As much as we’d like to think that personal finance is a perfect science, it simply isn’t. To some degree there is an extent of art and skill that has to be applied. You have to look at certain metrics, past returns, and other intangibles to make some educated decisions about your investment planning prospects. At times the process can be very subjective. And when things are subjective, that can open us to being misguided or wasting time going down the wrong path.
So if that were to happen, you would usually expect that kind of bad advice to come from some two-bit financial planner who doesn’t know what he’s talking about. Or it would come from someone pushing his own agenda.
But would you have ever expected bad investment advice to come from the beloved Dave Ramsey? According to a full feature in the October ’13 issue of Money Magazine, it’s true – and I bet you can suspect the reasons why.
I Don’t Know Much About Dave Ramsey:
Hang around anywhere that personal finance is discussed, and you can not help but hear people mention the name of David Ramsey. His face is plastered all over so many books, TV shows, websites, etc. His followers all love him and follow his advice religiously.
For a long time now when it came to Dave Ramsey I’ve felt like I was being excluded from some sort of club. Perhaps it’s because a lot of what he preaches does not apply to me directly. Dave’s message is more geared towards those who need help getting back on their feet after trying to battle their way through debt. I’ve always been more of a “I’m standing firm on my feet, so now how can I earn more passive income” kind of investment planning advice seeker.
So because of that I’ve never really bothered to read any of his books or look too deeply into his teachings. I’ve just been neutral on the guy and assumed that whatever he’s doing is helpful to someone other than me. Clearly given the number of Ramsey followers, he’s been doing something right.
Bad Investment Planning Advice:
So what sort of financial blasphemy is it that Dave Ramsey is being accused of in the Money Magazine article? They claim that he is teaching his followers to:
- Expect 12% annual returns (as demonstrated in this article here)
- 8% retirement withdrawals
- To seek out actively managed funds
Being a do-it-yourself investor and having read a great deal of personal finance books, I can assure you that those two statements are troubling.
12 Percent Annual Returns are Not Realistic:
It’s a well known fact among everyone from investment planning professionals to amateurs that the true average annualized return rate of the stock market since the 1920’s has been somewhere between 8 and 10% depending on whether you’re quoting the Dow Jones Industrial Average or S&P 500 stock market index.
Because of this, there is a widely held belief that over the long run (an investment period of 10 years or more) that the average investor cannot perform any better than the average market return. He can try, but he will more than likely fail to produce better results.
John Bogle (founder of Vanguard Mutual Funds and figure-head of the famous Bogleheads following) is one of the biggest advocates of popularizing this investment theory.
Maybe for a short-while in the 1990’s or some other snippet of time there was a period where stocks were returning more than 8 or 10%. But because the markets are cyclical, a down period will offset those gains and correct the average return back to the modest 8 to 10% return.
8 Percent Retirement Withdrawal is WAY Too High!
Now that we’ve pointed out that you can really only expect 8 to 10% returns (and not 12%), you can probably guess that taking out 8% of your money each year during retirement is simply a recipe for disaster!
Since the 1990’s the popular rule of thumb is that a safe withdraw rate of 4 percent during retirement should provide you with a high chance of success that your money will last you for at least 30 years. You could logically reason that the 4 percent withdrawal rate makes more sense when you consider:
- That you lose 3% to inflation, so really your net present returns will be more like 5 to 7%.
- Market fluctuations (which WILL happen).
Researchers who debate and explore these kinds of safe withdrawal rates all agree on one thing: The higher the number, the greater the likelihood of failure. If you were to even ask about 8 percent, they would probably laugh!
Actively Managed Funds vs Passively Managed Funds:
Another widely popularized strategy in the investing world is that investing in index funds (or passively managed funds) will always be better in the long-run. Not only will you receive better treatment, but you’ll also get more favorable tax treatment.
Again: John Bogle and the Bogleheads are very big advocates of these types of investments. The premise of index investing was basically what made Vanguard so popular.
