About a year ago, I was sitting by myself at the back of a bus filled with advisors and insurance agents. A few rows ahead of me, a guy proclaimed to the group: “I love math!” Someone else, taking up the challenge, threw out two numbers and said, “Multiply these…”
Now, I’m not always a social person. I’m often a quiet listener and keep to myself. But I love math, too. So I couldn’t help but perk up during this exchange.
The math lover in question quickly and confidently provided an answer to the multiplication challenge, albeit, not a very good one. Those around were visually and audibly impressed, despite the fact that his answer wasn’t even close! Then it happened again. He was given another two numbers. Again he answered confidently — and incorrectly.
By the third or fourth go around, I couldn’t keep quiet any longer. He gave his answer and from behind, I provided a meek retort: “No.”
Sometimes, the simplest language is the best. From there, this guy and I engaged in a ‘math off,’ if you will. It was fun!
Confidence has caveats
Confidence is one thing that author and media personality Dave Ramsey never lacked. He’ll be the first to tell you: He’s the smartest math nerd out there.
Why, then, do I continue to correct Dave Ramsey’s fallacious mathematical follies?
His opinions about personal finance are golden to some people. But this isn’t about opinions, it’s about bad math. Bad math leads to bad advice, and bad advice hurts people. Dave Ramsey hurts people, as I’ll show you. Not with opinions, but with math.
Dave Ramsey’s skeptics assert that the media personality should do more diligent fact-finding before doling out personal finance advice. (Photo: iStock)
Recently, on the radio…
On June 7, during hour two of “The Dave Ramsey Show,” Leanne from Wichita, Kansas called in. Leanne explained that she and her husband have four kids, all age 7 or under, and live in a 900-square-foot home. They’ve got a gross household income of $160,000. They owe $61,000 on their home, which is valued at about $129,000. They’ve got an emergency fund plus an additional savings of $20,000.
Naturally, they are avid Dave Ramsey fans. Listeners can hear Leanne’s childish, ‘fan girl’ giggles during the show. (Check it out for yourself; I gave you the air date above.)
Leanne wants to know what to do with their extra savings. So she asks Dave: “Do we invest it, put it down on a new house that would be bigger, or do we put it down on our current house to pay down our loan and try to work really hard on paying off our mortgage?”
Leanne added that her husband would like to buy a foreclosure house and rent something else in the meantime. Dave’s advice? Rent for a few years. Save the money. Then pay cash for a $200,000 home. Dave apparently believes that this couple can save $60,000 or even $70,000 per year. (Not a chance, but we’ll get back to that.)
Leanne also asked whether she should ignore “the naysayers.” She said she’s been advised by family members to avoid ruining her equity. Dave gave a quick answer, and confidently oozed his opinionated misguidance.
“I don’t care what they think,” Ramsey replied. “They’re not making $160,000 a year.”
You see, in Dave’s world, the factuality of opinions increases with income. Ergo, the opinions and beliefs of the mega rich (think Madonna, Jay Z and Beyoncé, or Matt Groening) are all more valid than his, since, according to celebritynetworth.com, they all have a net worth that’s roughly 10 times that of Mr. Ramsey.
But does all that money really make their opinions 10 times better?
In a move devoid of real math, Ramsey proceeded to tell Leanne that she can pay cash for a $200,000 house in two years. His thinking: They already have $20,000 in savings. They can add that to $80,000 of equity in their current home, then save about $60,000 per year for 2 years.
Sounds simple, right? Well, I dated a girl who spent eight years in college. Apparently, you can go to school that long and NOT be a doctor.
Be careful of simple math and simple assumptions.
Ramsey’s advice to callers can lack details about taxes or insurance benefits. (Photo: iStock)
Let’s look at the numbers
I assume Ramsonites are tired of my verbal assault. So it’s time to revisit my secret weapon: Math done right.
The couple now makes $160,000 annually. But Leanne tells us her husband was laid off for three months a year ago. Prior to that, they were making the same income for approximately three years. Since the three months of unemployment, they’ve recouped their savings, replenished their emergency fund, and managed to save an additional $20,000. Dave praised them, and thanked them for living the way they do.
It is fun to live without logic. But is it healthy?
It’s easy to figure out how little this young couple spends, or maybe more accurately, how much they spend. First, let’s assume their employers don’t match 401(k) contributions or simply doesn’t offer one. In such a case, avid Ramsey followers tend to invest the max amount in Roth IRAs ($5,500 each).
Dave believes Roth IRAs are a million-dollar idea. He’s told people to convert enough IRA money into a Roth IRA in one year, despite the enormous tax consequences it can create.
But they’re not following that advice
How do I know? I’ll tell you my dear Watson! Deduction.
If they were saving in a non-qualified account, then Leanne would’ve asked if they should or could use these funds.
