Dave Ramsey - Millionaire on the Prairie

Another Little Criticism

Learning about personal finance and investing has been a hobby of mine for the better part of 30 years… wow – that’s a long time! No wonder I make those odd noises when I get up from the couch…

Anyway, one of the first books that set me on my successful path was The Total Money Makeover by Dave Ramsey. I loved this book! I was in undergrad when I read it, and I promised myself that I would follow its tenets once I had graduated and was earning real money.

I’m not sad to say that this is one promise to myself that I’m glad I broke. See, while I still think that the debt snowball is a brilliant strategy for getting out of debt, I’m not so sure about the other steps.

In particular, I take strong issue with the step about only investing 15% of your income after you’ve gotten yourself out of debt.

What’s wrong with 15%?

On the fact of it, saving 15% is a great goal to strive for. My question for other personal financial afficianados is why stop at 15%? If you can comfortably save 20% or 30%, or even 50%, then why not do so?

See, somewhere along the line, I discovered FIRE. It’s an acronym for Financial Independence, Retire Early. Thanks to the vastness that is the Internet, I went deep down the rabbit hole of FIRE. I learned about people who saved 70% of what they earned, who’d lived on $7,000 for an entire year, who’d retired in their 30s! Eventually, I discovered Mr. Money Mustache – a fellow Canadian, whose face-punch imagery caught my attention from the word go.

The FIRE community is varied, like any other community. However, the one thing that they do seem to share is the belief that you need to save more than 15% to become financially independent anytime soon. There’s even this handy-dandy retirement calculator floating out in the world. (Plug in your own numbers – see if you like the answer!)

FIRE and Dave Ramsey seemed to have a lot in common. Both financial perspectives eschewed debt. They both emphasized having an emergency fund and saving for retirement. There are even many in the FIRE community who think Dave Ramsey is great, and happily pay homage to him.

Yet Dave Ramsey… is remarkably quiet on his thoughts about the FIRE movement.

Why is that?

Look. I can’t speak for Dave Ramsey or his organization. Maybe he’s a huge fan of FIRE, but it’s not part of his company’s mission statement. Or maybe he hasn’t heard of FIRE yet. There are a million reasons why he sticks to advising people to only save 15% of their after-tax income.

My theory is that FIRE is an anathema to employers, and Dave Ramsey is a businessperson who needs employees to work for him. As an employer, it makes no sense to encourage the pool of talent from which one draws to become financially independent. Employers have the advantage when employees are dependent on a paycheque. I think that this was most beautifully illustrated in the blog post of other fellow Canadians over at Millennial Revolution.

Allow me to be clear. I’m not for one minute suggesting that Dave Ramsey speaks for all employers. Of course, he doesn’t!

What I am saying is that it would not be in Dave’ Ramsey’s best interest as an employer to encourage the pool of potential employees to strive for financial independence. Think about it. Being FI gives jobs candidates more negotiating power since they don’t need the job to survive. The beauty of the FIRE philosophy is that it gives people choices, including the choice to work for personal satisfaction without consideration of the paycheque. After all, just because one is FI does not meant that one has to RE. If your job brings you joy and you’re also FI, then your are truly and wonderfully blessed. No need to retire early if you don’t want to.

Think about how terrifying that must be for an employer. If money is the primary tool to control the workforce, then what weapon is left when money is not effective? A financially independent pool of employees means the employers have to find another tactic to persuade people to work for them.

In my very humble opinion, 15% isn’t enough.

If you’ve paid off your debts and your budget has breathing room again, I don’t see why you should be implicitly encouraged to spend 85% of your money. Spending at that rate keeps you tethered to your paycheque longer than you may like.

Until recently, I didn’t really consider why Dave Ramsey doesn’t encourage people to pursue financial independence. Yes – some people won’t be able to save more than 15% of their income, even if they’re out of debt. I get that. If you don’t have it, then you can’t save it. However, those aren’t the only people who listen to him.

My question is more about why those who can save more are not being encouraged to do so.

Again, the only theory that makes sense to me is that he doesn’t want to use his platform to encourage financial independence. I find it odd. Firstly, I don’t believe that everyone who calls his show for help loves their job so much that they want to stay for as long as possible. Secondly, one of the very best things that money buys is freedom from doing what you don’t want to do. Thirdly, financial independence doesn’t mean that people become lazy and idle. Instead, it gives them the time to work on what truly makes them happy.

