Numbers fascinate me. Patterns and coincidence puzzle me. The other day I was in a meeting, sitting across from one of those leg-crossing men. I sat there, captivated not by the conversation but by the way he’d flick his left foot towards the ceiling no more than three times before lifting the heel of his right foot, allowing his right knee to act as the fulcrum for his bobbing left foot. I was able to predict with near certainty when he’d lift his foot to break the sequence. This was all done in my head, of course, as I suspect no one knew I was terribly bored and annoyed. Was he purposely doing this, or was the behavior so natural he was unaware of the predictability of his actions?

We are all creatures of habit, but bad habits can be harmful. Dave Ramsey has a bad habit of giving harmful advice to any caller who asks about cash value life insurance or more conservative investments.

On July 10th, 2015, the host of «The Dave Ramsey Show» gives very bad advice to two separate callers regarding separate issues. Dave causes thousands of dollars of harm to one caller by suggesting she cash out a cash value life insurance policy; with the other caller, he reveals his lack of understanding of bonds by suggesting a money market account to be superior. Like the leg-crossing man, Dave is a creature of habit. He gives cancerous advice over and over again.

Today we’ll disprove Dave’s recommendation that a couple cancel their cash value life insurance policy with math, fact, and a bit of sarcasm — uh, I mean wit.

The circumstances

Here’s what Dave says to the caller who owns the cash value policy — a universal life (UL) policy issued by Mutual of Omaha (MOO), to be more specific: «Yes, I would cancel this garbage,» said Dave, «[It’s] one of the worst products I’ve ever heard of … you got burned; you got fried.»

The caller, a 50-year-old women, had just finished describing how she and her 55-year-old husband had eight years ago purchased a 20-year UL policy, which had a return of premium rider (ROP) at maturity. She questioned if this was a good idea, since they aren’t good savers and this would act as a forced savings plan. It doesn’t appear they thought this was a bad choice prior to becoming Ramsey followers.  They had now paid $26,400 into the policy. If they continued to pay $3,300 for the next 12 years, they’d pay a total of $66,000 into the policy, but would be refunded $66,000. In other words, pay another $39,600 over 12 years to get a payment of $66,000. This is the contractual guarantee of the insurance policy based on the claims-paying ability of the insurer, not a hypothetical value based on aggressive assumptions that are likely to be overly allocated into particular market segments due to overlap.

Now, let’s discuss how much they can receive to cash out the policy right now. It’s just about enough to go buy a rusted-out van without windows: $2,400 according to our caller (for the insurance product, not the van).

Fifteen minutes into the meeting with the leg-crossing man, he stopped. Excitedly I watched — remember, I was quite bored — as he switched from his left foot to his right foot. His pattern changed. He went up to five foot flicks before doing a heal raise. Are you serious?! You can’t change the pattern. Yet he did.

Dave, with his southern roots of stubbornness, has never shown a propensity to change. But this time, July 10th, 2015, I actually thought Dave was about to do just that. He talked with the caller and seemed to be crunching the numbers with his imaginary financial calculator. (I assume he doesn’t own a financial calculator, given his consistently bad math and cynical criticism of those who «punch numbers.») I thought, Dave’s going to go against his heart. He is going to do what he instructs his callers to do. He will use his head and tell her to keep the MOO policy. But, as the famous saying goes, «When all you have is a hammer, then everything you see is a nail.» And Dave hammered the screw into the wood until it bent over and wouldn’t go in any further.

Dave tells the caller to cancel this thing out, to invest the $3,300 into «good» growth mutual funds and to do so in a Roth IRA. Dave gave advice he’s not licensed to give when he suggested the caller replace, finance or terminate an existing life insurance policy and instead invest those premiums into securities. Given the regular and consistent recommendation to implement his advice through one of his endorsed local providers (who, as discussed in an earlier column, pay a fee to Dave for these referrals), regulators must not continue to allow such devastatingly incorrect dribble to be broadcast without consequence.

The math

Enough with the verbal argument; it’s time for the … dun dun dun … math. You knew I’d eventually pull out my nerd machine. OK, here we go. The first set of math is easy: Continue to pay $3,300 for an additional 12 years and get $66,000 back, with no risk other than the (very unlikely) financial default of one of the oldest and largest insurers in our industry.

The next set of math takes a bit more work. Right now, the couple pays the premiums annually by using their tax return refund. Dave says to adjust their withholding to eliminate the refund. Then, he recommends that they set up an auto draft to invest each month. Take the $2,400 cash value and invest that, too. If you want to follow along with me using your HP 10bII+, then here are your inputs:

$2,400 PV (present value), 1% I (interest), 144 N (number of periods; 12 years times 12 months per year).

Using the one percent interest per term input given above, we get a hypothetical return greater than Dave’s famously inaccurate, inept, cancerous 12 percent assumption, since ours is NOT an average annual rate. Input $275 under PMT (payment), and you get ninety three thousand.

But, wait a minute … bad math equals bad advice. Our couple won’t have $275 to invest, oh no. There are several deductions we need to make before arriving at our investable number. First, our couple will be without life insurance. Dave and I BOTH believe in the value of life insurance. Dave counsels his followers to purchase life insurance at a value of 10x income, or, in the case of a stay-at-home parent, $400,000. (I use “counsels,” since, not being licensed, he is careful to avoid using the word “advise.”) Not knowing what our couple makes, since Dave did not ask, I used Dave’s $400,000 number. (For your consideration, you should also know he did not ask how much debt they have, nor how much they have for emergency savings.)

