| by Jason Steele |
I came across the Dave Ramsey phenomenon in response to a reader’s letter. More recently, I just read an article in The Atlantic magazine about him and his philosophy. I actually receive the print version of The Atlantic, which really allows me to thoroughly enjoy their writers in places, shall we just say, where the computer doesn’t go.
Anyways, author Megan McArdle attended Dave Ramsey’s seminar, and even gave his methodology a test. Her results were fairly positive. Now, I haven’t attended one of his seminars or read his books, so I will be relying on her experiences.
The Philosophy
Ramsey truly hates debt. He preaches giving up credit cards and all other forms of debt, with the exception of a 15 year home mortgage. One of the things that I did not know about him, was that he is very similar to an evangelist. He quotes extensively from the bible, and McArdle compares his meetings to a prayer meeting. His methodology is to withdraw all of the money you will spend in a month, and put them in envelopes. In this way it is thought that you will spend less money.
My Take
It is hard not to agree with Ramsey’s goals. We agree that almost all debt is bad. To me, credit card debt is one step better than pay day loans, but not by much. I also tell people to avoid debt on just about all depreciating assets, especially cars. On the other hand, I don’t have that much problem with debt on appreciating assets like your home or your education. Sure, we just passed through a very short, unique period where home prices underwent a correction, however over the long term, homes do appreciate in value quite reliably.
Where Ramsey and I disagree is in both our methodology of reaching the debt free goal, and our approach to promoting our philosophy. Dave would have you cut up your credit cards, as the picture in the article clearly shows. I personally feel that the benefits of using a credit card as a method of payment outweigh the psychological risk of overspending. For many people, Ramsey’s advice makes sense, as they have used their credit cards as a method of financing purchases they cannot afford to pay in full at the end of the month. There is the key difference between method of finance and method of payment. People like myself who use credit cards as a method of payment, pay their bill in full every month. They use other means to budget their money. If you ever find yourself tempted to use your card as a method of finance, Ramsey’s all cash solution is a reliable, if brute force method of kicking that habit.
When I say that the benefits of credit cards outweigh their risks, what am I talking about? First, when cash is lost or stolen, it is gone forever. When your credit card is lost or stolen, you loose nothing. My house was burglarized recently, yet little was taken. The police pointed out that they were almost certainly just looking for cash. They didn’t find any as the only cash I ever have is in my wallet. I also enjoy the charge back ability of a credit card. Frequently, just the threat of a charge back is enough to convince a merchant that they should do the right thing. Of course, the cash back rewards don’t hurt. I am saving 2% or more on everything, all of the time. That really adds up over the course of a lifetime. Finally, credit cards simplify my finances. I know when my payment is due, I don’t have to worry about each withdrawal and each check, as the money comes out of my bank account in one payment to cover many expenses.
The other big difference between Ramsey and I is how we get across our message. McArdle paid $220 for front row seats to hear him speak, while you can read my blog posts for free. Frankly, I have a hard time trusting anyone who would thinks it is a good idea to shell out that kind of money for a financial lecture. Another huge difference is that Ramsey is giving his advice in a highly religious context. According to McArdle, most of his attendees are evangelical Christians, and his talk concludes with a plea to get to know Jesus.
It so happens that I myself am not a Christian, but I do have the utmost respect for Christians and their faith. That said, I just don’t see the point in mixing religion and personal finance. I don’t pretend to have any crucial insights into spirituality, just some good advice on how to use credit cards for your economic benefit. I like to think that my advice applies equally to people of all faiths, or of none. I am not sure Ramsey can make the same claim.
I will, however, conclude with a religious analogy. It is said that different religions are just different paths to the same truth, or different ways of worshiping the same god. Likewise, Dave Ramsey’s method of achieving financial security and independence, like his religion, is different than mine, yet I think that in the end we both share the same goals.
