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Dave Ramsey’s How to Drive Free and Retire Rich

Dave Ramsey’s How to Drive Free and Retire Rich

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Dave Ramsey's How to Drive Free and Retire Rich 1

I recently came across the How to Drive Free and Retire Rich on Dave Ramsey’s site. It 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”.

The Drive Free Method

According to Dave Ramsey, 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.

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!

Too Good to Be True?

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. To be perfectly clear, I think Dave Ramsey’s How to Drive Free and Retire Rich is a great concept and it works. However, I think the numbers he presented is a little bit hyped up. For example:

  • 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 8-10%.  Let’s call it 9% for our purpose.
  • Second, short-term investing for 12% gain is not that practical in real life — over the span of 10-40 years…yes, that makes sense, but not 52 months. 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 in 2008, almost half of my “car fund” would have been wiped out by the stock market crash. You cannot depend on a plan that involves investing in the stock market to achieve a short-term goal.
  • Third, Dave Ramsey didn’t mention 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 about $14,000 to spend $12,000.
  • 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.

A More Realistic Math

Let’s make the Drive Free and Retire Rich more realistic. Here are some changes

  • Average car loan interest rate 4.21% for a 60 months loan (source: ValuePenguin)
  • Average new car price for midsize car and small SUV is $26,000 (source: Kelly Blue Book)
  • Average stock market return is between 8-10% (source: Investopedia)

The S&P 500 Index originally began in 1926 as the “Composite Index” comprised of only 90 stocks. According to historical records, the average annual return since its inception in 1926 through 2018 is approximately 10%. The average annual return since adopting 500 stocks into the index in 1957 through 2018 is roughly 8% (7.96%).

So here are some of the changes

Ramsey’s Revised
Car Price $26,000 $26,000
Interest Rate 9.60% 4.21%
Loan Length 72 months 60 months
Car Payment $475 $481
Investment ROI 12% 9%
Length 52 months 52 months
Money Saved $32,512 $30,298
10 years  $109,268  $91,919
20 years  $469,896  $317,246
30 years  $1,660,108  $869,603
40 years  $5,588,267  $2,223,627

Calculation made using Credit Karma’s Loan Calculator and Bankrate’s Investment Calculator.

Again, I think Dave Ramsey’s How to Drive Free and Retire Rich is fantastic. However, the numbers he presented is a bit optimistic. As you can see the revised numbers is a fair bit less, but still great. Can you imaging that a $475 monthly car payments could cost you almost $2.25 million over the course of 40 years? That is absolutely mind boggling.

Can you imaging that a $475 monthly car payments could cost you almost $2.25 million over the course of 40 years?

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.

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Evolution of Wealth
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Evolution of Wealth

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… Read more »

Mike Piper
Guest

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.

Dangerman
Guest
Dangerman

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… Read more »

Mike
Guest

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)”.

Bucksome
Guest

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.

MITBeta
Guest

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…”

MITBeta
Guest

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.

Jim
Guest

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… Read more »

ctreit
Guest
ctreit

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.

SGM
Guest

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!

Mil Hamilton
Guest
Mil Hamilton

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.

Alex
Guest
Alex

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… Read more »

MITBeta
Guest

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… Read more »

Marc
Guest
Marc

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.

Voice of Reason
Guest
Voice of Reason

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.

Jim
Guest
Jim

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… Read more »

JT
Guest
JT

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… Read more »

Dave Ramsey’s How to Drive Free and Retire Rich

by Pinyo time to read: 4 min
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