Anyway, back to the rabbit hole. We need to know how much to deduct from the $275 of monthly premium. Where could I find a reliable quote from a company Dave trusts? Ha! I went to Zander insurance agency, «the only company,» Dave trusts. I used their simple and consumer-friendly online calculator. (Seriously, it was an easy process; I give kudos where kudos are due.) Lastly, in an effort to give Dave’s bad advice every advantage, I assumed our mid-50s couple would qualify for the absolute best non-smoker health rating, even though I’m not sure what kind of health they’re in. Do you know why I don’t know what kind of health they are in? Because the popular radio show host was more concerned with bashing a reputable company and a particular type of product than he was with getting the facts.

Now, imagine my surprise when I saw the company who had the lowest rate among the quotes provided by Zander. It was comical to see our friends in the wild kingdom, United of Omaha, perched at the top of the winner’s circle. (For readers who are not insurance people, United of Omaha is part of Mutual of Omaha.) The rates for a 10-year term policy were $31.72 and $64.62 per month. So, rather than having $275 to invest per month, our couple only has $178.66 to invest per month.

Now that we have our input for PMT, we can solve for FV (future value). Hit the button and we get sixty seven thousa … dang it, I forgot another detail. Dave recommends the use of front-end load (this means commission) mutual funds. He recommends you do this over four fund types: growth, growth and income, aggressive growth and international. Amazingly, this isn’t seen as advice, since it’s not specific to the particular fund.

I want to get back to the math but we need to first take a little field trip. Don’t worry this will be f-u-n, fun.

Dave often says that if we flip a question so that we use our brain and not our hearts, then the answer will become clear. For example, he’ll ask someone who wants to invest $10,000 rather than use it to pay off $5,000 of interest-free credit card debt whether they would still think it was a good idea if we flipped the question around. Meaning would they, with no debt, take out $5,000 on a no-interest card to invest in the market. Everyone says, of course not. Dave smiles and tallies up another victory on his wall of glory. So let’s do the same, shall we?

Imagine if Bernie Madoff, who’s clearly barred from the securities world — as well as the free world, for that matter — were to develop a newsletter from his posh 8×8 Italian brick cell. Bernie’s newsletter preached how to make sure you’re not investing in a Ponzi scheme. Next, imagine that after enough positive public brand equity, Bernie were to create a system in which he could make money by referring his followers somewhere. I’m not too creative, so why don’t we just say he calls it Bernie’s Accredited Representative of Finance (BARF for short). Like Dave’s followers do with ELPs, Bernie’s followers could meet with a BARF advisor to invest in financial products. Our BARF founder would be paid a fee for each referral.

I’m not saying ELPs are anything but wonderful. I am saying that Dave is giving advice he’s not licensed to give, and that he should be held accountable. Currently Dave says whatever he wants. Since he’s not providing financial or insurance advice, he’s not under regulatory authority. And here’s where it gets fun. Would you say the same thing about Bernie’s BARFs? Would you agree that it’s not Bernie giving the advice, it’s his BARFers that are giving it? Our brains tell us this wouldn’t be right, and that regulators should step in to prevent such … what is the phrase I’m looking for … ah! … such parasitic, cancerous advice from being given.

Yes, more math

Here’s the last round of math. Brace yourself.

Our couple doesn’t have $275 per month to invest, nor $178.66. After deducting 5.75 percent for commissions, they only have $168.39 to spend. Solve for future value and we get $64,631. Are you kidding me? Dave «counseled» our couple, without knowing how much they have saved, without knowing their health, without knowing how much debt they have and without knowing their income to give up a guaranteed amount of $66,000 with no risk other than the default of MOO. He said to instead invest those dollars into an allocation of securities, which has a large potential for over-concentration into particular market segments and which is arguably more risky than the contractual minimum obligation of the «horrid» UL policy. Moreover, even at a compounded annual growth rate that exceeds the inexcusably deceitful, overly optimistic number he undoubtedly uses himself, this investment comes $1,369 shy of what our couple could’ve had, had they only not taken a bite of the forbidden fruit. In the words of my friend Jim Carey when playing Ace Ventura, «lah-who’a-zer.» (By the way, I’m not actually friends with Jim, but I would certainly consider accepting a friend request from him on Facebook.)

You might remember that I had planned on discussing how Dave gave equally bad advice to another caller on the very same show. But we are out of space; I already get yelled at over my word counts. We’ll circle back to that tragedy next month. Besides I need to keep some content in reserve for future columns … er … who am I kidding? As long as Dave keeps being a creature of habit, I’ll never run out of inaccurate advice void of proper mathematical footing.

As always, thanks for walking down this path with me. If you see something you’d like us to address from American’s “Favorite” finance coach, please email my editor at [email protected].

It’s absolutely, unequivocally, undeniably, inexplicably clear Dave Ramsey does NOT believe in permanent insurance. He believes there’s no need for life insurance when you have no mortgage, no debts, and have saved hundreds of thousands of dollars earning 12 percent “average” annual returns.

Dave tells his followers to be intentional with their money. Is it possible Dave is intentional with his wordings? Is it possible Dave himself would’ve been better off owning permanent insurance rather than term? Is it possible Dave is wrong about 12 percent annual returns (which is another primary reason he advises term)? Is it possible there’s a perpetual need for permanent insurance for some people, and that permanent insurance provides increased liquidity and spending capability in retirement?

The math proves yes.

Permanent vs. term: A mathematical analysis

A while back I stumbled upon an episode of Dave’s TV show in which he read an email from a listener named Tyler that posed the following question: How can you advise term insurance when it expires just when people need it the most? In response, Dave tried to insult Tyler, saying he sounded like a true life insurance salesman. Dave goes on to explain that he recommends term because when it expires his followers will have no debt, no house payment and hundreds of thousands in savings.

As the rant continues, Dave accidentally reveals one reason why permanent insurance can be better.  It’s not about the level premiums or the internal rates of return or estate taxes or income replacement as my compadres (as one reader referred to us last month) have vehemently argued in the past. It’s about security. Insurance equals security, and the security of death benefit proceeds doesn’t completely or necessarily evaporate with the elimination of debt and/or creation of wealth.

