There Is So Much Wrong With Dave Ramsey's Formula For Becoming A Millionaire


Personal finance guru Dave Ramsey went on a rant Tuesday afternoon against Twitter users who assailed him for promising consumers they could become millionaires by saving $100 per month.


It's a formula Ramsey has touted for years, but he kicked off his morning by tweeting this nugget of wisdom out to more than 300,000 followers:

"Saving only $100 per month from age 25 to age 65 at 12% growth = $1,176,000. Everyone should retire a millionaire!"

The backlash was instant and people had one main question: How can you promise a 12 percent return on investment over a 40-year period?

Ramsey defended himself during his live show Wednesday, calling the theory "inspirational" and "instructional." But for the legion of fans who eat up his every word each day, it could be the last kind of advice they need.


Here's where we take issue with Ramsey's defense:

Ramsey: "[I use this formula] to encourage you to save. That's why I would say it, to encourage you to be an investor. It wasn't a political statement, although I'm not above those. It wasn't a spiritual statement, although I'm not above those. It was a mathematical formula showing that if you save money over time, you'll have some."

Our take: It's noble to want people to save. But, of course, anyone would be inspired to save if you tell them they could make a million bucks just by tucking away a small amount of cash for 40 years. The fact of the matter is that his formula relies on a 12 percent rate of investment return –– something no one in their right minds would promise for that long a time frame.

An August report by S&P Indices found more than 80 percent of actively managed U.S. stock funds underperformed the market.

Yes, Ramsey went on to say that he "didn't bring up a guarantee," later, but there no was no such clarification in the original tweet.


Why? The way Ramsey suggests earning that return is to invest in mutual funds (of course, he suggests listeners call his hotline for his personally-endorsed funds, but we'll get to that later). He says his team can point people to funds that have "lifetime track records of" 12 percent returns. We'd love to see the numbers to prove that.

According to a study published in the Journal of investing, 75% of investment funds under-perform the stock market averages over the long term. The reason? High fees, taxes and trading commissions that eat up all the profit, not that most mutual fund advisors will factor those costs into their annual return estimates. The average mutual fund charges up to 3 percent of annual returns for the privilege of divvying up your investments, according to Forbes.

That's the reason more conservative experts like U.S. News & World Report's Kimberly Palmer use a 7 percent ROI when calculating a millionaire retirement goal:

"If you start saving for retirement at age 25, you only have to save about $4,830 annually to reach $1 million by age 65, assuming an annual return of 7 percent after fees. If you wait until age 40 to start saving, you'll need to tuck away much more: $15,240 per year, assuming the same retirement age and annual return."

Note: That's a monthly savings goal of $400/month, a far cry from the "coffee a day" $100 Ramsey estimates.


Ramsey: "Who could save $100 a month? People who work and stay out of debt and live on a budget. ... You would have $100 if you would cut your freaking cable bill back, stay out of the coffee shop and quit spending money you don't have on a bunch of junk."

Our take: Certainly, it is possible for a lot of people to tuck away that much cash per month by rejiggering their expenditures. But what about the 132 million Americans who don't even have enough saved for emergencies?

We doubt they can afford luxuries like lattes and cable, let alone investing $100 in a costly mutual fund, especially given the fact that U.S. households saw their income decrease by $49,000 between 2007 and 2010, according to the NY Fed.

And the sarcastic, finger-wagging tone Ramsey uses to blast people who say they can't save is insulting and a little hypocritical –– Ramsey himself declared personal bankruptcy before building his personal finance empire.

Ramsey: "It's simple concept in a culture that has the savings rate and financial maturity of a two-year-old. To simply put out there that maybe if you save some money you would have some blows people away. This is why I have a job for as long as I want one. I will never be unemployed. Just teaching people to save money and get a bunch of money and get out of debt. Me and Jenny Craig, we got a lock for life, baby. We got enough work forever."


Our take: Apart from being completely condescending, Ramsey is basically admitting here that his entire financial empire is based on the fact that people STAY in debt and need help figuring out how to make their money last longer. Why else would they need his advice?

Here's where some financial reform would come in handy –– much handier than letting Ramsey pick your mutual funds for you, we would guess. If enough consumers truly understood financial products like 401(k)s, Roth IRAs, and investment funds, chances are they could debunk Ramsey's advice all on their own. Unfortunately, deciphering the literature is not only difficult, time consuming labor, but it's difficult for most people to even know where to start.

In an interview with CBS MoneyWatch, personal finance writer Helaine Olen, hit the nail on the head:

"We're nuts when it comes to money and all we want is someone to tell us what to do. Most of us don't want to engage with our money even though we need it, and so the idea is, hey, I'll just follow this person and they'll tell me what to do. We also, in this country, have a huge attraction to this sort of tough thinking about money –– where anybody can make it and it's your fault if you don't."

If you need proof this is the kind of product Ramsey is selling, take this quote from his radio show today: "I'm just reading facts to you. I've been getting 12% on my money on average for many years. ... If you don't want to save or invest because you think the future is caving in ... then don't do it. But I'm gonna go get rich and you guys can all go gripe about it."


And lastly, this:

Ramsey: "If you can wander onto the internet and go buy an S&P 500 index fund, which you should be able to do if you can buy your potato chips over the internet, then you can. It has an average of slightly under 12% but that's an idiot-proof fund."

Our take: This is about the only thing Ramsey gets right. Low-cost index funds have been proven to be the financially sound choice for most investors, given the fact that they don't come with all the high fees that typically eat up returns for mutual fund investors. But then we wonder why Ramsey is trying to sell people on his endorsed mutual funds if he basically admits here that low-cost, index funds are the way to go?

We asked Mark Herber, President of Index Funds Advisors, Inc. for his take:

"We have never seen any client that earned these returns over the 40 years, but our simulated index portfolios, adding $100/month, starting with high risk and reducing the equity exposure by 1% per year actually came close to his calculation. But without passive funds, he would not even had data to make such a claim."


We reached out to Ramsey's rep for comment but haven't heard back since this afternoon.