Dave Ramsey is probably best known for his debt reduction strategy. If you have listened to his radio show much, then you know he is extremely aggressive in tackling debt. Once debt has been eliminated and an emergency fund has been established, then the focus is on investing.
The focus of this article is on Dave Ramsey’s financial philosophy, however, we have other articles that examine Ramsey’s views on specific subjects. You can read our thoughts on Ramsey in our life insurance review and disability insurance review.
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The Debt Snowball strategy has been successful for so many people because it breeds success and confidence. Ramsey insists on paying off your smallest debts first. Then, tackle the bigger ones (thus the snowball metaphor). Some financial experts disagree with this strategy and recommend paying off debts with the highest interest rates first.
However, Ramsey says it’s all about behavior modification. According to his website:
When you see that the plan is working, you’ll stick to it. By sticking to it, you’ll eventually succeed in becoming debt-free!
The success and feeling of accomplishment that comes with eliminating debt carries over into building wealth. The “gazelle-like intensity” that works for conquering debt creates a change in mindset. The lifestyle change involves cutting out unnecessary purchases and dialing back on all spending. Once these habits our set, it frees up money for investing. Once the debt is paid, it’s unlikely you will resume old habits and spend your disposable income irresponsibly.
Ramsey’s 7 Baby Steps
$1,000 baby emergency fund
Pay off all debt using the debt snowball
Save 3-6 months of expenses as your fully funded emergency fund
Invest 15% of household income into Roth IRAs and pre-tax retirement
Save/invest for your kids’ college
Pay off your home early
Build wealth and give! Continue to invest in mutual funds and real estate.
Dave Ramsey’s Financial Philosophy – Simple and Doable
One of Dave Ramsey’s strengths and the reason for his success the fact that he is an inspirational leader. He provides the motivation and tools for people to get out of a financial rut and make lasting changes. By Ramsey’s own admission, there is nothing new to his financial philosophy. He teaches tried and true principles.
People can get caught up in disagreement over his Baby Steps (shown above), but the success lies in just doing something. Just like with any exercise regimen, you can get caught up in finding the perfect type of workout, but success comes from a steady commitment to doing something on a regular basis. Otherwise, we can get stuck in the “paralysis of analysis”.
Dave Ramsey’s Advice on Where to Invest
Once the debt is eliminated and you have a fully funded emergency fund, it’s time to move to Step 4. So, where do you go to find help? This is one area where we take issue with Dave’s advice. He advises people to find an Endorsed Local Provider (ELP) so they can get help with their investing. Keep in mind, these are financial advisors who pay an ongoing fee to be an ELP. Unlike Dave Ramsey’s advice on buying life insurance (where he recommends only one agency – Zander insurance), Ramsey offers you a choice among many ELPs.
Ramsey discourages his readers from using fee-only planners or fee-based financial planners. Nor does he encourage his readers to look into no-load or low-load mutual funds. Ramsey acknowledges that you are paying an advisor commissions (and thus reducing the amount you invest), but he says it works out better for you in the long run.
Ramsey cites studies that show how people will invest more emotionally and pull out of the market when things start going south. So, this is probably decent advice for those people who have little to no knowledge about investing. However, if you have some investment knowledge and don’t invest emotionally, it would make sense to look outside the ELP options. Perhaps a fee-only or fee-based advisor could be a better choice now or in the future.
Caution to the Conservative: Ramsey is Very Optimistic about Investing
Dave Ramsey isn’t your average guy. He’s a risk taker and he probably scores much higher on risk tolerance questionnaires than the typical person. His optimistic personality and approach to business is what has made him so successful.
However, his high risk tolerance seems to influence his advice regarding investments. There is nothing controversial about investing 15% of your income into Roth IRAs and your 401(k) (Baby Step 4). What is a little unusual is the return on investment Ramsey assumes. Dave often talks about 8%, 10% and 12% rates for returns. It is not uncommon to factor in a 12% average rate of return when making projections. Some investment experts would say that is unrealistic and can leave people far short of their retirement goals.
It is important to look at historical data, your timeline for investing, and your own risk tolerance. A good financial advisor should help in these areas. It might be better to err on the side of assuming more conservative investment returns.
Only One Investment Type?
Ramsey recommends investing in mutual funds, and mutual funds only. Keep in mind, this is just one asset type. This is one point where he veers off the standard investment advice regarding asset allocation. Ramsey is suggesting investing 100% in stocks (since mutual funds are a collection of various stocks). No bond funds or money market funds are recommended. Again, recommending just one asset type keeps things simple, but there is the risk of being overly aggressive and having overlapping investments.
This type of aggressive, highly optimistic investing bleeds over into Ramsey’s advice regarding term life insurance. He typically recommends a 20-year or 30-year term policy, but never anything beyond that. The assumption is that your investments will reach the point that life insurance won’t be needed by the end of the term period. However, there are plenty of people who experience unexpected setbacks in life. Whether it’s an illness, job loss, or some other type of financial setback, nobody knows what might happen. The stock market doesn’t always grow at the rate we hope.
We often receive calls from people in their 50s and 60s who still need life insurance. We recommend considering a “term for life” or “term to age 100” policy for a small portion of the total coverage for some people. This isn’t for everyone, but for those who are more conservative and/or want to make sure their loved ones receive a death benefit regardless of their age of death.
Dave Ramsey’s Financial Philosophy – The Spiritual Component
We will conclude this article by saying that Dave Ramsey’s financial philosophy has a strong spiritual component. There is biblical justification for some of his advice such as eliminating debt. Ramsey is a Christian and most of his FPU (Financial Peace University) courses are held through churches.
One of the goals in achieving financial success and peace is found is found in Step 7. Ramsey encourages people to give out of their abundance. He wants to see you continue to build wealth and bless people as a result of financial success.
Finally, there are a few areas where we think Dave Ramsey’s advice could be better. There is no perfect system for financial success, yet some are much better than others. Ramsey has provided the motivation and mindset change which is the foundation for long-lasting change. His system and philosophy work as demonstrated by thousands who have reached their goals.
If you would like our advice regarding life or disability insurance, please give us a call and we will be glad to help.