5 Foundations of Personal Finance -Review Of Dave Ramsey’s Course

Dave Ramsey has a course that covers 5 foundations of personal finance. The course is aimed at young adults and offers five foundations they should follow. He has some good advice in the 5 foundations, but there are some glaring omissions and lots of room for improvement.

What are the 5 foundations of personal finance according to Ramsey and what does he get right and wrong with his principles?

What Are The 5 Foundations of Personal Finance According to Dave Ramsey?

Dave Ramsey teaches that there are 5 foundations to personal finance in his course that is targeted to high school and middle school students. These consist of:

1. Save a $500 Emergency Fund
2. Get Out Of Debt
3. Pay Cash For Your Car
4. Pay Cash For College
5. Build Wealth And Give

By following these 5 foundational principles, Ramsey claims students can enter adulthood with financial confidence.

1) Save a $500 Emergency Fund

The $500 emergency fund is there to help kids see the benefits of having a safety net. If they get a flat tire or some other unforeseen issue arises, they have the means to pay for it.

For a high school student making minimum wage, saving $500 may seem daunting. But learning how to slowly build a savings through putting a small piece of each paycheck away is a life skill. Additionally, practicing savings when you get a windfall, like birthday money, will help when they are adults and get one-time bonuses or windfalls.

It is recommended to keep the emergency money in a bank where it is difficult to access and kept separate from spending money. A key here is this money is for a safety net, not an investment.

2) Get Out Of Debt

Ramsey claims that most high school students already have debt. Whether car loans, credit card debt, or IOUs to friends and parents.

Dave is a firm believer in no debt. And he is especially against the use of credit cards. He is a proponent of saving and paying for everything in cash.

Ramsey has made a career (and much personal wealth) by criticizing people for their massive debt. And he sees the world through the lens of ‘ALL debt is bad ALWAYS’.

He recommends setting up a budget, cutting costs, and changing spending habits. Then saving for any purchase you want. Additionally, debt comes with interest so it will continue to grow and be a drain on your finances. It can be a big burden if your debt gets too large compared to your income.

3) Pay Cash For Your Car

Ramsey recommends even teenagers save up and pay cash for their car. He recommends this so they ‘don’t have to worry about payments’ and can ‘focus on their next financial steps’. He also claims it will ‘inspire them to be more careful on the road’.

One benefit of paying cash for a car is it prevents a high-schooler from over spending on a fancy car to impress their friends.

Although, most kids start driving around 16 and can’t get a loan until 18. They may be able to get a loan with a co-signer under 18.

Ramsey recommends you buy a cheap car for cash and drive it for a year. Then you save up more money and after a year you can sell the cheap car and buy a slightly better car.

This works because older cars depreciate slowly in value. The price difference between a 9 year old car and 10 year old car is small. (Assuming no damage or nothing breaks during that year).

4) Pay Cash For College

The fourth foundation is paying for college without taking out any student loans. Per Ramsey’s own site, “contrary to popular belief, it is actually possible to get a college degree without taking out any student loans.”

Ideally, you can pull this off. And if you do so you will graduate in much better financial situation than your peers who have massive student loan debt.

Ramsey recommends scholarships, financial aid, your own savings, and parental contributions as ways to pay for college as you go.

5) Build Wealth And Give

Having the ability to save early and have your money compound can help build wealth.

And Ramsey talks a lot about charity work and Christian faith. As part of that, he sets the goal of being ‘outrageously generous’.

Criticism of Ramsey’s 5 Foundations

The biggest criticism of Ramsey’s 5 foundations is the obsession around no debt. We get it, no debt is Dave’s entire schtick. But for most people, going through life without ever taking a loan is not only improbable, but also highly suboptimal.

Having a healthy relationship with reasonable debt is part of personal finance. Taking a moderate loan to help you make a purchase you need is not a crime.

Our biggest criticisms of the 5 foundations of personal finance taught by Dave Ramsey are:

Paying Cash For College as one of 5 Foundations

Student loans are a big issue. There is currently $1.7 trillion in outstanding student loans in America. Student loan debt is making it extremely hard for Millennials and Zoomers to start there adult lives.

But the issue isn’t with student loans in themselves.

Student loans, when used correctly, can be an investment into a great career. Taking student loans to go to college to improve your earnings for an entire adult life is smart.

If you limit your college decision to the ones you can afford for cash, you likely are being short-sighted. For many students, even going to the cheapest community college may require a loan.

Instead of telling kids to pay for college in cash, showing them how to make a smart investment in their future is a better way.

This is especially important since calculating the value of college is not hard. And more importantly, learning how to do the calculation allows you to evaluate nearly every financial decision you will make in your life.