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November 16th, 2009 at 22:00
Yes, Jason. Once someone is around the PF realm long enough, they undoubtedly will bump into Ramsey and his (shall I say fanatical?) following. I agree with his basic sentiments but not unlike Suze Orman, the commercialization of his work and the stubbornness of his fans (who don’t take kindly to any constructive criticism) leave a bit of a sour aftertaste for me.
November 17th, 2009 at 14:36
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I disagree with these statements, because I believe they miss the point and use bad examples. The focus should be on the value of the result versus the debt, and not on the value of a particular asset or asset class.
Housing is not an appreciating asset. It is a depreciating asset, just like a car. Just take a look at the concept of “a teardown”. That is basically a house that has zero value today, which is to be bulldozed off the lot to make way for a new house to be built. When that house was first built, it had value and was worth purchasing. But without the additional time and money spent to maintain the house, it degraded (depreciated) to the point where it had zero value.
Education can be too expensive as well. People who take on $100,000 of student loan debt to get their degrees to be a college professor at $60,000 (gross) per year are in debt for over a decade.
On the other hand, I might take out a $20,000 loan for a car, but it enables me to reliably get to and from a $60,000 per year job. Although it would be better to have paid cash for the car, I only pay $500/month for the car, while pulling in $2,500 per month in after-tax salary.
So I would argue that whether the debt was “good” or “bad” can’t be judged absolutely, but must be judged in context. If the debt provides more value than the cost, then it is “good”. But if it equals or exceeds the value, then it is “bad”.
On the Dave Ramsey thing, my personal observation is that the people who benefit most or become staunch advocates, are people who were not disciplined enough to use credit cards without carrying a balance. They were undisciplined with their finances, and dug themselves deep into consumer debt.
And some of them still are. They do great on his system. But if they were to get another credit card or personal line of credit, they would run it back up again and get themselves into trouble.
Your mileage may vary.
November 17th, 2009 at 14:48
Any asset neglected to disrepair will depreciate dramatically, homes included. I have never had a home depreciate, and I have never had a automobile appreciate. There are exceptions like buying real estate at the top of a bubble, or purchasing a collectible car, but the rule works >99% of the time.
I know people who buy cars for $500, essentially eliminating depreciation. I prefer well maintained used cars with under 50,000 miles. I have never taken a loan out to buy a car. I usually pay half of what the car cost new, and I often have a warranty. The car will usually sell for about 1/4 to 1/3 of new four years later, below 100,000 miles.
November 17th, 2009 at 14:52
Hey interloper
Nice ending “your mileage may vary”. But I really like your angle on the fact that we cannot use an absolute judgment on the value of taking on debt. The example on education was excellent.
November 18th, 2009 at 13:06
Jason,
Are you looking at real or nominal values? The Case Shiller data clearly shows that the long term value of housing moves in lock-step with inflation (wage inflation in particular).
Example: Your parents bought a house 36 years ago for $150k. They sold today at $300k. The house appreciated, right? Nope, they lost value. They averaged a 2% return per year, when the inflation average was closer to 3%. And that’s not counting all the additional money they put into the house to maintain it, remodel it, etc.
I have had a house lose nominal value on me, sold it for slightly less than I purchased it for, after owning it for a few years. Without a housing bubble forming or bursting. It can happen, and it does happen. It’s not that uncommon, because as any real estate professional will tell you, real estate is cyclical. Valuations fluctuate up and down, for various reasons.
If you’ve never lost value, even nominal value, then you’ve been very lucky. I personally don’t know anyone who hasn’t lost nominal value, let alone real value, on one or two houses in their lifetime.
An appreciating asset, by definition, would require no additional investment in it beyond the initial purchase. Anything that requires additional investment to maintain value or increase value is by definition a depreciating asset.
If I buy stock in Proctor & Gamble, I can let it sit in a brokerage account, or put stock certificates in a vault, and let them sit for 10 years. They don’t cost me any money to maintain. When I pull them out 10 years later, they will be worth more money than I put into them, in both real and nominal terms.
