Dave Ramsey is a fairly well known personal finance celebrity who is somewhat controversial for his methods. His fans love him and his detractors can’t find anything good to say about him. He created the Dave Ramsey baby steps and if you really keen – you can attend the Dave Ramsey Financial Peace University. It seems there are large numbers of people either for him or against him. One of the terms which is often applied (or self-applied) to Ramsey is that of “financial expert”. This article will take a look at Ramsey’s various methods to determine if that title is accurate or not.
In short I would say that Dave Ramsey is definitely not a financial expert. His main field of expertise is debt reduction motivation which is he very good at so maybe he should be called a “Debt Reduction Motivational Expert”. This is not intended to be a criticism since the “financial expert” label implies a high level of knowledge of all things finance which is pretty much impossible for one person.
Dave Ramsey debt reduction snowball method
Ramsey’s “snowball” method is one of his most effective strategies as well as his most controversial. Basically the idea is that if you have more than one loan – you should pay off the loans in order from smallest to largest in terms of the amount owing and ignore the various interest rates. Someone who had a car loan of $5,000 at 7% and a credit card debt of $9,000 at 15% should pay off the smaller car loan completely before paying any extra on the credit card loan.
This strategy is purely psychological – it is quicker to pay off the smaller loan and the person trying to get out of debt will be able to experience some debt reduction success which will enable them to then tackle the larger loan. If they try to pay off the larger loan first they have a higher chance of getting discouraged (because it’s taking longer) and giving up.
Logically the loans should be paid off in order of interest – highest to lowest regardless of the size of the loan. To do differently will result in higher interest costs.
I’m a pretty numbers-oriented type of guy so there isn’t a chance in hell that I would pay more in interest just for the pleasure of paying of a smaller loan first, but Ramsey’s results speak for themselves – I’ve read about many people who were able to pay off or reduce their debts because of his methods. Bottom line is that you have to do what works – if the end result is that the debts are paid off (and they stay off) then you’ve won the debt battle. It’s as simple as that.
Dave Ramsey “gazelle intensity”
Another one of Ramsey’s methods is his attitude toward intensity – he says that if you are going to pay off debt then you have to hate debt and do everything you can to get rid of it. He calls this “gazelle intensity“. I didn’t know that gazelles were all that intense but that’s not important.
I can’t argue with this strategy – whether it’s reducing debt, cleaning your house, getting shape or just about anything that is difficult – there just isn’t anything wrong with making it a top priority and getting it done. Of course you have to be reasonable – eating sub-standard cheap food to save money is not something that a self-respecting gazelle would likely do (intense or otherwise).
Dave Ramsey – “Pay off debt completely before investing”
This rule is so extreme that he even says don’t contribute to a 401k if you get an matching amount from your employer. This might make sense for someone who is drowning in debt and every penny is important but most people should go for the 401k employer match even if they are trying to reduce their debt. Once you get a handle on your debts then starting an investment plan is not a bad idea – if you are not quite ready for investing you should still spend some time learning about the basics of investing.
Some would argue that if expected equity returns are higher than your loan interest costs then you should invest before paying off the loan. However they are ignoring the different risk characteristics of different asset classes (or comparing apples and oranges). Paying off debt is a guaranteed return like investing in a high interest savings account. Investing in equities or stocks has a higher risk. There’s nothing wrong with either of those investment types but you have to consider your financial goals, investment time horizon and risk tolerance when choosing where to put your money. The other thing to consider is that most unsecured debt probably has a higher interest rate than the expected equity returns anyways (I assume 7% for long term equity returns).
This is the area where Dave Ramsey is not very strong – he continues to say that equities will get 12% return which is not very realistic and he makes a lot of basic errors on his radio show. Another problem is that he recommends using financial advisors who are paying him for the referrals so there is a conflict of interest. For all the good that Dave does – investment advice is not part of it.
Is Dave Ramsey a financial expert?
Not really – but he has helped a ton of people to manage and reduce their debts so if you need help with debts then he’s a great option. Just don’t listen to any of his investment advice.
If you want to learn more about Dave Ramsey then go check out Dave Ramsey – Financial guru review.
Photo credit to Durotriges