Dave has said, and I quote: “I’m 47 years old and still carry a few million in term insurance because SWI.”  He gets this southern boy grin and explains, “SWI is because Sharon wants it.” (Sharon is Dave’s wife.) He goes on to say that it’s more important to have the coverage than it is to put something new on her finger.

Now, this is where we get to have some fun.

Let’s look at the math between permanent and term for a hypothetical 40-year-old. We need a name for our mystery man. Let’s call him Dave, shall we? We’ll compare Dave buying a 20-year term policy at ages 40 and 60 versus buying a guaranteed universal life policy (GUL) at age 40. With the term scenario, we’ll assume he invests the saved premium into the market. We’ll break down the comparison with the following gross rates of return rate: 6, 8, 10, and 12. We’ll factor 1 percent for annual expenses and front end sales charges of 5.75 percent. Lastly, we’ll review if being half wrong on the rate of return equals out to half the value. (Your guess is as good as mine, unless of course you’re guessing yes … then your guess is half as good as mine.)

I ran the rates through a life insurance quote engine and took the median price for each age bracket, assuming the best underwriting health class. Keep in mind that I’m giving a huge advantage to term here, since it’s more likely for a 40-year-old to qualify for best class underwriting and less likely for a 60-year-old, which is the attained age for the second term scenario.

Using today’s rates, our 40-year-old Dave can get a $2M-death-benefit, 20-year term policy for around $1,345 per year. The 60-year-old Dave could purchase the same policy for $9,830. In comparison, our 40-year-old Dave could purchase a GUL for $10,170.

This means the 40-year-old term-buyer can invest $8,317 after sales charges into four different Class A “good growth” mutual funds. (Remember I’m only referring to our hypothetical Dave, not the real Dave. Use the math as illustrative and inspiration to do the math. Side note: One thing the real Dave and I agree on: Being intentional with our wordings is impactful.)

The 60-year-old Dave only has about $320 of saved premiums to invest per year.

I’ve also assumed that once every 10 years we’ll want to completely rebalance the gains in the portfolio. This would create capital gains and additional sales charges. In other words, we have a portfolio turnover rate of once every 20–30 years, since we’re only rebalancing or reallocating the gains.

Here’s how the chart looks for each at 10, 20, 30 and 40 years.

Dave yells at financial people like myself for hurting people with our “theories” and lack of real world experience helping people.  He jokes about how we grab for our HP calculators. Well, my HP calculator proves his math wrong. Even at a gross 10 percent compounded annual growth rate (CAGR) you have nearly $600k less than the death benefit of the life insurance in 40 years.

Who wants 10 percent when they can get 12 percent? The 12 percent Dave uses is an average rate, not a CAGR (see Stoffel vs Ramsey). Ten percent CAGR for the S&P 500 is more mathematically valid than 12 percent. Remember that stock price reflects growth, which is partly a byproduct of inflation. The currently higher CAGR includes higher inflationary periods, which, during lower inflationary periods like we’re in now, equates to lower CAGR. Hence, the long term 12 percent math is flawed. Warren Buffett expects CAGR to be closer to 7 percent due to the lower inflationary period we’re currently in.

Dave’s math is further flawed given two things:

First, the majority of the savings between term and GUL is during the first 20 years, not the second.   Thus, a lower CAGR during this period would greatly reduce the outcome.

Second, the death benefit of the life insurance is guaranteed. It’s not hypothetical. It’s a risk-free $2M benefit (oh, and tax-free,too … the numbers above don’t account for any estate taxes). Now, what would the risk adjusted return of the S&P 500 be? I’ve seen that number to be less than 5 percent. In fact, one of our readers who is an actuarial statistician wrote to me personally and showed how he got 4.91 percent. (Thank you, Anthony!)

Side note: Ever wonder why at 12 percent returns anyone would pay off a mortgage? One reader last month sent in an audio clip where a millionaire asked why he should pay off his 4 percent fixed interest rate mortgage. In summation, Dave said the 12 percent has risk and being debt free changes your mindset. (Thanks for the clip, William!) Shouldn’t this be the same argument with permanent life insurance?  The death benefit is guaranteed, whereas the discipline to save the additional premiums, the rate of growth and the number of years to grow are not guaranteed. Hence, the additional risk outweighs the possible additional benefit.

Those who practice personal finance and make plans for an individual’s specific situation are held accountable to the mathematical results. We use calculators to examine the results. In the Total Money Makeover, on TV, and on the radio, Dave often proclaims that even if he’s half wrong, he has still helped his followers. Just like term insurance isn’t better 100 percent of the time, this conclusion isn’t 100 percent correct. It’s nowhere close, in fact. If the math is half wrong, if 12 percent gross is actually 6 percent gross — which is 5 percent net after the 1 percent fee — then the person who followed this advice would’ve bought term, invested the difference, and been left with $1.4M LESS than the $2M death benefit in 40 YEARS.

Let that sink in for a minute.

The cost of security

The real Dave Ramsey owned term insurance at age 47, and showed no regrets about owning it, nor any indication his term insurance ownership years were coming to an end. If the real Dave had bought permanent insurance at age 40 right now, he would be better off at age 54. He would be better off through his early 80s, even at a 10 percent gross rate of return. He would be better off not because of the internal rates of return, but because of his family’s desire for security. See, we make the mistake of believing that at $1M of liquid savings we’ll be secure. When $1M is your new normal, then $1M is where you feel secure. Then it’s $2M, then it’s $4M, and so on. Once you have what you’ve got, you don’t feel comfortable going backwards. Losing your spouse financially means the reduction of income, whether by the elimination of wages, pensions, or Social Security. Life insurance provides security against this.