You can also find this kind of advice in a lot of other investment planning books as well. The book “The Big Secret” by investment company owner and Columbia Business School professor Joel Greenblatt discussed this at length within his text. He stated that active managers cannot predict the future of stocks any better than the rest of us. So they will not be able to outperform a passive index fund. Over time both funds return about the same amount of capital returns. But since Active Managers charge more in fees than passive funds, they will erode your gains and therefore yield less return to us, the investors.
Why Would Ramsey Give Us Misleading Advice?
So if 12-percent returns and actively managed funds are so heavily disputed, why in the world would Ramsey ever promote them?
Only Ramsey himself knows. But as the Money Magazine article suggests, there is one obvious reason: Referral income.
When you’ve built a name and brand as big as Dave Ramsey, that name becomes a hot and valuable commodity. And that’s exactly what Ramsey has done. When the author of the Money Magazine article called one of Ramsey’s recommended associates, this is what he found:
“So how was the advice? Smiler recommended I invest in American Funds’ target-date fund, which carried an upfront 5.75% load. That means for every $100 I gave him, only $94.25 would actually be invested on my behalf. Again, that load is how Smiler gets paid for his time.”
Making money off of referrals or endorsements is nothing new.
To some degree, that’s all that advertising is: A referral for a fee. Advertising is on basically every TV show, every radio station, and pretty much every website you visit.
So then is Ramsey doing anything wrong?
I think it depends on where you stand on his investment advice. I’m personally in the camp that believes the average investor will have a hard time beating the average market return. And therefore the passive index fund is more appealing.
If anyone ever tried to tell me they’ve got an investment with a guaranteed 12 percent return, I’d look at them with a great deal of skepticism. If they then told me that this wonder-fund cost 5.75% up-front, I’d tell them to go fly a kite.
Don’t get me wrong – endorsements and referrals are not bad by nature. But when you have as many people hanging on your every word like Ramsey does, I think you need to be very careful with what sort of things you want to lend your name to. Another well known personal finance guru Suze Orman was blasted 2 years ago when she endorsed a high cost prepaid debit card. Many people argued that she was exploiting the less-fortunate.
This is why even though investment planning is highly subjective, you still have to root your assumptions in a solid foundation. Anyone can look up the returns of the S&P 500 or other indices and see what kind of returns they could expect. The best thing you can do for yourself is collect a great deal of diverse opinions and listen to their points. Accept what you believe to be true, can agree with, or have experienced yourself. Dismiss those things that do not align. And never-ever believe something simply because one person told you – no matter how prominent or trustworthy they may be. The mantra I always return to here on My Money Design: No one will be looking out for your money the way you should be.
- Understanding the PE Ratio Formula and Why It’s Such a Popular Stock Metric
- Why Total Return Investing Is Better Than a Dividend Strategy
- How to Read Stocks and Evaluate Their Basic Metrics
Images courtesy of FreeDigitalPhotos.net
Matt Becker says
There’s nothing inherently wrong with getting referral fees, but the problem with Ramsey and anyone else in the investment world that does it is that they’re impacting decisions that will play a HUGE role in whether people have enough money to live the life they want. When he advocates for this kind of thing he is actively damaging peoples’ financial future, which will have a direct impact on things like whether they can help pay for their kids’ education or whether they can ever stop working. I have no idea why he continues to put forth this ridiculous information (it’s probably too costly to admit his mistake at this point), but people need to understand that his debt advice is great and his investment advice is downright dangerous.
[email protected] says
I agree with Matt….his debt advice is excellent. People should ignore the rest IMO.
I’ve never heard anything bad about his debt advice. In fact this article from Money is probably the first real negative thing I’ve come to learn about Ramsey.
I agree that there is nothing wrong with referral fees. Heck – we all make them in one shape or form with the advertising on our blogs. But when it’s to get people to buy into a front load fund that costs 5.75%, there is clearly something askew.
“We” have brought this on ourselves by the majority of people having no idea how to manage or handle money. Just look at the Cell phone contracts: Everyone jumps on a Free phone with a $100 monthly bill locked in for 2 years, vs buying their own phone for $400 and paying only $50/month with no contract ($2400, vs $1600). People do not understand recurring costs or costs that they don’t pay directly out of pocket. That is why this fee structure exists.
