Dave Ramsey is an expert when it comes to helping people get out of debt. His simple yet actionable advice explains the steps to change your finances from living in debt to living prosperously.
But while his advice on helping people to get out of debt is spot on, the investing strategy Dave Ramsey guides his followers with is dangerous.
So dangerous in fact that many people potentially end up with a lot less in savings and run the risk of running out of money during retirement!
In this post, I am going to look at Dave Ramsey’s investing philosophy and walk you through why it is flawed.
It is critical that you see this so that you don’t end up not saving enough for retirement or spending too much in retirement.
Disclaimer: I Like Dave Ramsey
Before you read why I am against the investing advice Dave Ramsey preaches about, know that this doesn’t come from a place of dislike for Dave.
I love everything he says about debt.
For the majority of Americans that stink at saving money, simply following his Baby Steps will get you in excellent financial shape.
Heck, I even followed the debt snowball method when I was in credit card debt.
I 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.
There are even a few things about Dave Ramsey’s investing philosophy I agree with, like avoiding annuities at all costs.
But with all of the love I have for him, when I start peeling back the layers about the rest of his investing advice, I found some disturbing things.
And I think this is due to his experience. Why is he great at helping people get out of debt? Because he was in a mountain of debt and figured out how to get out once and for all.
But he doesn’t have experience when it comes to investing. This isn’t how he grows his wealth. He makes his money through his syndicated radio show, selling books and his real estate investing.
So while he understands some things about investing, he doesn’t have the same knowledge as someone who has been educated on the subject or has built their wealth through investing.
The result is solid advice for getting out of debt and no-so-great advice for how to grow your wealth through investing.
And since my goal is to help you to achieve your financial dreams, I feel you should understand how his investing advice can leave you in rough shape when it comes to achieving your dreams.
4 Questionable Pieces Of Dave Ramsey’s Investing Strategy
#1. The 12% Belief
Following Dave Ramsey’s investing advice, he claims that over the long term, an investor can reasonably 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, he 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%. Your average rate of return is 25%.
As a result, your $100 should be worth $125, since your rate of return is 25% ($100 x 25% + $100).
But when you look at your account balance you don’t have $125, you only 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 a balance of $50.
In the second year, you earn a 100% return. A 100% return on your $50 is $50, so you end up with an ending balance of $100.
In those two years, you have earned 0% on your money.
I know this can be a little confusing, but this is how the stock market works. Here is the Dave Ramsey investment calculator he uses to prove the 12% return point.
Enter 1924 as the starting date and 2017 as the ending date and click the calculate button. The result shows an average return of over 12% and an annualized return of 10%.
Notice how the word average next to the 12% is in quotations? This is done to tell you that this is the arithmetic average and you can’t rely on this number.
Additionally, you need to check the box to adjust for inflation. This is because every year that passes, every dollar you own becomes less valuable.
When we check this box and click the button to calculate real world returns, our real world annual return is 7.43%.
You might be thinking why this is a big deal. Let’s use an example to help you understand it.
We have Bob who is expecting a 12% return on his money. He is making $60,000 a year and saving 15% of his income, or $9,000. He saves for 30 years.
Based on Dave Ramsey’s investing advice, he expects his balance at the end of the 30 years to be $2,432,633.
But when he goes to retire, he finds that his balance is worth $1,000,389.
While having a million dollars saved for retirement is excellent, look at the difference between what Bob was expecting to have and what he actually has.
It is a difference of over $1.5 million dollars!
Let’s look at another example. Joe got into debt at a young age and finally broke the cycle when he hit 40.
He is able to save $300 a month for 25 years until he is 65. Using the Dave Ramsey investment calculator, he expects to have $537,000 saved for retirement.
He makes plans based on this amount of money. But when he retires he sees his retirement account is worth $263,000.
This forces Joe to give up on some of his retirement dreams.
Mathematically there is nothing wrong with the 12% number Dave Ramsey is using. It is correct.
However it is very misleading because it doesn’t take into account compounding of returns.
By assuming you can safely earn 12% annually you are setting yourself up for great disappointment in retirement.
This is why the majority of financial experts cite 6-8% as a reasonable return to expect on your money.
#2. Asset Allocation
The next area of Dave Ramsey’s investing strategy that is misleading is asset allocation.
