsey’s advice is outdated, based on financial conditions 20 or 30 years ago. Here are some important reasons why you should not take Dave Ramsey’s advice.
1. An all-stock portfolio isn’t good for anyone
The fact that Ramsey suggests an all-stock portfolio is ludicrous in any economic time. Even in today’s markets, one should only be aggressive if you are 30 years or more out from retirement age. You will never hear a professional financial advisor suggest that any person at any age should put all of the investment eggs in stocks. Anyone who’s taken a basic personal finance class is familiar with the stock percentage based on age calculation. That is, you subtract your age from 100 and the result is the approximate percentage recommended to invest in stocks. As your age increases, the corresponding percentage in stocks decrease as you approach retirement age. The other parts should be diversified in an assortment of bonds, real estate, and other non-stock investments.
2. The debt snowball doesn’t make financial sense
Another major error of logic behind Dave Ramsey’s “debt snowball” method for paying down debt is the emotional satisfaction that consumers achieve from paying down the smaller debts first. According to Ramsey, he suggests that you pay off the smallest of your debt, but if you have a higher interest rate on the higher balance, you will suffer in interest tacked on each month you only pay the minimum amount. Even worse, your creditor may decide to increase your interest rate if you are only paying the minimum on a large balance. Some folks have had better luck transferring their balance from high interest cards to a 0% card for 12-18 months while they are paying off other balances. In general, it is always better to pay off your highest interest credit card first. Also, as you pay off your remaining debt, every few months, take the time to negotiate with your creditors to lower your interest rates.
3. Roth isn’t always better than traditional
One of Dave Ramsey’s 7 steps to financial fitness is to “invest 15% of household income into Roth IRAs and pre-tax retirement.” There’s two problems with that statement: Roth isn’t always better than traditional, and an IRA isn’t always better than a 401(k).
Roth vs. traditional. If your tax rate is the same today as when you withdraw the money, there’s mathematically no difference between putting money into a Roth or traditional account. If your tax rate is lower than it will be when you retire, then Roth is better; if it’s higher, traditional is ideal. Roth IRA’s are typically best for people in low-tax periods of their lives, such as young people just starting their careers. Those who’ve been in the workforce for a long time (and presumably are in a higher tax bracket) should go with a traditional IRA. Another case where traditional beats Roth is if you think you’ll be taking a break from employment in the near future (say, to spend time with your family or go to grad school). In that case, you should contribute to a traditional retirement account now, then rollover to a Roth when you’re in a lower tax bracket.
IRA vs. 401(k). If your employer offers a 401(k) matching program, you should always contribute up to the matching limit before contributing to an IRA. If you don’t, you’re passing up free money.
4. It’s impossible to get 12% returns over your lifetime.
Ramsey’s most misleading is the idea that if you consistently save $100 a month starting at age 25, you’d have a12% growth rate that would net you $1,176,000 in retirement. Most pension funds assume an 8% rate of return, and even that is characterized as wildly overoptimistic. In fact, a New York Times analysis found that the 20-year median rate of return between 1920 and present day was just 4.1%.
Using the more realistic 4% rate of return, investing $100 a month since age 25 would net you just $118,196 – about a tenth of Dave’s estimate. But wait, there’s more: if you account for 2% inflation, your $100 monthly contribution would, at age 65, yield you just $73,444 in today’s dollars. The bottom line: if you believe Ramsey’s wildly optimistic projections and think you’re safe if you invest just $100 a month, you’ll be in for a shock come age 65.
Ultimately, keeping abreast of the current consumer laws and regulations, looking at your finances honestly, considering the amount of time to invest, setting reachable goals and obtaining advice from a variety of sources is the best way to tackle your individual financial situation.