No Debt Discussion in the 5 Foundations

While taking on too much debt is a huge hinderance to most people growing wealth, responsible usage of debt should be encouraged.

Yes, you pay interest on debt. But you pay opportunity costs on saving up for a purchase. While you are saving money in a savings account for your purchase, you are missing out on being able to invest.

Simple example, if you save $10,000 up to buy a car instead of taking a car loan. It takes you 2 years to do it by saving $415 a month. You put all the money in a savings account at 1%. If you put $415 You would only make a little over $100 in interest.

[Professor B.T. Effer Note – If you are saving up for a purchase, you don’t want to put the money in a volatile asset like equities. If stocks go down, you won’t have the money you need to make the purchase when you want.]

Whereas, if you took out a $10,000 car loan for 48 months at a 4% APR, your payment would only be $225 a month. If you invest the $190 difference in your savings vs your payment ($415 vs $225 payment), that money can go to work for you growing. Investing $190 a month at the historical equity return of 8% grows to almost $5,000 at the end of 2 years. And $400 of that is returns on your investment.

In short, you may have ‘saved’ 4% interest on your loan. But the cost was only earning 1% on all your money ($415) vs potentially getting an 8% return on some of your money ($190). In the long run, you likely are better off with the reasonable car loan and investing. (Key word here is reasonable. The 20/4/10 Rule of Car Buying Is A good Start).

And No Credit Cards

Ramsey is a strong believer in no credit cards. But if you use your credit card like a debit card it is beneficial. When you only make purchases you can afford and pay off the balance at the end of the month, credit cards are wonderful tools.

The benefits of responsible credit card usage is:

• Earning ‘free’ money through the rewards and cash back. Potentially $1,000s worth.
• Great consumer protections for fraud and identity theft.
• Improved credit scores which helps with any future loans.

Yes. Credit cards can quickly get you in trouble if you abuse them. But for most adults, using credit cards is a great way to improve your finances.

Building a credit history is especially important for young people. Using a credit card early has major benefits to your lifetime credit score. (Learn all about how credit scores are calculated here). Having no or poor credit can be a huge detriment later in life when looking for home, auto, or other loans. It can lead to you being denied or getting a high APR on these loans.

And managing a credit card is an important skill to learn.

Investing, Business, and Opportunity Costs

Additionally, the 5 foundations have 3 redundant pieces of no debt advice. This is a glaring miss in explaining investing, how debt works, business, or opportunity costs.

Not having debt is fine, but you can be debt-free and still be poor. In fact, many of the poorest people don’t qualify for loans or credit cards. Therefore, not having debt is not sufficient for building wealth.

You build wealth through investing, making smart decisions about trade-offs, and owning equity (whether in stocks or in a business). Any personal finance course should be heavily focused on increasing revenue in order to save and invest more.

What Is Correct with Ramsey’s 5 Foundations

Despite the criticism of the 5 foundations being overly obsessed with never having debt and avoiding teaching about debt management. There are some good lessons in the five foundations as laid out by Ramsey. The positives of the 5 foundations include:

Emergency Fund

This part is correct. Have an emergency fund. Keep it separate from your spending money. And make it a bit difficult to access.

It is tempting to use your savings for a purchase. If you have a debit card linked to your emergency fund account, it is easy to use it ‘just this once’. Then you don’t get around to refilling it and when an actual emergency occurs you don’t have your savings.

The emergency fund is there for emergencies. It should be liquid and ‘risk-free’. The ideal place is a high-yield online savings bank that is FDIC-insured. FDIC insurance protects you up to $250,000 if the bank goes bankrupt.

As you get older, your emergency fund should increase from $500 to 3-12 months of living expenses.

Budgeting & Spending Less Than You Make

Budgeting is important, especially when you are starting out. If you don’t know where your money is going it is hard to make a plan.

And everyone should spend less than they make so they can save and invest.

Doing things like eating at home more, canceling unused memberships and subscriptions, and selling old stuff can make a big impact on your finances.

Don’t Overspend on a Car

Buying a car that fits in your budget is good advice. Until you are older and wealthy, there isn’t a need for a brand new car. Getting an older and reliable used car can save you a lot of money.

Cars are one area that people tend to overspend. It is a visible object that people see you in. A lot of people want to ‘appear’ wealthy and will buy a car that takes up entirely too much of their budget.

The Final Word – 5 Foundations

Dave Ramsey’s 5 foundations are better than nothing. Having an emergency fund, a budget plan, and being responsible about spending are all great advice.

However, the 5 foundations miss on some major personal finance principles. The obsession with no debt can be suboptimal. Ignoring credit cards can leave people with no credit history that can hurt them when they apply for a mortgage or car loan later in life. And knowing how to invest is the way to build wealth.

In summary, the 5 foundations of personal finance can be greatly improved.

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