Dave Ramsey is a famous financial guru, author, and podcast host with an enormous following.
His basic tenets include living 100% debt-free, maintaining a healthy emergency fund, living below your means, and investing in index funds.
The basics of his advice are sound, but he has many critics who fervently believe that he really misses the mark with his investment advice.
Here are a few of the marks he might be missing.
1. He Misses The Power Of Leverage.
Mr. Ramsey tells people to pay off their mortgages and live debt-free, but this causes people to miss out on the power of leverage. If someone puts down 20% on a $1 million home instead of paying cash for a $200,000 home in a market that is appreciating at 5% per year, the person with the $1 million home will be far wealthier in 20 years.
The $200,000 home will be worth $531,000 in 20 years, while the $1 million home will be worth $2.653 million. The person who bought the $1 million home will have accumulated $1.653 million in equity, while the person who bought the $200,000 home will have only accumulated $331,000 in equity. And yes, I know the person with the $1 million home will have paid over $900,000 in interest with a 7% rate. BUT much of that interest is tax deductible, and even with the interest, Mr. Million Dollar Home will still be better off. If his interest rate is even lower (likely), he will even better off.
Homebuyers still need to follow Mr. Ramsey’s tenets and avoid increasing their mortgage with cash out. But, if they do, they will be far better off with larger, leveraged homes after 30+ years.
I have personally watched this play out with close friends who bought homes in the 1980s and continually moved up in size – with maximum leverage – only to end up retiring with millions in equity in their homes.
If they had followed Mr. Ramsey’s advice, they would be millions of dollars LESS wealthy.
2. He Says Standard Deductions Make Tax Deductions Associated With Real Estate Irrelevant.
The standard tax deduction is very large now at $29,200. So, if a person’s other tax deductions for mortgage interest, property taxes, state taxes, charitable giving, a home office, etc. are less than $29,200, he should take the standard deduction instead. But, most of our clients buying real estate today have deductions in excess of $29,200.
The million-dollar homebuyer above, for example, would have $56,000 of interest to deduct plus property taxes and whatever other deductions may be available to him. Ramsey does not fully account for the amount of deductions available to taxpayers once they start itemizing.
3. He Ignores Currency Debasement.
Our wonderful politicians will likely continue to spend far more than they take in with tax revenues – knowing full well that the plan is to continue to “print” money to pay off that debt. This is otherwise known as currency debasement – and one of the best hedges against that currency debasement (inflation) is owning hard assets like real estate.
Owning more house (via leverage) rather than less house is beneficial in a few ways. First, homeowners will be that much better hedged with a larger home.
And second, their mortgage will become cheaper and cheaper to pay off as dollars become worth less and less. I’ve blogged about this a few times: Inflation Makes Your Mortgage An Asset; Don’t Prepay It!
4. Ramsey Loves Index Funds Too Much.
We have had a forty-plus-year run in stocks with a market that has been very bullish overall – largely as a result of continually falling interest rates. Mr. Ramsey cites that data as if it will go on forever, conveniently ignoring the 1970s when stocks did very poorly, and ignoring the period from 1929 through the early 1950s when stocks were pretty much flat overall. In addition, analysts like Mike Green like to remind us that when too much of the market relies on index investing, the computerized trading that drives stocks way up can also drive them way down.
The point is that Mr. Ramsey might want to encourage a bit more diversifying.
