Dave Ramsey‘s site has one of the best money hacks I’ve seen recently. Drive Free, Retire Rich explores the impact of carrying a car payment, and offers ideas on how your money can be used more wisely. Though the sentiment is familiar, I find Ramsey’s approach novel.
You want a brand-new sports car that would normally cost you $475 a month. The car you’re driving now is worth around $1,500. If you take that $475 and pay yourself instead of paying the dealer, you’ll have $4,750 in just ten months. Add that to the $1,500 you can get for your current car, and you can pay cash for a used $6,250 car. That’s a major upgrade in car in just ten months — without owing the bank a dime!
But let’s keep going. If you kept saving at that rate, you’d have another $4,750 in another ten months. Chances are, less than a year later, you could sell your $6,250 car for about what you paid for it. This means that you can step up again — with cash — into an excellent $11,000 used car just twenty months from today. Not bad!
Not bad, indeed. Ramsey goes on to explain how you could actually get “free” cars by investing your $475/month and using the returns to purchase your vehicles. (The assumed 12% return is a stretch, though the overall point is valid.)
How might I make this idea work for me?
- Instead of buying a new car from a dealer, I could set aside the amount I”m willing to spend on a monthly payment. The presentation uses $475/month as an example. I could never pay this much for a car. I’d be willing to go as high as $250/month.
- After a year, I’d have saved $3,000 for a car. According to kbb.com, the trade-in value on my current car is $3700. Using these two sources, I could buy a better used car for $6,700.
- Here’s where it gets interesting. If I kept making $250 payments to myself, I’d have another $3,000 saved at the end of the second year. Let’s say the $6,700 car lost another $1,000 in value and was now worth $5,700. I could trade it in and use my saved money to upgrade to an $8,700 used car.
- I can continue this cycle until I reach the level of car with which I’m comfortable. After that, the amount I need to save each year would decline sharply. I wouldn’t have to save to upgrade my car, simply to maintain the level of quality.
I’ll certainly remember this for the future. As soon as I’ve repaid my home equity loan — by March 2008 — I plan to begin saving for a car!
[Dave Ramsey: Drive Free, Retire Rich]
Note: I’ve never heard Ramsey speak before. Can anyone confirm whether that’s his voice in the presentation?
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LOL what a great story Melinda. Gotta love mom’s sensibility.
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I appreciate your take, Ethel. For our family, having a car breakdown wouldn’t be a good time. Add to that, we have at least four children in the house (two under 5!) at any given time. So, our family is limited on what kind of car we can have (minivans it is – and even used they are not cheap) and it MUST be reliable.
So, we buy what we can afford comfortably for the family vehicle. My husband’s car will be paid off in two years, and that will be driven until it dies.
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I appreciate Dave’s advise, but some of this seems like obsession with money and saving,etc. Buying this car, driving it for so many years, selling, buy an upgrade, saving more, selling, etc….just seems like obession with money and savings to me. Just make sensible decisions with your finances, but dont’ spend all your waking hours obssessing about them.
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Dave Ramsey is very good at remembering things like fees, interest, and depreciation when they support his arguments, and very bad at remembering them when they don’t.
Like a lot of what he says, this advice is pretty sound in its general intent–drive less expensive cars, and save rather than borrow–and pretty terrible when it comes down to the specifics.
Older cars have more mechanical trouble. It’s not a question of setting up sinking funds or anything else–you have to pay more to keep an older car running than a newer one. The total cost of ownership–which is what matters here–includes payments, taxes, insurance, and repairs. And even “repairs” has to take into account what you do to get to work or whatever if your old beater is in the shop again. Rental car? Miss a day of income?
It’s very like Dave to “forget” that in his detailed example and focus on the one item–payments–that helps him make his point.
Dave hammers on depreciation when it comes to new cars, but, somehow, that $1500 banger doesn’t lose any value at all during the year you drive it. I’ve bought a thousand dollar car or two, and they’ve pretty generally been scrap within eighteen months. I’m not hard on my cars; I’m just not an amateur mechanic.
Then there is the very worst piece of advice in the entire segment–that you should invest money in aggressive growth mutual funds that you are going to want within the next 5 years. That you should plan on getting %12 returns, year on year, is nothing short of insane. It is pretty close to malpractice for a “financial advisor” to suggest such a crazy thing. How about you just take your money to Vegas and put it on red? Stock funds are for a time horizon measured in _decades_.
Anyone invest in those “aggressive growth funds” five years ago to buy a new car today? How’d that work out for you?
In fact, it’s even worse than it seems at first, because Dave is forgetting (how convenient!) inflation, taxes, fees, and so forth as he extrapolates your “car payment” fund off into the limitless future. You just keep making 12 percent, year on year, and cars never get any more expensive! And you never pay tax on your gains!
It’s past ridiculous.
Yes, buy less car than you can. Yes, prefer saving to borrowing. But invest a car payment in a mutual fund for six years and buy cars with the interest for the rest of your life? Keep dreaming.
Pretty typically, Dave Ramsey is a genius at debt counseling (you don’t need that sportscar), and barking mad at investing (a mutual fund will return 12% yearly after taxes, fees, and inflation).