Currently, I believe the following. Pursuing FIRE status will always be an employee-driven social movement. Given its nature, it has to be. After all, as a group, employers cannot maintain their vice-like grasp on power where there is a financial balance in the employment relationship. When employees have the ability to walk away without negative financial consequences, employers run the real risk of losing employees’ labour. A vision remains a vision unless there are minds and bodies that can bring it to life.

The concept of financially independent employees is adverse to the employer’s interests. It’s hardly surprising that employers are not advocating that their employees put some of their focus on saving and investing.

Getting back to Dave Ramsey. His book was written long before the FIRE movement hit the mainstream. I do not believe that he suggested a 15% savings rate in an attempt to maintain the imbalance of power between employers and employees. That’s a pretty broad stroke, and it’s not one I’m intending to make.

What I am willing to say is that the practical effect of his advice to only save & invest 15% works to give employers the upper hand. I’ve had many good jobs in my lifetime, yet none of my employers has encouraged me to save and invest for my future. There’s never been any kind of nudge towards financial independence.

Think long and hard.

The sooner you invest your money, the sooner you can hit the target of being financially independent. There may come a day when you no longer love your job, for whatever reason. When that day comes, you’re going to need to have money in place to pay for those pesky expenses of living like food, shelter, clothing, etc…

I’m not telling you to not follow the Baby Steps. What I am telling you is to think about their practical effect on your personal finances. Take what works… leave the rest.

My Criticisms of the Baby Steps

Based on my understanding of them, the Baby Steps have two main problems. One, the Baby Steps encourage people to work longer than they might otherwise wish. Two, people will pay higher than necessary management expense ratios (MERs).

One of the more controversial figures in the personal finance section of the Internet is Dave Ramsey. Among other things, he is famous for encouraging people to follow his Baby Steps.

When I was first starting down my own money journey, I happily devoured The Total Money Makeover. Even today, I still think that the Baby Steps are a great path for newbies who are looking for a way to get out of debt and to start building wealth. When I had student loans and car debt, I followed the Baby Steps and paid those off. Once debt-free, it was very nice to have some breathing room in my budget.

However, when I got to the step about investing 15%, I had to pause a little bit.

Criticism #1 – Working Longer than Necessary

My first concern with the Baby Steps is that they implicitly encourage people to spend 85% of their income once all non-mortgage debt has been repaid.

Allow me to exceptionally clear. THERE IS NOTHING WRONG WITH SAVING 15% OF YOUR INCOME! When there is a choice between saving nothing and saving something, always choose to save something. Then invest that money for long-term growth and go about the business of living.

However, I was fortunate enough to have learned about early retirement. I wanted to retire as soon as possible. Investing the recommended amount of 15% of my paycheque wasn’t going to do it for me. In short, investing only 15% of my income while spending the rest wouldn’t allow me to fulfill my goal of early retirement. I was not interested in working 30+ years if there was a viable option for me to still have a financially solid retirement while working for less than 3 decades!

As a result of my independent self-study, I had learned from other sources that a higher savings-and-investing rate meant a quicker path to financial independence. I’m certain that the Baby Steps will help most people get to a comfortable retirement at a traditional retirement age. And if the Baby Steps help someone to start their 15% investment plan in their 20s, I’m sure that they’ll have millions of dollars after 30+ years of work.

My life’s dreams didn’t involve working for 30+ years. My career has a lot of perks, but jumping out of bed each morning in gleeful anticipation of another day at the office is not one of them.

Fortunately for me, I had the ability to save more than 15% of my income once all my non-mortgage debt was eliminated. At this point, I seriously deviated from Dave Ramsey’s plan. Firstly, I paid off my mortgage in my mid-thirties. Then I took my former bi-weekly mortgage payment and started investing it. To be clear, that former mortgage payment was more than 15% of my take-home pay. I first maxed out my RRSP, then I maxed out my TFSA contribution room. Once that was done, I started contributing to my non-registered investment accounts. Over the years, I’ve benefitted from raises. Generally speaking, two-thirds of each raise went to my investments and the remaining third went to improving my present-day life by spending on those little luxuries that make me happy.

I am not encouraging anyone to deviate from the Baby Steps if they want to work for as long as possible. There are people in this world who love their jobs! Saving and investing only 15% of income works beautifully for these people. They get to spend their money today, while enjoying their jobs, and will still retire at traditional retirement age with a nice, fat cash cushion. If this is you, then I congratulate you on having found a way to make money doing something you love.

