Book Review: The Total Money Makeover

In this book, Dave Ramsey lays out a brilliant plan for getting out of debt.  It's brilliant because any rational human being would see it as sub-optimal, but Ramsey realizes something important about human nature. We're not rational.

A rational plan for paying down debt would be to tackle the highest-interest debt first, keeping only what you need for one month in a savings account. An emergency fund would make little sense, as you could borrow from credit cards for that purpose.

Ramsey, on the other hand, realizes that most of us don't have the discipline to follow that plan. If we did, we wouldn't be heavily indebted in the first place. A cash emergency fund meets our psychological desire for security. Paying down the smallest loan first, regardless of interest rate, gives us the chemical rush that comes from successfully getting rid of the first loan payment.

Total commitment to the plan is necessary to override our cultural desire to keep up with the Joneses. The Joneses borrow to maintain their lifestyle. Getting rid of debt requires that we do the opposite. The key phrase in the book is, "If you will learn to live like no one else [frugally], later you can live like no one else [wealthily]."

Beef

My one quibble with the book, and it's a major one, is his investing methodology. Ramsey claims that you can make a 12% annual return by buying and holding mutual funds with the best long-term track records. He recommends this asset allocation (p. 157, 2007 edition):

25% Large cap stocks
25% Mid cap stocks
25% International stocks
25% Small cap/emerging market stocks

It's not the 12% that I disagree with. There are simple trading methodologies, such as momentum, that achieve compound annual returns in that neighborhood with low volatility. A market with a high return (momentum) over the past 12 months tends to produce a high return in the following 12 months.

The kicker is that the momentum effect disappears if you look back more than a year. Markets that had strong returns two years ago tend to underperform going forward. This is called mean reversion.

What if a large-cap manager got his track record by investing in a sector that happened to outperform large-cap stocks in general? If that sector mean-reverts, his outperformance will turn into underperformance. Think about home prices, which moved steadily upward from World War II until 2005. Those who bought real estate based on that track record suffered large losses from 2006 to 2009.

If a fund manager uses trading strategies, mean reversion might not apply. Strategies like value (buying "cheap") and momentum (following trends) don't disappear permanently the way the railroad, utility, and communications booms did. But these strategies aren't part of Ramsey's asset allocation.

A long-term track record is only an asset if you have a good reason to think that the manager's outperformance will continue.

Recommended, with Caveats

If you're in debt right now, Ramsey's approach is psychologically tailored to get you financially free. I recommend the book for that purpose. Borrow it for free at the public library.

Once you're out of debt, you can use the income that used to go to debt payments toward self-funding a ministry dream. For this, Mebane Faber's book on momentum investing, The Ivy Portfolio, is a good read. I've also written a post on how momentum works. 

I'll leave you with some excerpts from Dave Ramsey's book The Total Money Makeover:

Having been a millionaire and gone broke, I dug my way out by making a decision about looking good versus being good. Looking good is when your broke friends are impressed by what you drive, and being good is having more money than they have.

Are you starting to realize that The Total Money makeover is also in your heart? You have to reach the point that what people think is not your primary motivator. Reaching the goal is the motivator. Do you remember the circus game where you swing the large hammer over your head to hit the hit the lever to send a weight up to a pole to ring the bell? You reach the point that you want to ring the bell! Who cares if you are a ninety-eight pound weaking with gawky form? The girls are still impressed when the bell is rung. When the goal, not how you look, begins to matter, you are on your way to a Total Money Makeover. (p. 33, 2007 edition)

 Here's a quote from the inside jacket:

Instead of promising the normal dose of quick fixes, Ramsey offers a bold, no-nonsense approach to money matters, providing not only the how-to but also a grounded and uplifting hope for getting out of debt and achieving total financial health.

Ramsey debunks the many myths of money (exposing the dangers of cash advance, rent-to-own, debt consolidation) and attacks the illusions and downright deceptions of the American dream, which encourages nothing but overspending and massive amounts of debt. "Don't even consider keeping up with the Joneses," Ramsey declares in his typically candid style. "They're broke!"

