Dave Ramsey’s How to Drive Free and Retire Rich

I recently came across the How to Drive Free and Retire Rich slideshow on Dave Ramsey site via a fellow blogger Pat. The slideshow basically said the normal way thinking about car ownership is all wrong and there is a better way to go about this. Dave Ramsey proposes that you save your money first, invest, and use the proceed to buy your cars. After a while, you will accumulate enough money to make your car purchases self-funding for life, leaving you with enough cash flow to fund your retirement — which could be worth $5.5 million after 40 years. Essentially, the basis for “Drive Free” and “Retire Rich”.

dave ramsey's Drive Free Retire Rich

The Normal Way of Thinking

Most Americans take out a car loan to buy a car. For a typical $26,000 car, the average monthly payment is $475 at an average interest rate of 9.6%. And after 6 years of ownership you’ve paid almost $33,000 for your $26,000 car, which is now worth may be $6,000. At this point you’re probably thinking about a new car and the cycle continues.

The Drive Free Method

Dave Ramsey challenges the normal way and advocates these different ideas:

Trading up

Let’s say you have a car that’s worth $1,500 today. Instead of going out and buy a new car, save the $475 for 10 months and you’d have $4,750. Add that to the $1,500 and you could upgrade to a nicer car that’s worth $6,250. You can keep going an in another 10 months trade up to a car that’s worth $11,000.

That’s pretty sweet!

Invest the savings

Since the new car loan in the scenario above is 72 months, let’s continue saving $475 per month for the next 52 months. Assuming you invest your savings in a mutual fund that returns an average of 12% per year, you’d have $32,000.

By this time, your $11,000 car is quite old. Let’s say you spend $12,000 to buy another used car, you’d still have $20,000 left. This means that if your investment continues to earn 12%, you could afford to buy $14,000 to $18,000 cars every five years for the rest of your life.

The Retire Rich Part

Since you’ll never spend another dime on your cars for the rest of your life, you are now free to invest that $475 per month for your retirement. If you keep investing $475 per month in the same mutual fund returning 12%, you’d have

  • $100,000 after 10 years,
  • $470,000 after 20 years,
  • $1.6 million after 30 years, and
  • $5.5 million after 40 years

Retire rich…sweet!

Not So Fast Mr. Dave Ramsey

This sounds wonderful doesn’t it? My dad always said, “if it’s too good to be true, it probably is.” I think this is the case here. Although the concept is great, I don’t think the math is realistic. Let’s see some of the critical things that are missing from the picture painted above.

  • First, the most glaring problem I see is the 12% return on investment. The stock market has not performed at that rate for a long time. And some experts believe the more realistic level is closer to 7-8%.  This means that you would fall about $3,000 short at the end of 52 months, or have to wait 5 more months. Over the life time this becomes a significant amount.
  • Second, I can’t understand why Dave Ramsey would advocate investing in a mutual fund for a short-term goal. The stock market is volatile and your principal is not protected. For example, if I were following this Drive Free plan and were waiting to buy my next car this year, almost half of my “car fund” would have been wiped out during the 2008 stock market crash. You cannot depend on a plan that involves investing in the stock market to achieve a short-term goal — it will fail.
  • Third, Dave Ramsey forgot to pay capital gains tax. When your investment increases in value and you liquidate, you’ll have to pay capital gains tax. For most people, the long term capital gains tax rate is 15%. This means that you’ll have to liquidate quite a bit more than $12,000 to have $12,000 to spend.
  • Last but not least, there are a lot of expenses involved when you buy a car. For example, sales tax, destination fee, and registration fee — just to name a few. These fees add up quickly and could be significant depending on the price of the car.

Again, I am not trying to say that the idea is bad — in fact, I think it’s a great concept. However, I do think it is unrealistic. So what can we take away? Well, here are a few good points that Dave Ramsey made:

  • Don’t buy new cars. Buy used cars that meet your needs.
  • Avoid financing. Try to save money and buy with cash instead.
  • The less money you spend on cars, the more money you’ll have to invest for your retirement.