Now some of you may argue the GUL premiums don’t cease at age 80, whereas if we see a 10 percent gross CAGR then the saved insurance premiums plus interest have matched the desired security blanket somewhere past age 80. You’re right; you pay the GUL premiums until you pass. This may be prior to reaching 80, or it may be later. But I think this was a fair comparison. If you want to squibble about it, then let’s squibble over the rate of return, as well. Anyway, to prevent future squibbling I ran a 10 pay GUL policy starting at age 40 and paid up at 50. (And don’t yell at me about “squibble” not being a word.  It’s not. I made it up. I took a page out of Mr. Ramsey’s book: see investing advisor.)

We accounted for the cost of term insurance during the different age bands based on the rates assumed earlier. The first table below shows term insurance ending at age 60; the second shows it ending at age 80.

Term ending at age 60

Term ending at age 80

Again, the glaring point here is that being half wrong on the rate of return doesn’t equate to the outcome being half as much! This is why we use calculators and not blank statements or simplistic math that isn’t valid. (Thanks, HP calculator.) Furthermore, if you argue the first chart is more accurate since if you save the money you’ll no longer “need” the insurance, remember the mathematical need is not the same as the behavioral reality to maintain the additional security. Lastly, the ending amounts do not account for estate taxes, which certainly do change from time to time and would make the tax-free benefit of life insurance more attractive.

Building an estate with life insurance

I noted earlier that life insurance can be used to create an estate. It doesn’t sound like a radical assertion, I know, but it goes against what Dave says.

On July 14^th, 2014 a reader asked Dave if his 71-year-old mother should continue a universal life insurance policy she purchased to leave an estate, or if there was a better investment alternative.  Dave answered this: “…You don’t use life insurance to leave an estate. It’s a bad idea. You leave an estate by saving and investing. The only people who will tell you to use a life insurance policy to leave an estate are life insurance salesmen.”

Wrong! Just plain wrong. Many individuals benefit from using life insurance in an estate. Let’s call our 71-year-old woman Betty. Like many of her generation, Betty has plenty of income from Social Security and pensions, but has relatively lower invested assets. At this point she’d like to make sure she leaves an estate. How would this be a bad thing? Earlier I mentioned the show where a caller asked why he should pay off his mortgage, since earning 12 percent growth is much better than 4 percent paid in interest.  Dave replied that if your house was paid off and you were told to take out a mortgage and invest the proceeds, you’d think that was nuts. What he meant was that the security of having one’s house paid is greater than the potential additional interest made through leveraging. As our examples illustrated, the security of a known amount is better than the potential interest made through leveraging one’s need or desire for death benefit proceeds with volatile 100 percent stock investments made over the course of many years.

Here’s a shortened version of Dave’s response to Betty’s investment dilemma: “It would probably take about 13 years for the money to turn into $250,000. Assuming she’s healthy, I’d rather do that and bet on her living. That way, she can leave an estate and avoid the expense and rip-off part of the universal life policy.”

Interestingly enough, my HP calculator found that Dave’s right: It would only take 13.75 years to accumulate $250,000 if I input a 12 percent CAGR. But Dave has stated he understands the difference between compounded and average. He has also stated that he uses the 12 percent “average” rate to inspire and illustrate the power of compounding interest (once again see Stofell vs Ramsey). Yet when we do the math here, he’s using his standard go-to number of 12 percent, but in CAGR function not averaging. (There are plenty of examples online which will show how the math differs. Just use Google.)

Here’s the problem. First, when you use different growth methods at different times and don’t differentiate, it becomes very hard for people to know what you mean. Second, the average life expectancy for a 71-year-old female is 15 years (15.6 years, to be precise). So, what if Dave is half wrong? What if she earns only 6 percent before fees? Then it takes a bit over 20 years. If we account for the same tax and rebalancing as earlier, then it’s nearly 24 years. Furthermore, this assumption puts a portfolio which exceeds the average risk tolerance for most 71-year-old individuals. Therefore, even if the math is correct, it’s improbable that our Betty will maintain this course during adverse periods.

Think of it this way: When Betty first starts putting money away, she can be riskier with these funds. As the balance accumulates and her life expectancy decreases, it’s reasonable to conclude she’d want to scale back on risk. It is one thing to experience a downturn after year three or four, when there’s only twenty to thirty thousand dollars at stake, but when the number is bigger — say a hundred thousand or so — then a sizable downturn has a greater impact, especially when you consider her life expectancy has decreased. Will she live long enough for the benefit to come back? Will she continue to save and invest during this period?

The importance of income replacement 

Lastly, let’s look at income replacement. Let’s talk Social Security for a moment. A few years ago we started to notice a trend. I noticed that married spouses rarely pass away in the same year. Mind-blowing information there, I know! When the first spouse passes, the surviving spouse (assuming they don’t remarry) is taxed as a single individual the following calendar year. The surviving spouse also loses the smaller of the two Social Security benefits and possibly some pension income, but let’s ignore that.

Here’s an example: Let’s say that Bob and Mary get $3,000 per month from Social Security combined. Bob gets $1,800 and Mary gets $1,200.They take out $1500 per month from their IRAs to supplement their income. They have no debts. They just like to live life, travel some, and help out the kids or grandkids where they can. In short, they’re a normal couple. Approximately $500 of their Social Security benefits are taxed. No big deal. Their adjusted gross income is $18,500 and standard deductions should wipe out all of their federal income tax liability.

Bob dies. And here’s the trend we’ve noticed. Spending doesn’t drastically change. Mary still wants to do the things she did while they were together.  She still wants to give or help out the kids, do a little traveling, and live life. There are a few bills that are eliminated from Bob’s death, say a Medicare Part B premium, a car insurance, a supplemental insurance, and a cell phone bill. But overall, two do not spend much more than one. After Bob’s death, bottom line expenses change by less than $500 per month.  Mary’s new Social Security benefit is only $1,800, and her monthly income need has gone from $4,500 down to $4,000.