He gives sure-fire ways to build up savings for emergency funds, for your kids' college, and for your retirement, and he supplements this wisdom with heartfelt stories from real people just like you - people who were once languishing in debt but are now flexing their strong fiscal physique.

The Total Money Makeover is all about "renewing your mind," using God's ways of handling money (over 800 scriptures deal with money) to be "transformed" (made over). It's a plan to stop being "conformed" to the ways of the world and as ridiculously broke as the rest of our culture.

And this isn't theory. It works every single time. It works because it is simple. It works because it gets to the heart of the money problems: you.

Less Stuff, More Happiness

Five years ago, I moved halfway across the country. I decided not to ship anything, so I had to squeeze everything I owned into a 2000 Corolla. The only leftover stuff I didn't give away were some books and DVD’s that I left at my parents’ house. (Nope – I haven't read them since.)

I have more now, mostly tools and furniture, but I could still fit everything I own into a tiny 300 square foot apartment. It’s really true: less stuff makes you more happy.

Most of us have more than we think, but we spend constantly to buy small things. What resources could we free up by giving up just one of those things? 

This is a response to a read-worthy blog post titled Less Is More.

Debt Deliverance

Check out this recent episode of The Boundless Show:

Whether you're up to your eyeballs in debt or are financially free, you probably have to think about money every day. Handling money well is a biblical mandate, but many of us don't understand the full implications of this until financial woes are all too real. Listen as Martha and I talk with Chris and Valeen Tschamler about their story of dropping almost $35,000 of debt in less than two years. It's inspiration for us all, and motivation to use our money wisely and avoid seeing red.
 
Saving and investing money to self-fund your goals is diametrically opposed to accumulating consumer debt.

Listen to the episode here:

The Boundless Show, Episode 181 (mp3)

The Starbucks Sponsorship Plan for Short-Term Missions

So far, we've discussed how you can self-fund ambitious dreams like lifetime overseas missions or sending your kids to a Christian school. But what about something smaller?

I have friends who regularly take summer trips overseas. Individual trips don't have to be expensive, especially if they're mission trips, but funding them over and over again, every summer, can still be challenging.

Starbucks

Starbucks has a well-deserved reputation for taking care of its employees. It's a great company to work for, but how can you get them to fund your summer trips without having to work there?

If you've been following this blog, the answer is familiar by now. Step 1 is to earn more and spend less.

The Coffee Cost Calculator shows you how much money you'll have if you make coffee at work instead of buying it one cup at a time each morning. Assuming that you drink one cup a day, 250 days per year, you currently spend $813 per year more on coffee than you otherwise would.

If you make coffee at work every day and invest the saved money at a 7% inflation-adjusted return, the calculator says you'll have $11,200 after ten years.

I'm not hating on Starbucks. You can buy a 20-oz. bag of brand-name Starbucks coffee for $13 and save a lot of money making it at work. A bag that big makes a lot of coffee. That worth eleven grand to you?

$11,200 isn't enough to live overseas for the rest of your life. It'll pay for Christian school tuition for a year and a half. But that's not what we're after in this particular case.

Enough for Each Summer

If you're going to a developing country each summer for a mission trip, one of the major expenses is your plane ticket. That may be the expense that's hardest to pay for.

I used Kayak.com to look up the cost of a round-trip plane ticket from Oklahoma City to San José, Costa Rica. Using flexible travel dates to save money, I found two airlines, United and Continental, that will do the round trip for around $600 to $650. None of the round trips I saw cost more than $710.

If you save $813 a year by making coffee at work, you've paid for the plane trip.

There you have it:
The Starbucks Sponsorship Plan for Short-Term Missions.
If they decide to offer a real sponsorship plan for their employees, don't forget.

You saw it here first.

What the Joneses Are Doing

There are thee steps to self-funding your dream: (1) saving money, (2) investing wisely, and (3) time. Some of us don't think we can get past the first step because as our income goes up, so does our spending. We have to keep up with the Joneses. But what are the Joneses doing?

Chances are, the Joneses are paying for their new cars, cable TV, 4G phones, new furniture, and utility bills with debt. The average American household has $18,600 in consumer debt, a third of which is credit card debt. This number doesn't include home mortgages or home equity lines of credit.