It just seems to me that the Baby Steps should say “invest 15% or more of your household income in retirement.” Adding those two little words would plant the seed that retirement can come sooner if you so wish. I’ve met more than a few people who’ve expressed the desire to quit working, but cannot yet do so because they need the paycheque. For these folks, saving the recommended 15% doesn’t get them closer to their goal of retiring sooner rather than later.

Criticism #2 – Paying Higher-than-Necessary MERs

My second issue with the Baby Steps is related to Dave Ramsey’s love of mutual funds. I’ve listened to him on YouTube where he consistently exhorts his listeners to invest in mutual funds.

In the interests of transparency, I admit that there was a time when I invested in mutual funds. I was younger and less knowledgeable about the costs of equity products. It’s been years since I divested myself of those products and moved into exchange traded funds with VanguardCanada and iShares. There was one main reason that I exited from mutual funds and went into exchange traded funds.

Mutual funds are consistently more expensive than exchange traded funds and index funds. This is because mutual funds charge higher MERs than their ETF/index fund equivalent. Think of the MER as the cost of the product. The returns on my mutual funds were not twice as good as the returns on my ETFs, even though the MER might be twice as high (or many multiples higher!) on a mutual fund than on an ETF. If the mutual funds’ performance had justified the higher price, then I would have continued paying a higher price. When I realized I could get the same performance for a lower price, I hastily moved out of mutual funds and put my money to work in ETFs. I’ve never regretted my choice.

So when I listen to Dave Ramsey talk about how wonderful mutual funds are, I have to ask myself why wouldn’t he tell his listeners to invest in equivalent yet cheaper ETFs? The same performance for a lower price seems to be a good thing for the people following his advice.

I have never heard a persuasive explanation for why people should pay higher MERs when an equivalent and cheaper product readily available.

Take a look at this MER calculator. It demonstrates that higher MERs result in smaller portfolios over any given period of time, all else being equal. The longer you’re investing your money, the bigger the MER-bite. Whenever possible, invest in an ETF or an index fund instead of a mutual fund. You should not be paying an MER higher than 0.3%.

So that’s it in a nutshell. Though they are a great starting point, I hope that I have articulated my two biggest problems with the Baby Steps. I sincerely hope that this blog post has given you more information about how to influence how much longer you’ll have to work. The secret is to invest more today so you don’t have to work as long tomorrow. Whenever you do invest, pick exchange traded funds instead of mutual funds to keep costs down and to maximize the amount of money working on your behalf. Lower MERs ensure that a higher percentage of every invested dollar works for you as you pursue your investment goals.

At the end of the day, the choice of how much and where to invest is yours. If you want to work for as long possible, while paying more in investment costs, then follow Dave Ramsey’s plan to the letter. If you’d like to have the option of attaining financial independence as soon as you can,then invest more than 15% of your next income and choose ETFs over mutual funds.

Are the Lessons Still Working?

The older I get, the more I think about the ideas that have guided my life’s decisions up to this point. I ruminate on whether some of the ideas that I’ve held dear for a long time are still good enough to follow, or whether they’ve led me to a place that I’d rather not be. In short, I ask myself if those ideas are helping me or hindering me when it comes to achieving my dreams. One of those lessons that I ponder has to do with investing.

When I was younger, I read Dave Ramsey’s book – The Total Money Makeover. I immediately implemented its principles into my life. This book for put me on a very stable financial path. I was young and inexperienced, so this book helped me immeasurably when I was first getting started. And since I’m older than the Internet, I didn’t have access to the myriad of great blogs and websites that now exist to teach people about money.

Fans of Dave Ramsey will know all about the Baby Steps, which are designed to get you living a life that fulfills your dreams once you’re debt-free. If you’re not familiar with Dave Ramsey, get yourself to a library and borrow his book. You may not agree with him, or you may become a disciple. If you’re uncertain about where to start with your finances, his book is a good place to figure out what your next steps should be.

There is a lot to appreciate about the Baby Steps. I’m firmly in favour of getting out of debt. It’s a fantastic goal for just about everyone. I’ve yet to come across a situation involving revolving credit card debt and then think to myself “Wow! What a brilliant idea to pay 29% interest month after month, year after year! I wish I was doing that with my money!”

Nope! I have never once had that thought. When it comes to getting out of debt, I think Dave’s advice is pretty sound… for the most part.