What to do? We’ve noticed many who were taking $2,200 from the IRAs continue to do what they were doing before. The $2,200 per month distribution was $700 per month more than before, or $9,400 more annually. At the end of the year, Mary would owe a little more than $4,500 of tax she didn’t owe before.  This wasn’t to increase her lifestyle; it was just to maintain it. If we deducted this as a monthly amount, she’d be short about $400 per month. If she wanted to make that up, she’d have to increase her withdrawals by another $5,500 per year. So, while as a married couple Mary and Bob were fine, as a surviving spouse, Mary must increase her distributions by about $14,000 per year. Not to mention, without any life insurance, their estate saw a negative cash flow of about $30k for burial and income for the 12 months +/- depending on funeral costs and depending on the month Bob passed. In this example, $20k-50k of permanent insurance would be beneficial to some and unnecessary for others depending on the other details regarding their personal situation.

How life insurance can increase spending capacity

I noted earlier that permanent life insurance can increase the spending capacity for retirees. I’ll give you a simple scenario. I met a woman whose husband had passed. He left her with $400,000. Together they had a goal of leaving $50,000 to each of their five children. To accomplish this goal without life insurance, she would need to purchase standalone LTCI insurance to protect against future healthcare costs, and could only base spending on the $150,000 of net assets. She would need to continue to work to make sure this would happen. The solution offered by life insurance is much more attractive: All she needed to do was purchase permanent life insurance. Make it a single pay and then make an irrevocable life insurance trust the owner. This eliminates the need for LTCI insurance, frees up more cash flow and leaves her with over $300,000 to spend as she sees fit, while still accomplishing their goal of leaving $50,000 to each child. The freed-up premiums would have increased her cash flow and therefore freed income to spend by nearly $400 per month, and now she had two times the amount of assets to draw an income from. Permanent insurance can increase one’s spending capacity if used in the correct form for the correct situation.

Dave Ramsey is an intelligent person. He understands the difference between compounded annualized growth rates and annual averages, but chooses to ignore the mathematical impact since the wonder of compounding interest will “inspire” people to invest. He asserts that we math nerds fight over a few percentage points which are irrelevant as long as he gets people to invest. He says there’s no need for permanent insurance, that it’s garbage and a rip-off. He uses the example of a 32-year-old buying a 20-year term policy who follows the Ramsey system to illustrate why permanent life insurance is not needed. Yet poor unknowing Dave proves his very own point wrong by sharing with us that, at 47 years old, with no personal or corporate debt, no mortgage, ample savings, and ample income, he still maintains coverage past the point where his plan says it’s needed.

I’m not making this up. I’m just stating the facts. The fact is term insurance exists for a reason. It’s good and appropriate for people given particular objectives, needs and desires. The fact is permanent insurance exists for a reason. It’s good and appropriate for people given particular objectives, needs and desires.

Last month, I wrote about the Seven steps Dave Ramsey followers really need to thrive financially. I was astonished with the amount of interest and debate the piece sparked. To the many who support our voyage, thank you and I’m excited to walk with you down this path, holding America’s Favorite Finance Coach accountable for his investment advice. To the critics who believe anyone disagreeing with the guru means they haven’t read his books, listened to his show, or attended his FPU … you’re wrong, wrong, and right. I have not attended FPU nor do I intend to. I don’t need to smoke a cigarette to know they stink, cost lots of money, and are negative for my long-term health. Financial Peace University is taught by those who’ve mistakenly taken a myth for a truth.

This sort of mix-up is one that Dave is familiar with.

«I have heard it said that if you tell a lie often enough, loudly enough, and long enough, the myth will become a fact. Repetition, volume, and longevity will twist and turn a myth, or a lie, into a commonly accepted way of doing things.»

-David L. Ramsey III “The Total Money Makeover” (TTMM)

Hmm … 12 percent annualized rates of return, 8 percent safe withdrawal rates, no debt EVER, 7 percent mortgage rates used to debunk the tax benefits of mortgage interest, 100 percent stock-based mutual fund portfolios, asset allocation is a dupe, term insurance is better than permanent … I could keep going but I think you get the point.  Many of Dave’s truths are actually myths, but they’re said often enough and passionately enough that their validity is accepted without challenge.

Myth No. 1: The Ramsey brand of endorsement benefits clients and advisors.

Let’s turn our attention toward a classic Ramsey-backed idea: the endorsed local provider, or ELP. To be or not to be an ELP, that is the question.

Working with an ELP or an investing advisor (Dave’s fictitious title, not mine) is recommended in Step 4 of Dave’s seven-step plan. Please note that an investing advisor is not the same thing as an investment advisor representative (IAR). They get paid to sell you something not give you advice. But that’s not the real issue here. The real issue is I don’t think Dave actually believes in some of the core teachings he spouts with, as he puts it, “extreme confidence.”

It’s important to note up-front that Dave’s entire marketing plan points to the fact that his recommended advisors must be commission-based, rather than fee-based. Instead of going into his reasons, let’s take a look at the facts.

Fact: Investment advisors are prohibited from using endorsement. SEC Rule 206(4)-1(a)(1) of the Investment Advisers Act of 1940 determined testimonials or endorsements are a form of misleading advertising since they only share positive experiences.

Fact: The statement found on Dave’s site, “98 percent of users highly recommend using an ELP” would most likely be in violation of SEC Rule 206(4)-1(a)1.

Fact: The very term Endorsed Local Providers would also most likely violate the above rule.  I suppose you could argue he could rename them Dave’s Elite Squadron of Advisors. (Dave, if you’re reading this, feel free to use this term. No royalties needed.)

Fact: If ELPs were IARs they would have to disclose they pay a fee for the clients referred to them by the Ramsey system. 

