Dave Ramsey Is Wrong: Part 1

Tonight was the last night of Financial Peace University for my wife and I.  If you aren't familiar with FPU, it's a class by Dave Ramsey, usually hosted by a church.  Rather than misstate what they do, I'll quote his mission statement directly from his website.  "Ramsey Solutions provides biblically based, common-sense education and empowerment that give HOPE to everyone in every walk of life."  That's a pretty good mission statement.  I admit, they do it very well.  He's even better as a marketer, especially when it comes to knowing his target market and tailoring his message accordingly.  I've learned much more watching his marketing than I have from the content of the class.   I recommend taking it, even you are pretty knowledgeable regarding finances.  The lessons are more about changing behavior rather than financial knowledge.  Behavior trumps knowledge every time.

So why did I put "Dave Ramsey is wrong" at the top of this post?  Partly because it will evoke an emotional response from a lot of people who read it.  But mainly because as much is I like his stance on a lot of things (we both are big fans of HSA's and Roth IRA's, for example), he is wrong, contradicts himself, oversimplifies and/or uses too many absolutes on several topics.  Which is why this post is only "Part 1".

Since life insurance is my favorite financial product, I'm starting there.  From page 167 of Dave Ramsey's Complete Gude to Money  ( book of less than 400 pages is a "complete guide to money"?) under the heading,  "How Much Coverage?"
"You need to get coverage equal to ten times your income.  So if you're working and making $40,000 a year, you need $400,000  The ten-times rule of thumb is not an arbitrary number.  Remember, life insurance is designed to replace your income.  If your surviving spouse invests that $400,000 in good mutual funds at an average 10-12 percent return, he or she could peel off $40,000 a year from that investment to replace your income without ever cutting into the principal."

Sounds great, doesn't it?  It's easy to do the math.  10 x $40,000= $400,000.  $400,000 x 10% plus $400,000 principal = $440,000 minus $40,000= $400,000  It very much reminds me of listening to a politician.  We all stand up and cheer, and feel good.  Unless we start thinking too much and see the holes.  There are a lot of them.

• Where does the income come from for the first year?  Unless you wait to take income until the mutual funds have earnings, you cut into the principal right at the beginning, so it's not $400,000 that is doing the earning.  Your initial principal for the investment is $400,000 minus whatever you used to cover funeral expenses and all the other additional things that came up due to the death
• Dave Ramsey himself says in the same book on page 212, "Mutual funds make excellent long-term investments, but don't bother with them unless you can leave that money alone for at least five years.  This where you park your money for the long haul, looking toward retirement".  So what you're saying, Mr. Ramsey, is that if I die tonight then my widow should put my life insurance proceeds into a retirement investment and leave it there for at least five years?  And during that five years the bill fairy will come and wave her magic wand and all the bills will be paid and my kids will have their college tuition covered?
• Page 211 says, "The average annual return from 1926, the year of the S&P's inception, through 2010 is 11.84 percent.  Just keep in mind that's the eighty-year average..  Sure, within that time frame there are up years and some down years."   Between now and 1970 there have been 9 years that the S&P has been down for the year, with the worst year (2008) down 37%.  I wouldn't be comfortable betting my family's future on something that had approximately a 1 in 5 chance of dropping in value the same year I died.  I don't call that "Financial Peace".
• If I am a good, ambitious person, I should expect to be making more money in the future than I am now, and a lot of the plans for my family expect that too.  It doesn't give me financial peace thinking that if I died tonight then my family's income (assuming that I follow his plan and that the proceeds consistently earn 10% year after year in mutual funds, even though that has never happened) would never increase, that it would be locked at the same level it was on the day I died.

I could keep going, but going on and on about it isn't necessary.  If you haven't figured out by now that you should consider more than just "10 times your current salary" to calculate the right amount of life insurance, then you probably won't ever get it.  There are a lot of  other ways, often just as simple to calculate.  Listing them all here would be more confusing than helpful, since without knowing the particulars of your personal situation, no one can tell you what the best calculation method would be.  A good professional would get to know you in a way you are unlikely to get doing a web search or something like that.

 Anyway, I do need to go to sleep so I don't put my family in a position of using my life insurance proceeds to provide their financial peace.  One time of driving sleep-deprived  was more than enough.  (And I also recommend Dave Ramsey's book, More Than Enough--pun intended).