If I put money into a bank CD, I don’t have to pay a single dime to maintain the CD’s value. The CD won’t be worth 70 cents on the dollar because I didn’t spend money on maintenance. (Although I could lose real value, if inflation exceeds the yield on the CD.)
On the other hand, I have to sink money and time into maintaining my house and my car. They cost me additional money beyond my initial purchase. They degrade and wear out over time.
I’m not making these definitions up. Simply look at the IRS rules for confirmation. For example, for a rental residence, the IRS allows you to depreciate the value of the house over a period of time (currently 27.5 years), in the same manner as if you were using a machine in a manufacturing shop or a car for a business. On the other hand, the IRS will not allow me to depreciate the value of my stock over any period of time.
I don’t have any problem if someone wants to say there are good reasons for owning a house, and good reasons to take on debt to purchase one. But calling housing an appreciating asset is completely incorrect. If you don’t spend money beyond your PITI payment, your house will decline in value — definitely in real terms, but probably also in nominal terms as well.
November 18th, 2009 at 13:15
Which is all just a really long way of getting back to my point about not being able to judge debt in absolutes.
I’d argue it’s just fine to take on debt for a depreciating asset, as long as it provides more value than the cost of the debt.
Cars, houses, education, whatever. Take out the debt as long as you can handle it, and as long as whatever you’re getting in return more than pays for the (total) costs of that debt.
November 18th, 2009 at 14:32
Interloper, you make good points. Another reason I am ok with home and school loans is that the interest, is usually very low and is nearly always tax deductible. I am paying 5% on my home and I get a tax deduction. Even if my home never appreciates, it is a much better deal than paying rent as my interest is tax deductible and my principle is retained. When you pay rent, the money is gone and has no tax advantage.
An education loan is also tax deductible, and what you get in return is invaluable. Most degrees pay back within a few years, some within a year! I just don’t see how Ramsey can make an argument against that kind of investment.
November 18th, 2009 at 20:33
Interloper does a good job of explaining the main reason I’ve never been a big fan of financial “gurus” like Dave Ramsey. They tend to take personal finance issues to a simplified extreme which is far from realistic.
Yes they have basic rules that they have their listeners follow and most of the time it works very well for them because some basic concepts can apply fruitfully to a majority of people. What bothers me is not their advice but the philosophy they get their listeners to subscribe to. This philosophy is that there are certain concrete answers that are correct at all times, in the Ramsey example, credit cards are bad.
But this is not necessarily the case and when people follow so closely to these “gurus” they won’t listen to outside reason and have a much narrower scope of what is a very complicated part of life (personal finance, investing, etc.).
November 18th, 2009 at 21:58
Edwin
You are right on the mark. That is why pf stands for personal finance – it is “personal” and should be applied to individual’s circumstances.
November 18th, 2009 at 22:27
I haven’t had much exposure to Dave Ramsey, but I’ve seen a little and interacted with some of his followers. I suspect his hard-line, inflexible stance of “Debt is Bad!” is causing him to throw out the baby with the bath water.
I know that some people just cannot handle credit cards, so the system works really well for them. But using that stance as universal advice for everyone is obviously not appropriate.
I’d also caution you that rent versus own calculations are also not as straightforward as “rent is throwing your money away” and “you don’t get a tax break”.
At the end of the day, whether you rent or own, you’re paying for shelter — a landlord if you rent, or a bank if you purchase (unless you bought your house with cash, no loan). The question is merely which approach leaves you better off financially.
Where I live right now, there are houses available to be rented or purchased. The rent is $1200/month, or purchase for $330k+. Even under very favorable assumptions (purchased for 10% off ask price, 20% downpayment, 30 year fixed-rate mortgage @ 4.75%, 35% marginal tax rate) the numbers just don’t make sense.
Maybe someone else can justify spending $500+ more per month for the privilege of being able to paint their walls, etc. But I sure can’t. I’ll just put that extra in my savings and come out further ahead than if I bought the place.
November 18th, 2009 at 22:28
Oops. Edwin and Mr. Credit Card beat me to it. I’m too slow on the draw…