Fact: Working in a fee-based relationship would make it nearly impossible for ELPs to take on the types of clients Dave sends their way. 

Fact: Dave states he at some point held the appropriate investment, insurance, or real-estate licensing to give advice in the applicable areas. I could not find a currently registered or previously registered IAR or FA whose full name matched or was from the Tennessee area.

OK, so, if the name is no longer ELP and we remove Dave’s endorsement (he could still use his name in the agency titling, or advertise the firm on his site and his workshops with much success, I’m sure) and we omitted that 98 percent of users highly recommend an ELP, then his team could work as fee-based advisors, right? Not quite. Even if the necessary changes were made to Dave’s marketing approach, a fee-based advisor would very likely starve by working as an ELP.

Let’s look at the math behind all of this. While it was impossible to find the exact referral fee paid to Ramsey for the endorsement, multiple Google searches revealed fees ranging from a few hundred dollars well into the thousands. For the purpose of this column, let’s settle on a referral fee of $100 dollars, which seems reasonable compared to other lead sources.

Now, here’s the math for an American household with an annual income of $48,000 (the average annual wage for U.S. households, as provided by Dave) that is looking to invest 15% of said annual income, per Dave’s Step 4.

Average American household income: $48,000.

Example of 401k Employer Match: 3%

$48,000 x 15% = $7,200

$48,000 x 3% 401k employee contribution (to max out employer match): $1,440

$7,200- $1,440 = $5,760 left to invest with ELP per year, or $480 per month.

In scenario one, let’s consider an ELP who is fee-based at 1 percent AUM.  ELPs must have the heart of a teacher, not a salesperson. So we can assume they’d meet with the client a few times prior to making any recommendations. After investing 2–3 hours (roughly 1 hour per appointment) the ELP accepts a check from our client in the amount of $480. For the purposes of our example, let’s assume the initial investment takes place at the beginning of a quarterly billing cycle. Over the cycle, there’s $1,440 invested, but only an average balance of $960. The ELP would be entitled to one quarter’s advisory fees of .25% (1% divided by 4 quarters). In other words, our ELP would make a whopping $2.40 for 3+ hours of work.

But Mike, you’ve forgot these fees add up! Why, yes, they do. One full year later the client’s balance will be $6,087. (I used the conservative, widely-agreed-upon, historical S&P 500 12 percent average rate of return.)  If billed at that amount, our ELP would make a meager $15.22 for the first quarter billing. I even rounded up.

First year total fee compensation: $37.48

Second year total fee compensation: $103.11

Total compensation, first two years combined $140.59

I know ELPs are supposed to have the heart of a teacher, but in a fee-based relationship they certainly wouldn’t be compensated as much as one. If the ELP were to meet with the client a few times at the beginning and once a year for the first two years, then our ELP would have at least 5 hours invested with them.  If we subtract $100 from the total fees paid to the advisor of $140.59 (remember, this is going to Dave for the referral), then our ELP is left with $40.59 for two years’ worth of work.

Let that sink in for a moment, then we’ll move on to scenario two.

This time, our ELP is commission-based and uses mutual funds with 5.75 percent upfront sales charges. Every month, the ELP will make $27.60. He or she will also have some ongoing compensation from the funds sold and kept. Yet just the commissions will equal $662.40 over the two-year span. Subtract the $100 referral fee and you’re left with $562.40. That’s $521.81 greater than our first scenario.

Here are a few other things to consider. Will the ELP convert every referral? Not likely. Let’s say he or she converts 70 percent of referrals. Most referral services, and presumably this one as well, charge per referral sent, not per referral captured. So, 10 referrals equals seven clients.

Here’s the fee-based total over two years:

7 x $140.59= $984.31 minus $1,000 (10 referrals at $100/ea.) = ($15.69)

Here’s the commission-based total over two years:

7 x $662.40= $4,636.80 minus $1,000 (10 referrals at $100/ea.)= $3,636.80

Our fee-based ELP is in the red after two years. This person has worked for FREE for two years! What if they got two referrals per month rather than 10 referrals over two years?  I’m not going to bore you with prorating them, let’s just use the same math as above. Two referrals leads to 16 clients (yes, 70 percent of 24 is 16.8 however you can’t have a partial person; we only count whole people here) which gives us a loss of $150.56.

How many 100-percent altruistic advisors do you expect are out there?

Myth No. 2: Invest Dave’s way, and you can expect a 12 percent annualized rate of return.

I said earlier Dave doesn’t even believe his own math. He defines long-term investing as five years or longer. He then says to pick out a “good” mutual fund. Dave says never finance a car, yet today you can finance a used car for 1–3 percent. (Dave and I agree new cars are highly depreciable and often a poor choice.)  If you can make a 12 percent average on your good ole mutual funds, then why wouldn’t you invest the $10,000 car fund and make payments? Oh, because if you play with snakes you will get bitten! But here’s the thing: We’re talking about folks who have completed Steps 1–3 and are midway through Step 4. They’ve got a robust emergency savings now and no debt. Couldn’t they afford to do this?  Haven’t they proved they have the discipline to be financially responsible?

Dave clearly doesn’t believe in the 12 percent returns fallacy. Why? Ask this question: What about a mortgage? You don’t ever want a mortgage longer than 15 years, according to the guru. What about the tax deduction CPAs tout? “I can do the math,” Dave says. Why pay $7,000 in mortgage interest (7 percent is his number, not mine) on a $100,000 mortgage to save $2,100 in taxes (he uses 30 percent).  Um … I can do math, too. One hundred thousand dollars will make 12 percent. Twelve percent interest on $100,000 is $12,000. Mortgage rates are 4 percent, not 7 percent. And let’s use the more typical federal bracket of 15 percent, since the 30 percent pertains to higher income individuals who are certainly NOT using his advice.