Am I really sure they aren’t funding this kind of account? Technically, no. Because, as I often write, Dave Ramsey does not hold a securities license, does not hold an insurance license, and continually shows he does not understand math, taxes, or investing. He never asked for their total net worth or investments. Must be nice not to be regulated. Ramsey World really does seem magical!
Assume for a minute that I’m correct, and they’re not saving in these accounts. Taxrate.org estimates that our couple has to pay about $32,000 per year in taxes. If they also have $8,000 in other withholdings, then they’ve got $120,000 net. In other words, they’ve got $10,000 per month in take-home pay. They’ve replenished the emergency fund (to the tune of $30,000) and they saved their additional $20,000.
So they must save $50,000 per year then, right? Wrong!
People tend to spend differently when they’re out of work. (Photo: iStock)
Unemployment skews spending
Most people who are laid off do not spend the same way they did while employed. With this particular couple, their mortgage is tiny, and they have no debt. So spending goes way down.
During that period of joblessness, the husband presumably qualified for unemployment benefits, which are about $350 per week or $1,400 per month. Let’s assume spending was cut in half for those three months. And the savings withdrawal was lessened by unemployment benefits. The result would be a monthly deficit of only $3,600 for a whopping $10,800 total. Therefore, over the last year, our young couple that makes $160,000 a year, actually only saved $30,000.
How else did I deduce that they’re not the timid spenders that Dave Ramsey proclaims them to be? Easy. According to Leanne, they also made $160,000 for three years prior to her husband’s layoff. Sure, they had a 3-month stumble. But they make a nice household income. If they bought their house for, say, $110,000, and have paid it down to $60,000, that represents $50,000 of savings. Add this to the $50,000 of emergency money and boom! They’ve managed to save $100,000 over 4 years of making $160,000.
That adds up to a little less than $30,000 per year, not the $60,000 a year that Ramsey presumed they could save.
You might say: Mike, maybe they were paying down debts? Oh how silly of me. Maybe. But consider this: It may not matter. Here’s why:
- Given that all of their kids are 7 and younger, the amount saved by paying off liabilities and reducing their monthly outflows is probably offset by the increase to family size, and;
- We did the math using last year’s income. The math is the math, and they only saved about $30,000 per year.
Plus, I assumed their house has had very little appreciation, and that the savings for the down payment was created during this same 4-year time span. If it was saved prior to the four year period, then the amount actually saved annually is further reduced.
This is what we call a contingency. I’ve built contingencies into our assumptions (since we’re assuming). But wait: Why do we have to assume again? Oh right: Because of the lack of thorough fact-finding by Dave Ramsey.
Increasingly, employers and advisors are recognizing the link between physical and financial health. (Photo: iStock)
Of course, Ramsey always says that if he’s half right, you’re still OK. But he’s not even half right! It’s fun to be confident, but it doesn’t make you right.
Dave Ramsey misses a lot. Let’s check out another disastrously misguided assumption of his.
During the June 9 show, a guy called in asking if he should take money out of his retirement account to pay off his fiancée’s debt. Dave instructed him to never pay off anyone’s debt until you’re married. Dave got that one right.
Then, Dave said, as a rule of thumb, you should never take money out of a retirement account to pay off debts unless this will enable you to avoid bankruptcy or foreclosure. What Dave still doesn’t realize is that retirement accounts are protected against both. He apparently believes that we should live a debt-free, cash-only life. A life where a credit score means nothing. Dave himself proclaims he has no credit score, as inaccurate as that may be. So if your credit suffers for a few years, who cares?
Dave asked his caller about his household income. The caller said that he makes $36,000 and his soon to be wife makes about $25,000. Dave’s advice: Don’t take out the money, even when you’re married, because “you guys are in the 25 percent tax bracket.”
Maybe Dave meant the caller is in the 25 percent federal tax bracket? Let’s see. The 2016 25 percent federal tax bracket starts at $37,651 of taxable income. But the caller didn’t provide taxable income, he provided gross income.
I wonder if Dave Ramsey knows there’s a difference.
The caller’s gross income is reduced by, and let’s only use standard here, a personal exemption and deduction. This is a bit greater than $10,000. Thus, at worst, the caller’s individual taxable income, rather than his gross income, is $26,000
In other words, he’s well within the 15 percent tax bracket — not the 25 percent tax bracket. As a married couple, the taxable income needed to reach the 25 percent increases to $75,301. In other words, this is more than their gross income of maybe $61,000.
If Dave Ramsey can be so very wrong about a simple tax question, what else is he wrong about?
If Dave Ramsey, a self-proclaimed financial expert, can make the rookie mistake of superficial fact finding that’s void of material information needed to make a proper recommendation, then what other rookie mistakes might he be making?
If finances are arguably as important as health, then why on earth would anyone take advice from someone not licensed, or from someone licensed 20-plus years ago — and even then only licensed for a few years at most?
Wait, I guess now I’m asking for an opinion. So let’s go back to the math. The math was bad, and so was Dave’s advice to these callers.