Wednesday, July 9, 2014

Dave Ramsey blew it today!

It doesn't happen often. 

Dave Ramsey is the guru of practical financial advice and one of my personal heroes.  He coined my favorite saying: "When you do stupid, you reap desperate."  But since Dave isn't God, he--like the rest of us--is capable of giving uninformed or bad advice.  And he did so on his 7/9/2014 podcast.

A gentleman called into the show who obviously had made a series of horrendous choices that led him to owe $170,000 due to poor business decisions.  He now had a job that didn't pay too much and he was planning on how get out of his predicament.  Of the $170,000 about $16,000 was credit card debt.  He had two whole life insurance policies and they had a cash value of $19,000.  The man was asking Dave whether to cash in the whole life policies to pay off the credit card debt.

Dave asked several insightful questions about the man's financial situation.  It turns out the man was trying to help a company that was insolvent to be profitable again.  The company, however, had owed the man $3000 in expense reimbursements. 

Here are the two things that Dave got right:
  1. He told the man to cut up and cancel his credit cards.  That always sounds drastic when Dave says it, but this man desperately needed this advice.  He has been engineering his way out of one difficulty into the next one for years.  He reminds me of poet-laureate Nipsey Russell who once quipped, "When your Visa bill is too high, and your Diner's Club charge is too large, take a loan on American Express, and pay  it off with your MasterCard."  I'm pretty sure this guy was trying this advice and was in the mess he was in as a result.
  2. He told the guy to stop loaning money to his company (in the form of using his own debit card for expenses and then not getting reimbursed).  This man is a dreamer.  He thinks that he can help a failing company quit failing but using a failing financial technique (borrowing against his own living expenses) to fund activities that his company should be paying.  Maybe the reason the company is failing is because the management team is lousy.  Maybe he should look for a real job with competent management at the helm.  Otherwise, he will -- as Dave Ramsey rightly observed -- be pointing to a debt someday and saying, "Yes, that is the debt I got for that company I used to work for before it went under."
Now Dave, if you're reading this, I know that you are seldom wrong.  And I will continue to be an ardent fan.  But you gave one bit of bad advice because you didn't ask enough questions or be willing to admit that there are solutions that don't fit your cookie-cutter paradigm for finances.

Dave told this man to cash in his whole life polices, pay off the credit cards, and then buy term insurance.

Here's a list of reasons why that is bad advice:
  • By law, all whole life policies are required to lend to the owner of the policy any amount up to the cash value of the policy.  So the man could borrow $19,000 from the policies (at about 5%) and pay off the credit cards.  Doing so would preserve the death benefit for the man's family.  Meanwhile, his cash value will continue to grow inside his policy even when he has a loan against it.
  • Term insurance is only affordable if you get it early in life and buy it at a level premium for 20-30 years.  If this man is approaching 50, his term insurance premium could be as high as $2800 / month.  Chances are pretty good that continuing his whole life policy is cheaper now than paying for term insurance.
  • Term insurance is cheap for a reason -- it is intended only to insure people while they are young when it is statistically improbable that the insured will die.  But think about this guy's situation.  He is in debt up to his ears, living a fast-paced lifestyle involving travel, is a class A personality type, and in stress from his financial situation. He is ripe for a coronary event.  If they guy can't afford term insurance (and I've been pricing it lately for a man my age and it hurts!), then his family could be left with nothing when he dies.  It makes you wonder if Dave will get a call from his impoverished widow someday. The premium will never go up on his whole life policy.  The term life insurance will get prohibitively expensive at age 50.  "When you do stupid, you reap desperate."
Now this man didn't have much cash value in his policy.  So it tells me he bought a bad policy or hasn't had it more than a few months.  A properly designed policy accrues significant cash value from day 1 of the policy using a paid-up additions (PUA) rider.  Since this fellow lacked financial acumen, he probably made the mistake of purchasing his policy from a publicly-traded insurance company.  Those companies do not have the policy-holder's best interest at heart.  They serve their stockholders.  They pay dividends to their stockholders.

Whole life should only be purchased from a mutual company.  A mutual company is owned by the policy-holders rather than the stockholders. They pay dividends to their shareholders.  At some point (usually 6-7 years after the policy starts), the dividends can actually pay the premium for the rest of your life.  So if you fall on financial hard times, the policy can pay its own premiums (which term insurance cannot do).

Still, here is what Dave should have told the man:
  • Destroy your credit cards and close your accounts.
  • Take policy loans on your whole life insurance to pay off the credit card debt and as much other debt as you can.
  • Tell your boss that you can't continue to fund his business.  He needs to reimburse you now.  If he doesn't, then find another job that treats you right.
  • If you're married, quit making financial decisions with which your wife doesn't agree.
  • Get on a budget.
  • Work on the baby steps in order.
  • Continue to pay on your whole life premium until it can become self-funding (from the interest if you have a policy from a public company OR from the interest + dividend if you have a policy from a mutual company).
Dave tends to tout the old A.L. Williams (now Primerica) line:  "Buy term and invest the difference."  Suze Ortman does the same.  If all you are doing is purchasing the death benefit, then go ahead and do that.  "Invest the difference" really doesn't work all that great.  Ramsey tells listeners that they should be able to average 12% in mutual funds. 

That may be possible, but is that really good? 

Look at the following scenario where someone is invested in the market for 4 years:
  1. Year 1 -- They gain 100%
  2. Year 2 -- They lose 50%
  3. Year 3 -- They gain 100%
  4. Year 4 -- The lose 50%
If you average the return rates for the 4 years, you have 100 - 50 + 100 - 50 = 100 / 4 = 25% average rate of return.  Now if I told you that I could guarantee a 25% average rate of return, would you be happy with that?

But look at the actual dollars in this situation if someone had $10,000 invested in the stock market:
  1. Year 1 -- Grows from $10,000 to $20,000 (100% gain)
  2. Year 2 -- Loses from $20,000 to $10,00 (50% loss)
  3. Year 3 -- Grows from $10,000 to $20,000 (100% gain)
  4. Year 4 -- Loses from $20,000 to $10,00 (50% loss)
So while you had a 25% average rate of return, you made ZERO dollars.  Even one bad year in the stock market (remember 2008?) can devastate your account so that it may take decades to recover. So when Dave tells you that you can average a 12% rate of return, don't run out and buy mutual funds until you think it through this example again.  I wouldn't plan my future retirement based on that advice.

Put prejudices on hold and get more information

I can understand why Dave isn't a fan of whole life insurance.  And the typical policies from public companies really are a bad deal.  Biblically speaking, these companies, "server two masters."  But when you purchase a policy from a mutual life insurance company, you can pay premiums for a few years (typically 6-7) and then you have paid-up life insurance for the rest of your life.  You also can borrow against your own money in the policy and at the same time receive dividends and interest every year on that policy.  The interest rate is guaranteed and grows tax-free inside of your policy.  Read some books by R. Nelson Nash on the Infinite Banking concept or sign up for the Infinite 101 course or a webinar from Paradigm Life (which is not an insurance company).  You'll see that there are many life-benefits to becoming your own bank using a properly structured whole life policy (and never having anyone run your credit history again).