So what do you think? Let’s hear it.

About the Author

By , on Aug 25, 2009
Pinyo
Pinyo is the owner of Moolanomy Personal Finance. He is a licensed Realtor specializing in residential homes in the Northern Virginia area. Over the past 20 years, Pinyo have enjoyed a diverse career as an investor, entrepreneur, business executive, educator, and financial literacy author.

Leave Your Comment (25 Comments)

  1. JT says:

    The stock market crashes too often which has been less than every ten years recently. This not only halves or even wipes out the principle investment. It also destroys whatever incentive that a financial seminar may have instilled a novice investor in the first place. A conservative fund is the best long term investment over the decades that DR refers to. I do not think that even 7-8% is realistic. It seems to me ups and downs of the market are driven by universal fears and investors pulling their money out. I think that anyone who is going to do this plan in the long run is going to have to factor these universal emotions into their strategy. Financial advisors who are educating others to keep their money in the market no matter what are setting them up for failure. I wish things were different but they are not.

  2. Jim says:

    I’m a big DR fan, but realize this isn’t a realistic plan. I have read of another plan to not only drive for free, but for a profit, but it takes some work.

    Through craigslist and haggling, you can find and purchase a roughly 2 year old vehicles significantly under blue book value — especially in these times with motivated sellers You should pay full value in cash IMO, so this requires some capital. After 3-5 months of driving, you can list it for blue book value which will not have changed by then), and sell the car for more than you paid. This is basically flipping cars. You would be starting out with lower end cars, but as your capital increases, so does thee quality of vehicle.

    You need some mechanical knowledge to avoid buying a car riddled with mechanical problems and perhaps the ability to do maintenance and tune-ups. You need the patience to buy and sell vehicles on a regular basis. You also you also need to avoid too many transactions per year, as many states have a threshold at which you might be considered a car dealer.

    Finally, you cannot be picky. You aren’t driving your dream car. You aren’t picking a car based on color. You are driving a car that you are confident that you can flip in a few months.

    The worst case scenario is that you misjudge a car and end up with a fairly new, low mileage car, 100% paid for that you end up selling for less than you wanted — maybe the equivalent of a couple car payments.

  3. Voice of Reason says:

    To everyone who is so sure that Dave Ramsey’s plans don’t work, I challenge you to try it. To everyone who is so sure Dave Ramsey’s plans do work, I challenge you to try it. Then lets all report back in 52 months.

  4. Marc says:

    This is AMAZIN!

    And yet so easy to accomplish!

    Actually if we were to start using our brains more efficiently we could start figuring things out on our own!

    But ah! The TV set is calling!

    ‘Later gotta go buy a lottery ticket (after 5 years playing I figure I’m about $8,500 in the red) and watch football games.

  5. MITBeta says:

    A lot of people like to complain about the cost of maintenance or upkeep of an old car, but very rarely have I ever seen these costs equal or exceed the cost of a new car payment for more than a couple of months. I think many people use these expenses as an excuse to buy a new (or even new to them…) car when there was still a lot of life left in their old car with the average monthly upkeep cost still being pretty low.

    When the cost of maintaining the car matches the monthly savings for a new car for a long period of time, it may be time to get a new car.

  6. Pinyo says:

    @Ctreit – “if you present the upside as rosy as he does, you will find many disappointed people who are applying these great ideas. If they don’t get the results he projects, they may then throw in the towel. Why trick people like that?”

    My though exactly. Don’t turn good idea into an overkill that will later disappoint.

    @Mil and Alex – Another good add regarding maintenance of older car further eroding the concept; although the cheaper insurance rate may make up for some of that added expense.

  7. Alex says:

    One thing that wasn’t considered is that if you buy a new car, you don’t have to worry about as many repairs. If I kept the car I have now and tried to save the $475 a month, it’d be much harder because of the ongoing expenses of the old car.

    Still, its a great idea. I am currently saving up for a new car now. I dedicate some of my money to a separate cash fund for the car, and dedicate some money to my investing account. This way, I will have a solid cash base and hopefully use some of my gains to further add to the cash account.