I personally hate referral fees and commissions. I think they promote the exact opposite of what is in my best interest (and every other consumer). But I will have to live with them as long as everyone else demands this structure vs paying directly for service model.
I would echo that Dave Ramsey has pretty good advise for most people for getting out of debt, but fairly poor advice for investments from what I have seen.
Nice analogy with the cell phone contract fees. It’s amazing what 5 minutes and little math can do to reveal the better deal.
Ben @ The Wealth Gospel says
Dave Ramsey is selling a product, so he’ll do whatever he has to do to sell that product. My big issue with him is that his plan is a one-size-fits-all plan. He recommends the same things for everyone, rather than realizing that some people have different goals and levels of fiscal responsibility. As a former financial planner, I know how important it is to tailor your advice to the individual in front of you and not just spout off rules of thumb and absolutes.
Up until now I always thought of Ramsey’s “product” as being his books, show, coaching, etc. Now that I know he has these shady investments, this puts him in a whole new light.
DC @ Young Adult Money says
It’s important to take anyone’s advice with some caution. 12% returns sound INSANE if we are talking after inflation (which I’m assuming he is not, but if he was WOW!). I also did not know Dave Ramsey advocated actively managed funds. I should really just read his book since my wife won it in a giveaway, but I haven’t gotten around to it. It seems like too much weight is given to his opinions in the personal finance world.
Ramsey does have a ton of followers. Sometimes it can be a bit obnoxious to hear his teachings (no matter how good the good ones are) echoed over and over.
[email protected] says
I read that article and thought it was very well done. You can’t discount Dave Ramsay for all the help he’s given people when getting out of debt or really even Suze Orman for that matter. I also don’t blame them for trying to make money, but I do agree that many people blindly follow and don’t do their own research. Kid of reminds me of a television evangelist or something. That is scary.
You’re right – they’re not technically doing anything that thousands of other TV/radio personalities have done – cashing in on their success. I’m just a little disappointed that it comes across as ripping off those who don’t know any better.
John S @ Frugal Rules says
I’m with Ben on this one, my issue is his “one size fits all” approach. At the end of the day, we all have different situations and thus requiring different solutions. That said, I didn’t read the article, but would love to know his thoughts behind his numbers. That 8% withdrawal number is just nutty in my opinion. I know there are some good actively managed funds out there, but overall you really need to be looking at passively managed…unless you want to fund someone else’s retirement that is. 😉
Even if his referred advisers were to find a way to tailor the advice to your specific needs, it would still be absolutely insane to pay 5.75% for any fund. Even a decent adviser will charge you less than half of that.
We don’t have too many investment opportunities here, so his advice regarding investment is useless to me. I have read though in many places that it’s not really great advice.
What I did like from his book and ‘gospels’ was all the stuff relating to getting off debt, not keeping up the the Joneses etc. In this matter his advice probably helped many people and shaped some minds to a better money management. The investment advice though is clearly lacking.
I’m curious – where is “here” for you that there aren’t many investment opportunities?
Nothing wrong on his other debt-related advice. I’m sure a lot of it is very personal and straight from his experience.
Romania. We do have a Stock Exchange, but I wouldn’t put my money there just yet 😀
Donny Gamble says
I don’t think that Dave Ramsey gives bad advice, I just feel like it is suitable to some more then others.
Do you think that 12% returns and 8% retirement withdraws are reasonable?
JC @ Passive-Income-Pursuit says
I never really had any debt issues but when I was laid off I started to get really interested in personal finance and read one of his books. Even being a novice at that time with finance, especially the investing side, projecting 12% returns never sat right with me. It just didn’t pass the smell test as almost every other book cites the 8-10% annual returns over the long run and most actively managed funds won’t be able to beat the index any given year, let alone 2 straight years. I’d rather plan on 8% and if 12% comes then great. But suggesting 12% returns is easily obtainable will just lead people to saving less, thinking that they can just earn in the market to make up for lower saving.
JC @ Passive-Income-Pursuit says
Also meant to add that the rest of his advice is generally spot on when it comes to handling debt/budgeting.