If you’ve read my post on investment diversification, you know how important it is to be diversified across many asset classes, but this isn’t the case with the investment advice Dave Ramsey gives his listeners.
Here is Dave Ramsey’s investment strategy from his website:
Dave recommends mutual funds for your employer-sponsored retirement savings and your IRAs. Divide your investments equally between each of these four types of funds:
- Growth & Income
- Aggressive Growth
He recommends you invest in 4 stock funds, 3 of which are roughly the same asset class. By investing in a growth, growth and income, and aggressive growth funds, you are basically investing in the same companies, just using different funds.
This is not diversifying your risk. You want to invest in different types of investments, like large cap companies and small cap companies.
For example, let’s look at a growth fund and a growth and income fund. We will look at mutual funds from Vanguard.
Here are the top 10 holdings in the Vanguard Growth Index Fund (VIGAX) and the top 10 holdings in the Vanguard Growth and Income Fund (VQNPX):
Of the 10 holdings in each, 40% are held in both funds. If we were to dig deeper, we would continue to see overlap. What this means is that when you buy both of these funds, you are essentially buying the same fund twice.
This is not diversification. It’s like buying a bottle of Coca Cola and a bottle of Pepsi for a party.
Both are cola. You are better off buying a bottle of Coca Cola and a bottle of A&W Root Beer or Ginger Ale.
To be truly diversified when it comes to investing is to own various asset classes. This includes owning some combination of the following:
- Large cap stocks (both growth and value)
- Small cap stocks (both growth and value)
- International stocks (both large cap and emerging markets)
- Bonds (treasury, municipal, corporate)
- Commodities (oil, precious metals)
- Real estate
You don’t need to own something in each of these categories, but you should have exposure to more than just one which is what happens when you follow Dave Ramsey’s investing philosophy.
When you are fully diversified, you lower your overall risk and are still able to achieve a decent return.
But when you follow Dave Ramsey’s investing philosophy, you increase risk and don’t increase your return.
#3. Load Mutual Funds
A big part of the Dave Ramsey investing philosophy is investing in load mutual funds.
Here is what he says on his website:
Many investors hate the idea of paying around 5% of their investment for up-front commission. But because it’s a one-time expense, the value of your investment grows without being bogged down by expensive fees. And, as your investment increases in value over time, the commission has less impact on the overall cost of owning the fund.
Loaded funds also come with help – an investing professional. The commission pays for your pro’s extensive knowledge of the thousands of mutual funds available. The up-front commission is really not a lot to pay to have someone on your team, teaching you how to invest successfully.
When you buy a load mutual fund, you pay a fee upfront to invest. The fee you pay goes towards your financial advisor and this is how he earns his money.
If you were to invest with a financial advisor that charged you a fee based on assets under management, you would pay a percent of how much you have invested with them, which is usually around 1%. This fee is how the financial advisor is paid.
When investing in load mutual funds, the typical charge is 5.75%. This means that for every $100 you invest, $5.75 is going to the advisor and you are investing the remaining $94.25.
Here is why this is a bad idea. Let’s say you are investing $100 a month into a load mutual fund for 25 years. Your investment grows at 8% a year. How much do you have?
You invested a total of $30,000. Of this amount $1,725 went to the advisor and you invested the remaining $28,275.
Your ending investment is $284,521.
But what if you invested in a no load mutual fund, one that doesn’t charge any upfront fees?
Your investment would be worth $301,879.
That is a difference of over $17,000!
And before you think that the fee you pay is worth it because the fund is professionally managed, think again.
All mutual funds are professionally managed. And the evidence shows that most of the actively management mutual funds perform worse than passively managed index based mutual funds.
For example, here is a great chart showing you how many actively managed mutual funds outperformed the S&P 500 Index:
As you can see, the odds are slim that you earn what the market earns by investing in actively managed mutual funds.
In other words, the odds are great that if you invest in actively managed mutual funds, you will end up with less money than if you invest in index mutual funds.
Don’t make the mistake that many other investors make, thinking that the more you pay for a mutual fund, the better it will perform.
When it comes to investing, the opposite is true. The less you pay, the more likely you will have higher returns.
How is this possible?
Because the money you pay in fees comes out of the fund itself. This eats away at your ability to grow your wealth.