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The 12% is definitely a stretch (especially in today’s market) but the advice is great overall. This is one piece of advice that I agree with from Ramsey but as far as his advice concerning credit cards that just bothers me to no end and is dead wrong (and I can prove it: http://www.creditcardchaser.com/dave-ramsey-credit-cards-i-love-ya-dave-but-you-are-dead-wrong/ )
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As a woman who comutes home alone 28 miles at night, I am willing to pay extra for reliablity. Having an unreliable car is not an option.
I just took my 11 year-old Nissan (which was starting to have issues) and traded it in for a new Honda Accord. I’ll probably keep the Accord 10 or so years. I did my homework and bargained well for both the Accord and the trade-in. My only regret is that I probably should have gotten a Civic and saved $4000.
One thing to keep in mind is that if you decide to sell your old car private party, you either have to sell it to someone you know or go along for the test drive (also not a good option for a single woman) or trust the person to bring the car back to you after a test drive. If they don’t, you can’t file a stolen car report since you gave them permission to drive it (it becomes a civil case) and, I believe, you’d be responsible if they have an accident. If you trade it in, the dealer needs to make about $1000 on the deal to cover their inspection expenses and make a profit. Also, at least in the state of Washington, you can deduct the value of your trade-in from the price of the new purchase for the total you will pay tax on. For instance, if your trade-in is worth $9,000 and you buy a $20,000 car, you will be taxed on $11,000 (which saves you $8hundred-some; if you did sell it private party at $10,000, you’d be $100-$200 ahead).
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The people who are critical of this method need to get DR’s book and read the whole thing not this synopsis. He addresses pretty much every hole you guys ‘find’ in this theory.
The most common one I’ve seen pointed out here is that a car loses a lot of value after 1 year. This is not true for most older cars. According to his statistics, cars with over 80,000 miles lose about 5% of their value year over year. New cars lose 20% of their value the second you drive it off the lot and then 10% of their value each year after until it becomes a higher mileage older used car. If you don’t believe these numbers go to KBB or MANA and check them. He also shows the math over 2-3 year periods, not yearly. At the end you are driving a car worth 20k that will lose 3k of its value for the years you drive it instead of financing 30k and losing 9k of value over the 3 years you drive it. Sure you have 4k+ more for your trade in but you just gave 4.5% to a bank instead of making 4% on your money. That’s a 8.5% swing in interest.
The other thing I see people talk about is catastrophic breakdowns. First off, this is part of his program the Total Money Makeover. This isn’t his suggestion for everybody to buy a car. It is part of a system. If you are following the system, you have a catastrophic account for unexpected expenses. You build this before you even address your debt. That’s how important it is to his system. Second, if you are facing 3k in repairs on a car worth 1.5k you would never fix this car. You call a junkyard and get $250 for you car, take the money you had been saving and you go buy a different car.
The last thing to address is…of course most people can’t keep the big picture in mind when saving for a car. That is why ‘most people’ live in debt, have $500 car payments and think they are investing their money on a commodity that depreciates.
I stumbled on this article researching something else and I know it’s old and I’m not angry or anything despite the way the tone reads. I just found it disheartening to see such a simplified version of what I think is the perfect way to buy a car.
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I just recently saw this video on Dave’s website and I loved the idea immediately. It makes complete sense to “pay/save” what your typical car payment would be instead of paying that money to the bank or dealer plus interest! My husband and I began this savings process immediately after we finished paying off his car. Just having the savings for a new car building automatically makes the stress of replacing a car within the next couple of years melt away. Thanks for posting this…3 years ago. Better late than never I guess.
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I do have to say that one needs to keep taxes in mind with the scenario; I bought two used cars recently and paid $750 for one and $661 for the other for taxes and tags; that’s no small change…
I do agree overall with the theory of ‘paying yourself’ over time to save for the better car (would be better than financing at 6.9%). It shows you very quickly what it’d be like to have that payment missing from your monthly cash flow. Might even change your priorities rather quickly (from wanting a nicer car to wanting a nice, fat emergency fund!).
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Well that is good advise and all, but what about taking the Ramsey hack and turning it into potential cashflow (over a period of a few years of course). Since most millionaries stop at 13K cars as the median in the Millionaire next door. Then why not?
Go with a 2K car. Sell the 2K car and put the 2K towards getting a 5K car. Sell the 5K car and put the amount towards the 13K car. Drive the used 13K car and sell it again for 13K and go back to the 2K car. (Netting you a bunch of free rides and 11K!) Wash, rinse, repeat.
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Don’t buy too big of a hunk of junk though. My mom bought $500 beater cars every six months to a year when I was growing up and it was the worst. We got stranded so many times, had car fires, couldn’t get to school, and even drove a car for about a year that wouldn’t go in reverse (we couldn’t park downtown unless we found a corner space!). It was a nightmare. Because of this, although I am frugal I will never drive a car once it starts breaking down more than once or twice a year.
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If you had followed Dave Ramsey’s investment advice you would have lost money. He always advocates for real estate (no matter how inflated the market is) and magical mutual funds with 12 percent returns. That is not a realistic long term expectation. He says you can pull money for the fund to buy cars, but the money will still compound into millions. You certainly couldn’t do both. There is a whole list of inaccuracies in his free car video.
http://www.ilogicbomb.com/topic/8/Will+Dave+Ramsey+get+you+out+of+debt+just+to+make+you+poor%3F++
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