Never refuse free retirement money

However… I’m not as dedicated to everything that Dave preaches as I used to be. Our beliefs about best practices for your money diverge when it comes to saving for retirement and building wealth. If you read his book, then you’ll know that Dave wants you to stop investing for your retirement until all of your debt except for the mortgage on your home is completely gone.

In my opinion, ceasing retirement contributions is a bad choice for a number of reasons. Firstly, people already have a serious problem with saving for retirement and building wealth. That problem generally takes the form of them not doing it! Secondly, the longer money is invested then the more time the money has to compound and grow in the market. It’s so vitally important to simply start investing so that your money starts to grow as soon as possible!

Thirdly, the debt burden to be paid off could be quite large and it might take several years to eliminate it. That’s several years of missed investing! If you’re an older person who’s suddenly decided that it’s time to clean up your personal finances, then you don’t have the luxury of waiting to invest for your retirement. Finally, if you’re getting any kind of retirement match from your employer, then you’re giving up free money when you stop making contributions to your retirement accounts at work. You should not say “NO!” to free money from your employer!

Why pay more for the same thing?

The second area where I disagree with Dave is in respect of where to invest your money. He is a firm believer in buying mutual funds, preferably ones that invest broadly in the stock market. He urges his followers to invest in mutual funds with long-term track records and which provide 12% return on investment. Since he’s from the USA, he encourages people to invest in the S&P 500. I have no quarrel with investing in the stock market. I just can’t figure out why he wants people to invest in mutual funds instead of exchange-traded funds.

For the most part, there’s an ETF out there that is equivalent if not identical to whatever mutual fund has caught your eye. Buying an ETF instead of mutual fund is less expensive than buying a mutual fund. This is because ETFs have lower management expense ratios than mutual funds do. If you want to contribute to a mutual fund that invests in the stock market, then find an ETF that invests in the stock market. Compare the two and then buy the one that’s cheaper. You’ll be investing in the same thing, for a much lower price. The difference between the MERs for the two investment products is money that will stay in your pocket.

Imagine your investment as a 2L carton of milk. You can pay $2.49 for the milk, if it has the mutual fund sticker on it. Your other option is to pay $0.75 for the milk, if it has the ETF sticker on it. One carton is vastly cheaper but you’re still buying the same milk. Why would you pay more for the same thing?

Until I hear a persuasive argument from Dave on why he prefers mutual funds over ETFs, I can’t ever see myself agreeing with him on where people should invest their money once they’re out of debt.

Investing 15% isn’t enough when time is short

The third area where I disagree with Dave is with the amount of money that he wants people to invest. Once you’ve reached Baby Step 7, Dave wants you to invest 15% of your income for wealth-building. Presumably, you can spend the rest of it in any way that you choose.

Woah… 15% of your paycheque isn’t a lot of money if you have no other debts. Personally, I think this number should be way higher. I’d like to see debt-free people investing atleast one-third of their take-home pay, and ideally half of it! My reasoning goes back to the fact that money needs lots of time to grow to significant sums.

If you don’t become completely debt-free until you hit your mid-50s, then you won’t have enough time to build a super-sized cash cushion. Maybe you’ve got a pension so you don’t have as much interest in building your own pot of gold. If you don’t have a pension, then you’re going to need to fatten both your RRSP and your TFSA as fast as you possibly can so that they can get you through your second childhood.

I think saving 15% is a good enough amount if you start in your 20s. This is because young people who aim to retire at 65 have 40 or more years to invest 15% of their income and watch it grow. However, if you’re starting in your 40s or 50s, then you need to save a lot more because you don’t have 40 years of growth ahead of you. There’s no guarantee that you won’t be a victim of downsizing or ageism once you hit your 50s. Dave likes to throw around a rate of return of 12% on mutual fund investments. The longer your time horizon, the better your odds of getting such a lofty return on your portfolio. If you’ve got a short time horizon, then the growth of your portfolio is going to have to come from your return AND your savings so make sure that you save more than 15%!!!

There’s no harm in saving more. Please do not misunderstand – I don’t want you to lead a life of deprivation while you build wealth. I’m not advocating that you deny yourself some of life’s luxuries in order to build mounds of wealth. Sacrificing all the things that bring you happiness and joy alone your journey simply to save for retirement isn’t a good way to live the only life you’ve got.

I just want you to consider saving more than 15% of your income.

If you have no debt and no mortgage, do you really need to spend 85% of your paycheque? Could you not stumble along on two-thirds of it and still do/acquire/experience most of the things on your want-list?