    Just my .02 – thanks!

  8. Mil Hamilton says:

    Good Logic, the only thing that concerns me is that there will most likely be maintenance/ repair cost on older model vehicles. The repair cost can become substantial in regards to the value of the vehicle, and may not be acknowledge in the resale value. In other words, the compounded savings stated above may take longer than you think.

  9. SGM says:

    Great post Pinyo! I never want another car loan again. I’ve been without a car payment a little bit over a year and can’t see myself paying a huge car payment again. I plan to pay for my next car in cash!

  10. ctreit says:

    This is a very well written analysis and critique of Dave Ramsey’s ideas. Many of Ramsey’s ideas are excellent and could be a good start to change bad behavior. However, if you present the upside as rosy as he does, you will find many disappointed people who are applying these great ideas. If they don’t get the results he projects, they may then throw in the towel. Why trick people like that? These ideas are still good, even if you use more realistic numbers.

  11. Jim says:

    Dave Ramsey is very good at debt reduction. And he does like cars a lot. But I’m not so sure I buy his argument in this slideshow….. the obvious flaw is assuming a smooth 12% return year after year from the stock market. The past 10 years prove this isn’t true. The average investor should assume a lumpy 8% average return, with periods of underperformance and periods of overperformance. I try to hang on to my cars for 8 years or more as long as they are in good running condition and I am not paying too much in maintenance cost (drive it into the ground, lols). And pay cash for each car. But then I am not fixed on driving the latest and greatest.

  12. MITBeta says:

    By the way, not that there’s anything wrong with doing it this way. But the counter argument is that I could be using the gains on my car fund to fund my retirement and then retire everything at the same time, which is the more traditional way of doing things.

  13. MITBeta says:

    Isn’t this the whole point of retirement savings? This is sort of like saving for retirement for individual costs in retirement individually: “Well, I’ve ‘retired’ my car costs, and now I’m working on ‘retiring’ my housing costs, then I can get to working on ‘retiring’ my vacation costs…”

  14. Bucksome says:

    I’m a Dave Ramsey fan (after all his course inspired me to start blogging), but I did think throughout the course that his projected rate of rate for investments is unrealistic.

    Too bad because it may turn off people to all the good advice he does give. BTW, I also disagree with his advice to not have any credit cards or ever use them.

  15. Dangerman says:

    Thank you for clarifying Pinyo, it is entirely possible to “drive free.” One could probably make a graph of free car value vs. investment growth rate, assuming certain depreciation, taxes, etc.

    @Mike Piper – “not “free.” Just because a person can fund car purchases with saving & investing doesn’t mean it’s free. That would be like saying “My retirement was free! I paid for it entirely from investments!””

    I think Dave was using the term “free” as in marginal cost compared to buying a brand new car with financing. Since the amount “paid” for the first car in Dave’s plan ($475/month) is equal to the amount paid for the first new financed car, and all subsequent cars in Dave’s plan require no further cash inlays, those subsequent cars effectively have have a marginal cost of zero. Hence, “free.”

    But ok, getting a PF blogger to twice admit that clarifications are necessary in an anti-Dave article is good enough for me today.

  16. Mike Piper says:

    Dangerman, the point isn’t that your calculations are or aren’t wrong.

    The point is that it’s still not “free.” Just because a person can fund car purchases with saving & investing doesn’t mean it’s free. That would be like saying “My retirement was free! I paid for it entirely from investments!”

  17. Pinyo says:

    @Dangerman – “And you CAN drive free for life if you drive ~$6,000 cars.” Right, but not a $14,000 car that most people that follow his plan believe the could buy. I should really clarify my statement.

    Good discussion by the way. I appreciate your insight and comments.

  18. Dangerman says:

    @ Pinyo “… important things that make a big difference. … you can’t drive free for life…”

    I don’t understand, which part of my above calculations were wrong?

    By my numbers, (1) the difference in growth rate only changes the future value in 6 years by only $3,000 (less than 10%), so there’s no “big difference.”