Look back at the example I showed you above. In 30 years you paid less than $2,000 in fees to invest your money. But you ended up with close to $17,000 less.
The $15,000 difference is your opportunity cost. Had that $2,000 stayed invested, it would have grown to be worth $15,000.
What could you do with an extra $17,000?
In other words, you are paying money for something you can easily do for no fee at all. And as you invest more money, the numbers only continue to grow larger.
Related to the load mutual fund advice is Dave’s recommendation on advisors.
Years ago, if you wanted to work with a financial advisor who followed the Dave Ramsey investment philosophy, you went with one of his Endorsed Local Providers (ELP).
These were financial and real estate professionals who Dave promoted as the best in the business. According to the Dave Ramsey website, they were held to a higher standard of excellence so that investors were treated right.
To be part of the ELP program, advisors had to pay a fee. This fee was used to cover employment costs and website maintenance.
In exchange for this fee, advisors were given referrals from the Dave Ramsey website and they had territorial rights to their geographic area, meaning no other advisor in their local area could be an ELP.
The advisors that joined the program had to follow the Dave Ramsey investment philosophy. This meant selling investors front loaded mutual funds.
Today the ELP program has been replaced by the SmartVestor Pro program. I am not going to give a full SmartVestor Pro review, but this program is an advertising service where investors can connect with local advisors.
Advisors pay and advertising fee to be listed on the Dave Ramsey website. Under this new program, advisors no longer have territorial rights.
What this means is that instead of getting all of the referrals for your local area, investors now get the names of multiple advisors. The advisors have to compete for the business.
There is no confirmation as to why the ELP program ended, however the change came when the Department of Labor proposed a new law regarding fiduciary standard.
Without going into great detail, the basis behind fiduciary standard is that an advisor has to put their client’s interests ahead of their own, regardless if the advisor will make money or not.
Surprisingly to many investors, not all advisors do this.
If an advisor is not a fiduciary, and many advisors aren’t, they only have to invest your money in a way that is suitable for you.
In other words, let’s say there are two identical investments and one charges a higher fee than the other.
An advisor that follows the fiduciary standard is required to put your money into the one with the lowest fee. It is their duty to do what is best for you.
An advisor that does not follow the fiduciary standard is not required to put your money into the investment with the lowest fee. They can choose either one, as long as the investment is suitable for you.
What does this mean? If the advisor earns a commission from the higher priced investment, and they are not a fiduciary, they do not have to tell you this. They can even choose to only offer you investment choices that give them a commission.
An advisor who is a fiduciary can still sell you an investment that they earn a commission off of, but they have to disclose this information to you.
The fiduciary standard stops this conflict of interest by making advisors act in their clients best interest.
To be affiliated with Dave Ramsey, advisors in the SmartVestor Pro program pay Dave Ramsey an advertising fee.
The only other thing an advisor has to do is agree to the Code of Conduct.
While having a code of conduct is a step forward, it still isn’t good enough. Instead of following the fiduciary standard, advisors affiliated with Dave Ramsey only need to follow the suitability standard and be registered with the Financial Industry Regulatory Authority (FINRA).
This means they can still sell you high commission investments when a lower cost option is available.
It is important to note that Dave Ramsey has been a vocal opponent of the fiduciary rule. His claim is that it will hurt investors.
He feels that advisors will limit their advice because they can now be sued by investors. I believe there is another reason.
Dave Ramsey makes a mountain of money off of the advertising fees advisors pay to be part of the now defunct ELP program and the new SmartVestor Pro.
Just how much money?
The fee advisors pay ranges between $400 and $900 depending on many factors. If you take the 1,000 advisors in the SmartVestor Pro program and they each pay the minimum $400 a month, this comes to $400,000 in fees Dave Ramsey is earning.
Over the course of a year the earnings from the SmartVestor Pro fees comes to $4,800,000!
As you can see, Dave has a vested interest in keeping this program running.
#4. Retirement Withdraw Rate
The final piece of advice that Dave Ramsey gets wrong is the rate at which you can withdraw money from your retirement plan to live on.
He suggests an 8% withdraw rate is acceptable. Most retirement experts suggest only 4% is an acceptable withdraw rate.
And some experts think you can’t follow a static withdraw rate.