Mrs. and Mrs. Jones may even have borrowed against their home to buy yet more goodies, since loans against homes aren't counted as consumer debt and don't always affect credit scores.

Even before the 2008 financial crisis, one in five Americans said they planned to borrow to pay their winter heating bills.

What could you buy with $18,600? Would this close the gap between you and your neighbors? The problem with comparing yourself to them is that they didn't have that money, either. They're still making payments on what they bought.

Crucifying the Dream

Let's look at what the Joneses are giving up by borrowing this money.

If they're paying 16% interest on their consumer debt and inflation is at 4%, their inflation-adjusted rate is 12%. Let's make the charitable, but unlikely, assumption that interest rates will stay at these low levels in the future. Let's also assume that they roll over this debt to new credit cards and aren't concerned with paying it off.

How long will it take before their debt expands to $200,000 after adjusting for inflation?

The handy-dandy calculator says 20 years.

Recall that $200,000, throwing off $14,000 a year in passive income, is the amount of money a family needs to live overseas indefinitely. It would put two children through Christian school at $7,000 annual tuition per child.

By borrowing to finance their lifestyle, the Joneses have sold their future. In twenty years, they will owe an inflation-adjusted $200,000, an amount that could have bought them their life's dream.

We hope the toys were worth it.

Debt Is Slavery

You may be frustrated because you can't afford cable TV and an iPad. But chances are, the Joneses can't either. Borrowing gives us the appearance that they can.

Don't let new furniture and a shiny car steal your dream from you. You have a passion to serve God. Steward His money well.

The world will be a better place for your service, not just for you, but maybe for the Joneses, too.


¹ A good name is to be more desired than great wealth,
Favor is better than silver and gold.
² The rich and the poor have a common bond,
The LORD is the maker of them all.
³ The prudent sees the evil and hides himself,
But the naive go on, and are punished for it.
⁴ The reward of humility and the fear of the LORD
Are riches, honor and life.
⁵ Thorns and snares are in the way of the perverse;
He who guards himself will be far from them.
⁶ Train up a child in the way he should go,
Even when he is old he will not depart from it.
⁷ The rich rules over the poor,
And the borrower becomes the lender’s slave.     Proverbs 22:1-7

Marriage Can Help

We've already discussed how you can reach your dream by (1) saving money, (2) investing wisely, and giving yourself (3) time. If you can fund your dream on $14,000 a year and save $500 a month, you could reach that goal in as little as 18 years.

What if you want to get there faster? If you're young and married, you may have an advantage.

Out of College

Take James and Jean, a typical working couple just out of college. They want to reach $200,000 in investments, which throws off $14,000 a year at a 7% inflation-adjusted return. If they live on James' salary and save Jean's, they'll reach their goal sooner.

To find out how long it will take, use this calculator. I assumed that after taxes and tithe, Jean will save $25,000 a year, or $2083 a month. With a 7% inflation-adjusted return (enter 0% in the "inflation" box), they can reach their goal in only seven years.

Big Dreams
  
Using the numbers above, a young couple with no debt eventually gets a $200,000 investment portfolio throwing off $14,000 of passive income ever year. They'll be in their early thirties by the time this happens. What does it buy?

• It's enough for a family to live overseas in some countries. Since they're not drawing from their investment portfolio, but just living off of the return that it generates, they can stay abroad indefinitely if they manage their money wisely.
  
  
• Two children could attend private Christan school. Again, it would fund their tuition indefinitely.
  
  
• It could replace part of Jean's income. This will make it easier for her to stay at home with the children if she wants to.

The Marshmallow Test

In every season of life, we're faced with hard decisions. Should we play or study? Have fun or wait for marriage? Watch TV or do our taxes?

Saving money is a test of commitment. Do you want your dream badly enough to sacrifice for it today, tomorrow, and for the next seven years?

Stanford researchers did an experiment in the 1970's testing children's ability to delay gratification. It's called the The Marshmallow Test. Watch the experiment in the video below.

I smile because I recognize myself in those children. I struggle with the same conflict every day.

How badly do I want my dream?