    And you CAN drive free for life if you drive ~$6,000 cars. Actually, probably more like $8,000 cars assuming that the used cars you buy don’t further depreciate very fast.

    I completely agree that the future value over the 30-40 years of retirement savings will make a big difference, and you won’t have $5.5 million. But you’ll still be a millionaire a couple of times over.

  19. Pinyo says:

    @Dangerman – The reason a lot of people take stab at Dave Ramsey is because he sometimes gloss over important things that make a big difference. A lot of things he preaches are good enough when grounded in reality, but he likes to take it up a notch and make it unrealistic for most people.

    The truth is, you can’t get 12%, you can’t drive free for life, and you won’t have $5.5 million in retirement savings.

  20. Mike says:

    DR is a self-promoting idiot. I agree with Mike that he’s basically dressing up “save up for the car first and don’t buy too much car (or too new car)”.

  21. Dangerman says:

    Thanks Pinyo.

    Although he’s not perfect, many PF bloggers take shots at Dave – and it seems to me this only encourages the bad behavior that Dave tries to fight. For example…

    @evolution of wealth: “I feel bad for the people that think it is as easy as Dave makes it sound…”

    It IS as easy as Dave says. Get moving!

    Ok, even taking into account all of Pinyo’s criticisms… Dave is STILL right. Here’s the math (with lots of approximations):

    1. assume 7% growth, this gives a future value of about $28,500 in six years.

    2. a 7% growth rate is a reasonable one that can be achieved by a lower risk asset allocation, such as a balanced fund, under most circumstances. In 2009, you won’t have lost “almost half of my car fund,” you would have lost roughly 30% IF you cashed out at the bottom, but only about 15% to date from the high.

    3. Capital gains – none if you’ve lost money, of course. But back to the $28,500 scenario: you’d pay a little under $600 in taxes on the growth. Formula: (FV – 52*475)*0.15.

    4. Misc fees – sales tax in most states is usually about 5%, for $600 on a $12,000 car purchase. Destination fees can almost always be waived through negotiation. Registration at your local DMV is less than $100.

    Total: 28,500 – 12,000 (car) – 600 (capital gains) – 600 (sales tax) – 100 (registration) = $15,200 left over.

    In another five years at 7% (with no additional deposits) that $15,000 becomes about $21,300. Look, a FREE car!

    Now, you probably can’t do this ad infinitum if you buy $14,000 cars (as Dave alleges), but you CAN do this forever if you buy $6,000 cars. So the only thing Dave is really wrong about is how sweet your free cars will be for the rest of your life.

  22. Mike Piper says:

    To me, this is yet another example of Ramsey taking generally good financial advice (save up for a car rather than financing the purchase with debt), and combining it with astonishingly bad investment advice (expect 12% returns on equity-based mutual funds over relatively short periods).

    Like a microcosm of Ramsey’s advice in total.

  23. That is a great article. I love the way you set up his arguement and then talk about the holes in it. As I was reading the top part I couldn’t agree more with your points at the bottom. I feel bad for the people that think it is as easy as Dave makes it sound and then end up failing and think they did something wrong. It never ceases to amaze me how much some of these public figures want to use the stock market when it is grossly inappropriate. Does he get a lot of investment company ads like Suze?

  24. Dangerman says:

    “more realistic level is closer to 7-8%. This means that you would need to either save twice as much, or wait twice as long between buying your cars.”

    Your math is wildly wrong here.

    If I’ve done my Excel right… the future value of a monthly payment of $475 for 52 months with monthly growth of 0.948% (equal to 12% annually) is $31,742 (i.e. “about $32,000″ as Dave says). The future value of a monthly payment of $475 for 52 months with monthly growth of 0.565% (equal to 7% annually) is $28,621. A difference of some $3,000. So Dave’s assumption about the market doesn’t really matter.

    On the other hand, if you “save twice as much” by saving $950/month your future value at 7% would be $57,242. Overshooting by far.

    • Pinyo says:

      Dangerman — You’re right about my bad math. I was trying to do this late at night and was only looking at the difference in gain versus the entire investment. I will make the correction. Thank you.

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