OK, so $12,000 in interest. We’ll assume gains are taxed as capital gains, since I can’t imagine how he’d argue for using IRA dollars to pay off the mortgage. So, here’s what we have:

$12,000 ­– $4,000 in mortgage interest paid + $600 tax deduction = $8,600 (capital gains tax should not be applicable)

That’s right: If you believe in 12 percent long-term averages, you do not pay off your mortgage early.  And you will not be bitten by snakes because you have discipline. You have proven your discipline by accumulating 3–6 months’ worth of expenses in cash savings and by paying off all of your debts, according to the earlier steps in Dave’s plan.

If all of this is true, Dave Ramsey doesn’t believe in 12 percent returns for long-term averaging and neither should anyone else.

The big picture

There are many great advisors out there.  Many of these hardworking, honest, sincere, and genuine advisors also happen to be ELPs. ELPs are not bad. Commission-based investing has its place. The collage of contradictions and inaccuracies related to Dave’s “investing advisors” and his “investment” advice are what bother me.

I’m very lucky to be walking this journey with you all. Thank you for your support.  Help me hold America’s Favorite Finance Coach accountable to his words by emailing my editor [email protected] with any thoughts or questions.  And, in the words of all of our mothers, “words hurt people; choose them wisely.”

It’s no secret that many financial professionals don’t agree with much of the advice Dave Ramsey gives. This is because his financial assumptions are often false. Yes, he’s entertaining, but truly helpful … not always.

About a year and a half ago, Ramsey used Twitter to lash out at several financial professionals who had been chastising his investing advice. He tweeted:

“@ScottTruhlar @BasonAsset @behaviorgap @CarolynMcC// I help more people in 10 min. than all of you combined in your ENTIRE lives #stophating

— Dave Ramsey (@DaveRamsey) June 1, 2013

These comments strike me to the core. Many financial professionals help more people in the course of their career than Dave Ramsey ever will. So this column is for you, the thousands of financial professionals who strap on your boots (boots sounds tougher than nice leather oxford shoes), and spend their days, nights, sometimes their weekends helping everyday Americans struggling with poor spending and savings habits. Every month, I will dissect a piece of Ramsey’s financial advice and hold him accountable to providing sound financial principals instead of idealistic fallacies. If the pen is actually mightier than the sword, then, Sir Dave, I challenge you to a duel of math and wit.

7 baby steps to getting out of debt

Let’s start at the beginning. On his website, Ramsey lists “7 baby steps to getting out of debt.” These steps are the cornerstone to his popular book Total Money Makeover. Like so much of his advice, they sound good until you dig in and challenge the assumptions.

There are savers and spenders in this world. Ramsonites are inherently spenders. If they were savers they wouldn’t need his seven-step system. Spending is an addictive habit, which leads to less and less contentment as time goes by. Other addiction counseling services have found it takes 12 steps to recovery, not seven, but I digress. The table below outlines Dave’s seven steps, and what I believe they should be:

Now, let’s go through these step by step to illuminate the strengths and weaknesses.

Step one: Save $1,000 for an emergency fund. Ramsey calls for this $1,000 emergency fund to pay for “… those unexpected events in life that you can’t plan for: the loss of a job, an unexpected pregnancy, a faulty car transmission, and the list goes on and on. It’s not a matter of if these events will happen; it’s simply a matter of when they will happen.”

This is a good first step, considering that you can’t save $1,000 before you’ve saved $10 or $100. However, what does $1,000 really prepare you for? By Ramsey’s definition the loss of a job — but if you’re making $12 per hour, then you’ve managed to save a whopping 2 weeks’ worth of wages (cut it in half for a dual earning household). How far will $1,000 go towards an unexpected pregnancy or a faulty car transmission? Dave, when was the last time you paid attention to the actual costs for these sorts of expenses? I’ve got good insurance, yet our last child was still over $3,000 in out of pocket expenses. (And let’s not forget the fact that giving birth typically translates into time off from work, which isn’t always paid.)

This step starts with a few dollars but needs to continue to at least $5,000. Five thousand dollars can help protect families from unexpected life events. One thousand dollars doesn’t come close.

Step two: Pay down debt using the Debt Snowball. Ramsey’s rational is this: If you target the smallest debts first and ignore the ones with the highest interest rates then you’ll be encouraged by the psychological effect of lowering the total number of open accounts. He goes on to recommend that we re-allocate the funds used to pay off each card to the next smallest debt that you owe, so that over time your payments become larger.

Common sense tells us this is a good idea, just like common sense tells us driving faster to an appointment will get us there more quickly … unless of course you happen to go past a police officer. But ask yourself this: Is paying down debt the same as saving? No. Paying down debt is spending your money in a different way. Spenders have debt because they’re spenders.  Spending down debt is not the same as saving. As we pay down debt it relieves stress, but it does NOT teach us how to save. What happens if you follow Mr. Ramsey’s advice and suddenly lose your job? Great, you have $1,000 saved and you’ve made extra payments on your Macy’s credit card — remember, the debt snowfall rule says target lowest balances first which would most likely be retail store cards, not universal credit cards or auto loans — but you have no job and no money. Don’t worry, though; you can go buy a nice new Chaps blazer for your job interview.

Step two should be to give. You might be thinking that giving prior to paying down debt only further prolongs a debt-ridden life. It doesn’t, and here’s why. First, at this point you’ve created a reasonable safety net of $5,000. Second, gifting — or tithing, as some call it — is fundamental to becoming a saver. Giving is voluntary; paying down debt is not. As a voluntary practice, it takes discipline to habitually do this each and every month. If you have the discipline to gift every month then you’ve created a lifestyle change. The discipline of gifting is the same as the discipline of saving. Gifting at step two helps yourself and those around you.