Exactly! I’ve never heard anyone ever quote anything as high as 12%. Getting people to believe in a number that high could be dangerous for their future. Even though I frequently quote 8% returns on my site here, I actually use 6% in my own personal calculations just so that I over-save and compensate for anything that may or may not go wrong.
I agree that it is better to be conservative with the future projections. I usually use 7.5% but then add ~2.5% inflation for safe measure. This is very conservative, so sometimes I bump to 8.5% with 2% inflation just to see what things would look like :-). It is kind of crazy to see how much a % or two makes. A 1.5% change in real returns reduced my time to FI by almost 50%. Hence why worrying about Fees that are coming off of your returns is a huge deal.
It is possible to achieve periods of 12% total returns. I worked out that I’d achieved something like this over the last ten years (when you factor in dividends). The more relevant question that one should be asking is what level of risk one needs to take to hit those kind of numbers. In my case, that meant a few small cap dividend payers in the mix. That may be too much risk for folks just starting out.
Grayson @ Debt Roundup says
Having people use the 12% return calculation will really cause chaos as it equates to a big difference in what they project and what they actually earn.
Matthew Allen says
My gosh! People have been slamming Ramsey for his 12% return expectations ever since I can remember, and I’ve been listening to the guy on the radio for 15 years! Never once has he wavered on this number – and I’ve heard his rebuttal rants on his radio show several times.
I actually believe the guy. 12% IS POSSIBLE – and I have numbers to prove it! Back in January of 2012, I actually defended the 12% “myth” on my old money blog. I created a chart showing all of the funds I was currently invested in along with their returns –
Here is my brief defense on why you should expect more than 10% returns. The entire market averages 8 to 10%. Some mutual funds yield average returns, some below average and some above average. Pick the ones that yield above average returns. It is the full-time job of the investors within the respective funds to try to beat the market. Some do it better than others – and they publish their results publicly. I have several funds that have lifetime average returns greater than 10%.
Dave’s investment advice actually IS good one-size-fits-all type of advice. I’ve NEVER heard him recommend any specific investments. He ALWAYS says invest in mutual funds with long track records. The extent of his specific advice is that he says to spread the investments over 4 different mutual fund types – growth, aggressive growth, growth & income, international. That’s it! Never once have I heard him say anything about picking actively managed funds over passively managed funds.
Dave does not get kickbacks from fund companies for investments that advisers put their clients into. Dave gets paid directly from the advisers just for the referral. In no way does he specifically endorse any investment that any of those advisers put their clients into. He just endorses the adviser, who agrees contractually to give advice in line with Dave’s way of thinking. I’ve heard of bad advisers who made it into his ELP program, then later got screened out.
Dave is not wrong. I’m planning on 12%-ish, although I use 10% for all of my calculations just to be safe. It’s really not that hard to find a few mutual funds that perform like this in the long run.
Debt and the Girl says
I don’t really listen to any of those financial advisors except maybe Clark Howard but I don’t follow him or anything. Everyone makes mistakes no matter how well informed they are. I’d rather do what best for me.
I tend to meet a financial problem or big decision and then consult multiple types of financial advice (blogs, professionals, successful friends and family) and then decide what’s consistent or makes sense for me. It’s too hard, like many others have said, to take one persons complete financial handbook and apply all of it directly. Finances are too situational. That being said, there’s so many opinions out there I can’t fault anyone just because I disagree unless I know for sure it’s intentionally misleading or harmful. I thought this was an excellent post.
Jack @ Enwealthen says
Hmm, I don’t know much about Dave Ramsey other than he is very popular and promotes getting out of debt. Not very applicable to my situation, so like MMD, never really dug too deeply into his methods.
That said, I can see how people new to his philosophy and ignorant of the average stock market returns could buy into a 12% annual return given the stock market performance since 2008. I’ve had some great returns the last few years too, so has everyone else who’s in the market. But in no way, shape, or form, do I expect those returns to continue. On the contrary, I expect a major correction in the coming year.
Ever since 1996 it’s been one bubble and correction after another. If only we could stop looking for the quick buck / quick fix we might have a chance at a sustainable growth path.
Nice Research hope this article will help for some one i don’t thing so that 12% Return and 8% of retirement will be reasonable for any one.