When it comes to personal finance advice, everyone has their opinion. In a way, this is good, as you can get different perspectives on how people handle their money. Just look at the never ending debate of investing vs paying off debt as an example.
The problem with all of this information though is that you have to weed out what is good advice from what is bad advice. When it comes to investing, Dave Ramsey investing advice is dead wrong.
I Like Dave Ramsey
Now, before I get attacked for that last sentence, hear me out – I actually like the guy and agree with 99% of the things he talks about. His list of baby steps is great:
- Save $1,000 in an emergency fund
- Pay off all debt using a debt snowball plan
- Save 3-6 months worth of expenses in an emergency fund
- Invest 15% in retirement accounts
- Save for kids college education
- Pay off your house
- Build wealth and give
For the majority of Americans that stink at saving money, simply following this plan will get you in excellent financial shape. Heck, I even followed the debt snowball method when I was in credit card debt.
I even love the fact that he recommends term life insurance over whole and that he encourages people to get disability insurance since the odds are much greater you will get hurt and can’t work than they are of you passing away prematurely.
But with all of the love I have for him, when I start peeling back the layers about his investing advice, I found some disturbing things.
Dave Ramsey Investing Advice
So why am I against Dave Ramsey investing advice? There are 4 reasons:
- Assumed rate of return
- Investing options
- Endorsed Local Providers
- Proposed fiduciary rule
Let’s look at each of these in detail.
Assumed Rate of Return
Dave claims that over the long term, an investor can reasonable expect to earn 12% per year on their investments. Sounds fine, but in reality it is wrong. Well, technically his math is right, but he is wrong with what will happen in the real world.
When calculating annual return, Dave simply uses arithmetic to get to 12%. Here is an example of this. You invest $100 for 2 years. In the first year, your investment loses 50%. In the second year, your investment gains 100%. The average rate of return is 25% (-50 + 100 = 50/2 = 25%). So your $100 should be worth $125 ($100 x 25% + $100).
But you don’t have $125, you have $100. How is this? Let’s look at the numbers more closely. You have $100 and in the first year you lost 50%, or $50. This leaves you with $50. In the second year, you earn 100% of your money back. But you only have $50, so 100% of that amount is $50. The $50 you started the year off with plus the earned $50 gets you $100. In those two years, you have earned 0% on your money.
This is how the stock market works and it is known as compound annual growth rate. So, while mathematically there is nothing wrong with how Dave got to his number it is very misleading.
If you invest your money and earn an annual compound return of 8% you might think you doing bad since you are not earning 12%. In reality, earning 8% is great and it is what you should expect over the long term when investing. Earning 12% annually is not going to happen. I fear that people who are following his investing advice might take on too much risk (invest too heavily in stocks) just to try to get that mythical 12%. When then market tanks and these people lose their shirts (and probably pants too), they aren’t going to be very happy.
The biggest issue I have here is that Dave recommends investing in load mutual funds. It pains me to even type that. For those of you that are unaware, a load mutual fund is an investment that charges you a fee upfront to invest, usually 5-6%. So if you were investing $1,000 into one of these mutual funds, you would pay $60 to the broker and invest $940. This will happen every time you invest more money into the fund. It is not a one-time deal.
Why is this bad? Because you can invest in mutual funds for free! I don’t know anyone that would choose to pay for something when you can get that same exact thing for free. And it isn’t like there are only 5 no load mutual funds to choose from. There are thousands. Look at my online broker comparison chart. There are a handful of firms where you can invest for absolutely nothing.
So why does Dave recommend loaded mutual funds? His argument is that paying a load is cheaper in the long run than paying an advisor 1% each year on your assets. And since most investors give into their emotions, the DIY route isn’t ideal.
I can see that argument working for some people, but many people would be better off investing in no load mutual funds with a discount broker or even a robo-advisor.
Endorsed Local Providers
The third area of concern is with the Endorsed Local Providers. I have an issue with this because it is completely misleading. Here is what Dave’s website says about the ELPs:
For in-depth investing help, contact your investing Endorsed Local Provider (ELP). Dave’s investing ELPs are financial advisors who will show you how to invest the way Dave teaches. ELPs don’t work for Dave but they have earned his endorsement because they are honest professionals and who will make sure you understand your investments.
What is misleading about this? It’s misleading because these “honest professionals” are on the list because they paid Dave to be on the list. If any vetting is done on Dave’s end, it’s minimal.
The way it works is: you as a customer fill out a form and then they match you with investment professionals. I threw my info in and was contacted by commission brokers. These guys are the ones selling you the mutual funds that charge you 5% upfront and these guys are not fiduciaries.
If you are unfamiliar with a fiduciary, it is an investment professional that puts your needs ahead of their own. In other words, they make recommendations for you based on your goals/objectives/risk tolerance/etc. regardless if they will make money or not. Someone who is not a fiduciary is free to sell you investments that are are “appropriate” for you, but they don’t have to offer you the lowest cost option or even disclose that they might make some money by selling a certain product to you.
Proposed Fiduciary Rule
Earlier this year, the government made headlines when they wanted to pass a fiduciary rule regarding investment professionals. What this rule would do is make any advisor a fiduciary. After reading this above point on ELPs, it is no surprise that Dave Ramsey is against this new proposed rule.
He claims it would hurt the middle class but really it would hurt the advisors in his network that rely on his following to find new clients. They would have to stop offering clients the products that they make money on and instead offer clients products that were best for them, regardless if the advisor earns a commission.
Advice You Should Follow For Investing
So what is some good investing advice you should follow? Here is a quick bullet point list to run through as well as links that have a lot more information:
Educate Yourself. The more you understand about investing, the more likely you are to succeed. I know we are all stretched for time, but investing isn’t complicated. It sounds complicated because there is a ton of information out there. Just know that most of it is selling you something. Here is a link to some of the topics I’ve covered about investing and is a good place to start reading.
Have A Plan. Having a plan when it comes to investing is critical to your success. When times get tough (and they will) having a plan to remind yourself of why you are investing helps.
Pay Attention To Costs. The fees you pay eat into your returns, much more than most think. Understand how fees work and what you are paying, not just today, but over 30 or more years. Also, look into mutual funds and ETFs as your core holdings.
Diversify. You can’t be invested 100% in stocks and think you will never lose money. On the flip side, you can’t be invested 100% in bonds and think your money is going to grow enough to allow you to comfortably retire. You need a mix of both and of some other asset classes as well.
Your Emotions Will Be Your Downfall. Most every investor that fails does so because they give into emotion. They either get scared and sell when they shouldn’t or they get greedy and buy when they shouldn’t. Learn to control your emotions.
Focus On The Long-Term. Related to your emotions is your time horizon. Most people look at the market on a short term basis and the volatility scares them. The market will by jumpy in the short-term, but over the long-term, the trend is positive as seen in this chart:
The bottom line is this. If you are in debt and/or need help with budgeting and building a solid financial foundation for which to grow, you cannot go wrong by following Dave’s advice. But when it comes to investing, his investing advice will do you more harm than good.
Readers, what are your thoughts on Dave Ramsey investing advice?