Step three: Save 3–6 months’ worth of expenses. I agree with Dave here. I review too many financial plans where people only have a month or so in cash or cash equivalents, with the rest of their assets invested. I always ask, “What would you do in an emergency?” They usually respond with something like, “We’ll put it on the credit card.” While I understand they have the assets available to liquidate after the fact to pay the card balance back off, it’s still more conservative to have this amount of expenses stashed away in the bank. If you’re like me, you’ll even keep this fund partially in cash.

Step four: Invest 15 percent of household income AFTER debts are paid.

I heartily disagree here. Investing and paying down debt should occur simultaneously because, again, you only learn how to save by SAVING and continuing to save. While I’m not advocating debt is good or leveraging is appropriate, I am suggesting that habits are often lost if not continued. Think about the number of New Year’s resolutions to eat and drink healthier that are broken during the Super Bowl weekend and never adhered to again. Don’t stop saving. Instead, invest and pay down debt.

Continuing with step four, Ramsey says to use commission-based investing and to work with an “investing advisor.” While I don’t want to go into great detail on this now, it’s important to note that there’s no such thing as an investing advisor. I guess if you’re not a licensed advisor or an insurance agent, you can make up any title you want. Notice how “investing advisor” sounds very close to “investment advisor;” in fact, Google “investing advisor” and you’ll only get results for “investment advisor.” Ramsey intentionally uses a similar term, since investment advisors are held to a fiduciary standard, whereas investing advisors (who I can only assume are stockbrokers/financial advisors considering the commission structure) are held to a suitability standard as well as the Ramsey standard (#YesI’mHating).

Ramsey calls his legion of investing advisors ELPs, or endorsed local providers. Wonder why he doesn’t believe in a fee-based model? Consider Rule 206(4)-1(a)(1) of the Investment Advisers Act of 1940. (If you don’t recall the specifics, don’t worry. Next month’s column will use facts and math to prove why ELPs can only work in a commission structure.)

Step five: College funding for children. I’m not going to argue about college funding. That’s a choice for each individual to make, and there are good points for each side. Ramsey thinks parents should pay for college, and that’s fine. I think kids will appreciate college more with every one of their own dollars that goes towards it. Additionally, there are practical considerations at stake. If a parent has three children and they don’t start saving until the parent has reached age 30, then they’ve only got 12 years to recoup/save for these expenses per child (36 years until retirement divided by three). On the other hand, each child probably has 40+ years using the same retirement age. But to each their own on this step. I’ve met some people who take great pride in the fact they were able to help their children through school and their kids graduated with no student loans. I don’t think there’s a right answer here.

Step six: Pay off the mortgage. Eliminate the biggest debt most people have … it makes sense, right? This should help individuals need less income in retirement. Again Ramsey almost got it right but missed a very important point. Retirement is about income, not assets. You must have assets to have income, you say? Wrong. Social Security is not an asset, is it? It’s only income.  Think about it this way. Many of the people whom I serve would have a very nice retirement with $2,000,000 in assets — unless $1,950,000 is tied up in their home. If that’s the case, then they’re broke. But good news: They’d still have completed Ramsey’s steps 1-6 (assuming Social Security and $50,000 covers 3–6 months’ worth of expenses).

Here’s an example of when step six doesn’t make sense. Last year I helped a husband and wife, one still working and the other retired, but both taking Social Security. They had previously followed the advice of an advisor who I can’t say for certain was an ELP but his plan certainly stunk of one. He had them refinance their home to a 10-year mortgage so they’d pay less interest and get the house paid off in their lifetimes. In order to cover this larger monthly mortgage payment they had to do two things. The husband had to continue to work and they had to withdraw money from their retirement savings each month. We did some simple forecasting using reasonable rates of return based on a Morningstar report and found that, yes, they would get their house paid for in full by their early 70s. At that time, they’d have a $350k house free and clear and about $100k in retirement savings. In the process, they converted a liquid asset (retirement savings) to pay off an illiquid asset (home equity).

I asked if they ever want to leave their home. They replied no, especially not after working the extra years to pay it off.  Yet somewhere between their late 70s and early 80s, they’d have to sell or tap into their equity. They weren’t concerned with leaving the house to the kids mortgage-free. They needed to take care of themselves first. The only thing this plan accomplished was more years of working and a debt-free inheritance for the kids … oh, the good life.

Paying off the mortgage can be a noble thing, but it can be absolutely the wrong thing if you’re in retirement or close to retirement. Tying up most of your assets into the place you love and never want to leave is just as harmful as having too much debt. You may have no debt, but you also have no money.

Step seven: Build wealth and give. I agree with Dave that we should give back. The more we get, the more we should give. Again, I think this should happen much earlier because when you learn how to gift you learn how to save. Gifting should really be step two, as I previously stated.  This is especially true when you consider that Ramsey preaches much of his advice is faith-based. How on earth can he suggest to give only once someone has received so much? By the time he suggests you give, you’ve saved tens of thousands of dollars for emergencies, you’ve paid off all your debt, you are investing 15 percent of gross wages, you’ve paid or are paying for your children’s college, and you’ve either paid your house off or are close to it. Only then are you supposed to give. In other words, don’t go without so you can help someone else first. Take care of steps 1–6, then learn the word generosity.

This was just the beginning. Today we debunked several of the 7 baby steps, which are core to Dave Ramsey’s “Total Money Makeover.” While the advice wasn’t entirely bad, there are certainly some glaring deficiencies.

I like math — strike that, I love math — and I don’t particularly care for opinions. Remember, this column is for you. If you notice any particular financial advice from Dave you’d like to refute, please email my editor at [email protected]. I appreciate your help holding America’s favorite finance coach accountable to good, sound financial advice and not just the entertaining garble that most won’t take the time to validate.

Source: Life Health PRO.

More information:
Two great Dave Ramsey myths, debunked