Dave Ramsey is one of the most popular personal finance authors in the country. This is a review of the 2013 edition of his book, “The Total Money Makeover“. His philosophy can be summarized in a sentence he repeats throughout the book: “If you will live like no one else, later you can live like no one else.” He promotes a lifestyle that might seem extreme to some people, as it involves being completely debt-free (ideally without even car or mortgage payments) and paying cash for everything. The book starts out with a seemingly random list of money “myths”, ranging from the dos and don’ts of credit cards to cosigning loans. It is clear that Dave Ramsey hates debt with a passion.
The Money Makeover is made up of 7 financial “baby steps”, which are:
- Save $1,000 to build up an emergency fund
- Pay off any non-mortgage debts from smallest to largest, regardless of interest, to create some quick wins. He calls it the “Debt Snowball.” He even suggests using any savings in excess of the $1,000 from Step One to pay off debt.
- Create a 3 to 6 month emergency fund ($5,000 to $25,000). He writes that “an emergency fund can turn crises into inconveniences”.
- Invest 15% of gross income for retirement.
- Save for college through an Educational Savings Account (ESA) or a 529 Plan.
- Pay off your mortgage. He argues that most people keep a mortgage for the wrong reasons, such as for the tax deduction. He recommends to either refinance to a 15-year mortgage or to pay off additional principal every month.
- Build wealth by continuing to invest your money. Once you reach a critical amount, you can start spending money on “fun” items. He also discusses the importance of giving some of your money away.
In many ways, Dave Ramsey’s message is counter-cultural and a lot of his advice makes sense. Reducing your debt, investing at least 15% of your income towards retirement, and paying for all purchases in cash are all sound principles, which few people follow.
The book is written in a style that is easy to understand, with very few advanced financial terms or concepts. Some readers will enjoy the humorous, non-politically correct tone of the book (for example, “If you were so fabulous with math, you wouldn’t have debt, so try this my way”). Others might be turned off by it. The bottom line is that people struggling with debt could very well benefit from reading this book.
The most questionable part of the book is the investment advice. He recommends investing in actively managed mutual funds (as opposed to low-cost index funds). The problem with mutual funds is that they often come with significant fees which can really hurt a portfolio’s long-term performance. In addition, most actively managed mutual funds underperform index funds. The book assumes a ridiculous 12% annualized rate of return, which doesn’t take fees into account. A 7% or 8% rate of return would have been a much more conservative and realistic assumption. The assumed 12% rate of return becomes an even greater issue later in the book because Ramsey claims that you can live off of 8% of your total nest egg in retirement! The 4% rule is a much safer alternative. Curiously, his recommended asset allocation is made up entirely of stocks, which provides relatively little diversification. In fact, Ramsey doesn’t recommend investing in bonds or Real Estate Investment Trusts (REITs).
His suggestion that you don’t need a FICO score (by not applying for loans or credit cards) might appeal to some people, especially in light of the recent Equifax breach. However, this could make it difficult to obtain a mortgage loan from a traditional lender (something he admits in the book). A lack of a credit score could affect you in other areas as well. For example, they are used to calculate your car insurance rate. According to Esurance, “Statistical analysis shows that those with higher credit scores tend to get into fewer accidents”, so they may be offered lower rates.
Finally, a good portion of the book is made up of annoying “success stories” which appear in almost every chapter. These “filler” stories add little to the overall content of the book and can be skipped by most readers.
How practical is the information in the book?
Inveduco rating: B+
Most of the information is simple and detailed enough to allow anyone to apply it without any additional instructions. However, the investment section should have been expanded to include a more in-depth discussion of risk-tolerance, asset allocation, and other investment options, such as bonds. Ramsey invites readers to attend one of his Financial Peace University classes or read his first book, “Financial Peace”, for more detailed information.
How sound is the advice in the book?
Inveduco rating: B-
Other than his one-size-fits-all investment advice, which is likely to underperform most index funds and incur unnecessary fees, the book contains a lot of good advice. However, his advice to pay off your mortgage in 15 years might not be the best move, depending on your situation. Consider the example he provides on the difference between a 15 and 30-year mortgage on a $250,000 house (and assuming a $25,000 down payment). He writes that a 15-year mortgage would cost an extra $550 a month but would save the homeowner $143,874 in the long run:
|Monthly payment||Total payments|
|30 year mortgage at 7%||$1,349||$485,636|
|15 year mortgage at 7%||$1,899||$341,762|
Those numbers sound great until you dig a little deeper. What if instead of paying an extra $550 every month for 15 years you kept your 30-year mortgage and invested the $550 into an index fund for 30 years? Assuming Ramsey’s 12% annualized interest, you would end up with $1,759,323! Now you might be thinking that if you pay off your mortgage in 15 years, you could then invest the full amount ($1,899 in our example). But this underestimates the power of time on compound interest. As we have discussed in the past, time is one of the four pillars of investing. Let’s examine these options side by side:
|Mortgage paid off in 30 years with the difference invested every month||
Mortgage paid off in 15 years after which the full amount is invested
|Total mortgage payments||-$485,636||-$341,762|
|$550 invested for 30 years at 12%||$1,759,323|
$1,899 invested for 15 years at 12%
|Investment gains minus mortgage payments||$1,273,687||$559,027|
So, in this case, if you paid off your mortgage in 15 years you would be debt free but you would have left $700,000 on the table! Of course, the interest you pay on your mortgage and the expected rate of return on your investments could make a difference in favor of paying off the mortgage early. The point is that a one-size-fits-all approach should be taken with a grain of salt.
Does the book live up to its claims?
Inveduco rating: A-
The back cover of the book claims that readers will learn how to pay off all their debt, recognize dangerous money myths, and secure a “big, fat nest egg for emergencies”. The book largely meets those promises.
Inveduco rating: B+
If you are struggling with large amounts of debt, this book could give you both the strategies and motivation needed to follow through and become debt-free. People who need to create a budget and put some order into their finances might also benefit from this book. On the other hand, if you have already read several personal finance books and are comfortable with basic investment principles, you are unlikely to learn anything new from this book.
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