Response to "Total Money Makeover"

Dave Ramsey is one of the largest money talk franchises on radio with more than 4.5 million weekly listeners on 400-plus affiliates.  He has written several books, including “The Total Money Makeover - A Proven Plan for Financial Fitness”, where he outlines his philosophy on personal finance and the steps for building personal wealth.

Ramsey has a strong opinion on debt -- he sees debt as dangerous to your financial health. “Debt brings on enough risk to offset any advantage that could be gained through leverage of debt.” (Pg 21) The only debt he tolerates, and only grudgingly, is a 15 year mortgage, and only if you are paying over the payment due every month. Ramsey himself felt he was victimized by debt when he went from a rich 26 year old to bankruptcy within a few years. He says that his views on debt were codified after this experience.

The first five chapters are completely infected with Ramsey’s anti-debt bias -- any debt is bad debt. These chapters focus more on psychological motivation then sound financial arguments. He argues that there are five hurdles that someone must overcome in order to makeover their financial situation. Denial, debt myths, money myths, ignorance and keeping up with the Joneses. Evading reality and holding onto wrong ideas about money, debt and happiness lead people to make bad financial choices.

Ramsey is correct to call for people to make an objective assessment of their financial situation. Many people evade that they have a problem, spending money and taking on debt they can not afford while raising their risk of insolvency. People don’t want to think about the possibility of disaster or set goals necessary for financial success. Spending as much as you are brining in is not a long term strategy for reaching financial goal. Growth, on the other hand, is the sign of financial health. I think Ramsey hits very close to the mark on this section since most people do not integrate their personal goals (or even take time to identify them) with their financial goals to the depth required to implement them. This is part of the reason I talk with my financial planner at least once a year to make sure I have an independent objective and expert assessment.

Ramsey’s book is basically a self-help book full of infomercial style testimonials and bible versus. His style is almost that of a preacher arguing with his congregation to repent for the sin of debt. His advice is very basic, though much of it is sound and needed by people struggling for financial health.
Despite giving some sound advice there are problems with Ramsey’s arguments. First is his reliance on testimonials as evidence for the success of his financial plan. While a few anecdotes could be useful, there are so many that you loose track of what the lesson is from the stories. Going more in depth with at most 1 or 2 stories per chapter, showing the numbers in spreadsheet style would have been a more effective way to demonstrate effectiveness even to a laymen. People can only hold so many examples in their mind when learning new concepts and strategies.

The problems don’t stop at the testimonials -- he attempts to argue by appeals to religion. I understand that religion may be important to some, but Proverbs 22:7, “The rich rules over the poor, and the borrower is servant to the lender” (NKJV) is not an argument. Arguments are made with appeals to reality and logic, in the case of personal finance, this has to involve numbers and not verses. Implicit in the verse he selects is that creditors and people who go into debt are immoral. This is a grave mistake from someone who presents himself as a financial expert.

Credit is just money -- unconsumed goods -- loaned by one productive person (or a group of them) to another. Interest (in a free market, which is not what we enjoy today) represents the costs of consuming those goods now versus using them for some other purpose. Interest also factors in the risk associated with the person who is receiving the loan. If the loan is not repaid by default, then the goods that money represented, the saved productivity, is consumed without a productive return. The investor loses his money. If the venture succeeds, the producer pays the interest out of the profits which he was able to earn through the productive use of the loan. Debt then is a tool when viewed from this perspective: a way to leverage productivity. What works for a corporation works the same for an individual. A company using loans to meet payroll is in serious trouble. A man using credit for food, rent, and other consumption items is in the same kind of trouble. This is why loans are good for houses (and even cars, provided you use it for productive purposes and measure your choice on how well it gets you to work). This is the kind of argument the author could have replaced the bible versus with that would be more compelling and in line with his recommendations.

A third issue with his arguments represent the method he used to identify them -- an epistemological error. First presented here in the book, but often repeated, is variations of this:

I have found that if you look into the lives of the kind of people you want to be like, you will find common themes. If you want to be skinny, study skinny people, and if you want to be rich, do what lots of rich people do, not what some mythsayer (sic) says to do.

To understand the error in this kind of argument I’m going to use an example I first heard from Dr. Doug McGuff and John Little in their book “Body By Science”. People look at champion swimmers and bodybuilders and want to change their body composition to match theirs. The way many people think leads them to conclude if they want to look like Michael Phelps, they should train and eat like he does. If they would like to look like Arnold Schwarzenegger, they should do what he did preparing for the Mr. Universe competition. After all, all the swimmers in the olympic finals all have the same body type, as do all the competitors in a body building competition. The error lies in the conclusion that the cause of the swimmer body type is their training and diet.. To put the hypothesis that swimming causes a swimmers body you can simply visit a national AAU swim meet. At the start of the meet you will see competitors with all different body types during the initial qualifiers. Over the course of the day, this variety changes dramatically, becoming less and less diverse, until in the finals almost all the swimmers have the same body type. The reason is a self-selection process, the swimmer’s body type is the best for swimming. What you are observing is an accelerated evolution at work. The erroneous conclusion that swimming causes the body type is reversing cause and effect -- the body type is what enables exemplary performance at swimming. So when using observational statistics it is important to keep the entire context and not assume a cause-effect relationship from a correlation.

Looking at rich people and seeing that they have little or no debt is interesting but does not demonstrate a causal relationship. As with the swimmers, the cause/effect relationship could be reversed. Perhaps the fact that they were able to earn money productively early on caused them to stay out of debt. It could be that the two things are totally unrelated when business credit and personal credit are combined for a given individual. Perhaps the virtues or values of productive people (ie. their productivity, creativity, integrity, etc.) are the cause of both their financial success and their lack of debt. Observational statistics can help find patterns and lead to inductive theories that must be tested by holding the whole context of the situation avoiding the pitfall of assumed cause and effect.

The second half of the book discusses Ramsey’s seven “baby steps” to financial makeover. Each step on it’s own I for the most part agree with him, especially his retirement advice and savings advice. His concept of a debt snowball is a good strategy for people trying to pay off debts quickly.

Start an emergency fund of $1,000.
Pay off all debt fast using the “debt snowball” method (except mortgage).
Build emergency fund to cover 3-6 months of expenses.
Invest 15% of household income into Roth IRAs and other pre-tax retirement accounts.
Save for your child’s college fund
Pay off home early
Build wealth and give! (Mutual Funds & Real Estate)

His wealth building advice is much shakier then his debt reduction strategy. He talks about investing in real estate and mutual funds. Most mutual funds do not beet the S&P 500 index over the long term so selecting the right mutual fund is crucial and understanding the risks and alternative are key to making that kind of investment decision. Real estate is also risky, as demonstrated by the recent credit bubble puffing up the market which is now in the process of correcting for over-investment through lowering prices. Many people have put more cash into their houses then they could now get on the open market for much of the foreseeable future.

Overall, I would not recommend the book. His strategies for debt reduction are implementable and can be found all over his website and radio show. For all the advice Ramsey gives about avoiding debt there is an awful lot of expensive training materials, books and seminars offered at the end of the book. People would be better off spending that money on reducing their debt and listening to his free radio show for the motivation, or better yet, picking up another book that can show you how to get the numbers. Sites like Mint.com can help people see exactly where their money is going which can be very motivational in addressing budget, debt and investment priorities objectively. Ramsey’s training material, books and seminars appear to be an expensive way to motivate yourself to financial health.