Let’s take a look at an example of these various withdraw rates to see how they play out. We will assume you have $1,000,000 saved and will be taking this money out starting at age 65.
As you are taking your money out, your investments will continue to grow at 8% annually.
Here is how much money you will be withdrawing based on an 8% and 4% withdraw rate and your ending balances.
As you can see, when you are withdrawing 8% of your money every year, your account balance is decreasing in size.
On the other hand, when you are withdrawing 4% of your money every year, your account balance grows.
This is because you are earning more than you are withdrawing each year.
But this example doesn’t paint a true picture because the market fluctuates from year to year.
When we look at these numbers in the real world, we see some scary numbers.
Here is the data from a monte-carlo simulation. It takes 30 years periods from 1928-2017 to see what the likelihood is of you surviving retirement and not running out of money.
Using the 4% rule, you have a 99% chance of not running out of money. And in the worst case scenario, you still have more than enough money than you started with!
But if we look at an 8% withdraw rate, the numbers are very different.
You have an 18% chance of running not out of money. And the best case scenario, you have $5 million left.
I don’t like those odds. And neither should you. You worked hard for your money and saved with the purpose of enjoying your golden years.
Don’t let a foolish mistake cost you your dreams. You need to stick with a lower withdraw rate otherwise chances are you are going to run out of money in retirement.
How You Should Be Investing Your Money
Now that you see the issues with Dave Ramsey’s investing advice, how do you go about investing your money?
I know that you follow the advice of Dave because he is a trusted source and because investing is overwhelming with all of the investment choices out there.
So I’ll give you two options to consider.
Why should you listen to me? I’ve been in the financial services industry for close to 15 and I’ve worked with investors who had millions to invest.
All along the way, I was a fiduciary and always put the client first.
On a personal level, I’ve been investing my money since the late 1990’s and have grown my wealth to close to seven figures through a buy and hold investing approach.
You can grow your investment wealth without a financial advisor and you don’t need to be paying loads on mutual funds to invest.
You can do it all yourself with just a little hand holding.
The first option is Wealthsimple and they are perfect for you if you want some hand holding when it comes to investing.
They are commonly known as a robo-advisor and after you answer a few questions, Wealthsimple will pick a fully diversified portfolio for you.
All you have left to do is set up an investment amount and start investing.
They also offer other great features to make investing easier for you which you can learn about in my full review.
To get started with Wealthsimple, click here.
The other option is for those of you who are comfortable with being more hands on. It is called M1 Finance.
And while M1 will handle the entire behind the scenes work for you like Wealthsimple, the biggest difference with M1 is that you pick your portfolio.
You don’t answer a risk questionnaire like you do with Wealthsimple. You can choose from pre-built portfolios or you can build your own custom portfolio.
You can learn more about M1 Finance in my detailed review and why I love it so much.
The best part of M1 is that if you decide to go this route and need some help, assistance is just a phone call away to answer any questions.
You can click here to get started with M1 Finance.
How Much Money Will You Save?
If you decide to go with one of these options over a SmartVestor, here is how much money you will save.
If you invest $24,000 for 20 years, here is how much your investment will be worth after fees and expenses.
As you can see, the fees that you pay to invest make a huge difference over time.
The difference can be as much as $35,000!
How much more enjoyable would retirement be if you had another $35,000 in savings?
Investing Basics To Learn
Regardless of the route you decide to take, you should educate yourself on the basics when it comes to investing.
Not only will it help you to make smarter decisions with your money, but it will help you to save money and grow your wealth more consistently.
Here are some key things to keep in mind to be a successful investor.
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 tremendously.
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 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 and you will see more success when it comes to investing.
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.
But if you pull back and look at things over the long term, you will see things aren’t so bad.
The market will by jumpy in the short-term, but over the long-term, the trend is positive.
I love Dave and the advice he gives listeners for how to get out of debt. It is spot on. But I disagree with Dave Ramsey’s investing philosophy.
It misleads people into thinking they can save less than they should because they can achieve higher returns that are simply not possible over the long term.
Furthermore, if you follow Dave Ramsey’s investing advice when it comes to your withdraw rate, you are very likely going to run out of money.
And the last thing you want to do at 85 years old is to have to go back into the workforce!
At the end of the day, I highly recommend you follow Dave’s advice on getting out of debt. But follow different advice when it comes to investing your money.