You’ve no doubt heard of Dave Ramsey, the popular get-out-of-debt guru. Those of you who pay attention to such things have probably heard the following about him: his advice for getting out of debt and living within one’s means is great but his investing advice leaves something to be desired, at best (and is downright dangerous, at worst). The criticism has obviously gotten to him, because he recently devoted an entire podcast (it was the March 11th, 2013 episode) to defending his investing advice. While he may sound incredibly defensive in the podcast, in my experience he’s just extremely cranky-sounding in general, so I wouldn’t read too much into it.
So, objectively, how does Dave Ramsey’s investing advice stack up? Is he an enlightened guru? Or is he just going to end up costing his followers their retirement savings? My opinion is that as with most things, the truth lies somewhere in the middle. His advice isn’t great by any stretch of the imagination, but it’s not as bad as many of his critics would have you believe.
In A Nutshell: Dave Ramsey On Investing
Dave’s investment advice is pretty simple, in keeping with his overall message. First, he doesn’t advise anyone to invest for retirement until they’ve saved up $1,000 in an emergency fund and paid off all non-mortgage debt. While I don’t necessarily think this approach is ideal, there’s nothing particularly controversial about it (I know a few experts who would vehemently disagree).
After paying off all non-mortgage debt, Ramsey recommends you invest 15% of your income (as reasonable a number as any) for retirement. This is where things begin to get a little crazy. Ramsey actually makes several highly-controversial recommendations at this point:
- Diversify over 4 different asset classes - Nothing controversial on the face of it. Dave recommends investing 25% of your retirement portfolio in each of the following for asset classes: growth stocks, growth and income stocks, aggressive growth stocks, and international stocks. Notice anything missing? Yep, it’s…
- No bonds – Dave doesn’t like bonds. For anybody. Ever. He does make an attempt to explain himself, but makes several fundamental errors while doing so. More on this later. Suffice it to say I very, very, very, very strongly disagree. It is my opinion that all investors, even very young investors, should probably keep a token bond allocation. This advice is quite bad and Dave’s defense of it strikes me as extremely weak.
- Don’t go it alone – Dave discourages his followers from trying to invest on their own. Instead, he recommends you invest through his Endorsed Local Provider program. Basically, it’s a list of local (to you) providers who recommends. There have been accusations Dave earns a revenue stream off his ELP program, making for obvious conflicts of interest. I don’t have any special information, so I won’t comment on the subject.
- He hates most kinds of annuities – Dave is down on variable annuities on account of their complexity, which makes sense. But he also dislikes fixed annuities, which doesn’t make any sense. He simply advises us to “stay away from fixed annuities” without offering any explanation as to why (that I can find, at least).
The Good, The Bad, And The Ugly
So how does his advice and defenses of it stack up? I’ve broken things down.
Dave advocates buy-and-hold
He rightly states that timing the market is a loser’s game. Instead, he preaches the virtues of buying a diversified basket of securities and holding on for the long haul in spite of market conditions or short-term trends. This does tend to lead to superior results over time.
Stay away from individual stocks
Dave recommends investors stay away from individual stocks. I agree: most people have no business investing in individual securities.
Dave makes the psychology of investing front and center
Dave knows the biggest impediment to a successful investment program is psychology, not picking investments. The biggest mistake an investor can make is to panic and sell out at the wrong time. This is an area I think he receives far too little credit in. His solution to this problem leaves a lot to be desired, but he deserves credit for drawing attention to it.
He makes it easy to get help with your investments
Say what you want about his ELP program, but he makes it so easy to get over one of the most significant humps in setting a long-term investment program: hiring financial help. Sure, his ELPs don’t exactly set the bar high, on average, but what’s the alternative? Not investing at all or putting your money in penny stocks? For a lot of the less-sophisticated Dave followers, those are both realistic outcomes.
Dave doesn’t care about expenses
Dave does a grave disservice to his followers by stating how he doesn’t really like index or no-load funds. Why? As he puts it, if you bought a no-load or index fund, you probably did it without the help of a competent financial advisor. That’s blatantly untrue. Plenty of financial advisors use no-load index funds, including the majority of the best ones. Investment expenses matter, even more-so when investing through an advisor. While it’s true investment advice isn’t free, going Dave’s route is among the most expensive and least-efficient imaginable. You could easily get better advice for less money than what Dave suggests.
There are seemingly few requirements to get into his ELP program
Dave’s ELP program is great in theory, but there don’t seem to be particularly stringent requirements to gain entry. From what I’ve seen, almost any advisor, regardless of skill, could get accepted just by paying a fee. I hope this isn’t true, but I’ve seen no evidence that it isn’t and plenty that it is.
His methodology for selecting mutual funds is provably incorrect
Dave recommends you buy “good growth stock mutual funds earning at least 12% per year.” How does one do that, you may ask? It’s easy! Just sign up for an account on a site like Morningstar (I do highly recommend Morningstar’s free, not paid, account). Of course, past performance is no guarantee of future results. Surely Dave knows how many dozens and dozens of studies there have been conducted proving this approach doesn’t work, right?
Dave still stands by his claim that you can get 12% returns
First of all, the long-term market average is not 12%! Anybody who tells you otherwise is lying. The data is shaky before 1920, but according to Ibbotson (not free, sorry) the annual compounded growth rate of US stocks going back to 1825 is only 8.5%, nowhere near 12%. 12% is crazy. But even if 12% were the correct number, are you likely to earn it on your portfolio? You may, but probably not. While the market may return 12% over the very long term, the chances of you investing through one of the boom periods isn’t all that high because there are many periods with much lower returns. Take the 40-year period from 1968-2008, for example. According to Larry Swedroe, stocks generated only a 4.2% real return over that period, a period, by the way, that included one of the greatest and longest bull markets in stock market history. That’s no more than long-term government bonds returned over that same period. That’s a loooooong time for all that risk you’re taking with equities not to pay off, which brings me to my next point.
Dave recommends 100% stocks
This is horrible advice. Expected returns doesn’t necessarily translate to actual returns. If the risk of owning stocks were guaranteed to pay off over long periods of time, they wouldn’t be risky and there would thus be no risk premium for owning them. Stocks are considered risky because there are no guarantees. Stocks will probably return more than bonds over the next 30 years, but they might not. Can you afford the consequences if they don’t? If not, you had better own bonds. Dave doesn’t seem to take this risk seriously even though history has shown its not unheard of (in fact, it happened quite recently). While I don’t think this advice is going to bankrupt anybody, it’s definitely going to make for a lot of either extremely happy or extremely bitter retirees in 30 years. Hopefully it’s the former but you shouldn’t underestimate the probability it’s the latter. That’s why I own bonds.
Dave recommends an absurdly high withdrawal rate
Last I heard, Dave was saying you could withdraw 8% of your portfolio per year in retirement. That’s absurd. Under certain very specific conditions and in a bull market this might be reasonable, but it’s absurd to think an 8% withdrawal rate would hold up under more normal conditions or, gasp, a secular bear market. Anybody who retired and tried to withdraw 8% circa 2000 is almost certainly back at work today.
If I had to rate Ramsey’s get-out-of-debt advice, I would probably give it a 9 out of 10. It’s excellent. His investment advice, on the other hand, would probably warrant more like a 3 out of 10. His advice is poor even by guru standards. Unfortunately, it doesn’t matter. If stocks do well, Ramsey will look like a genius. If they don’t, well, he’s already a multi-millionaire. He might lose credibility, but not his fortune. His followers, on the other hand, could be wiped out. Dave can afford a 50% drop in the value of his portfolio; his followers can’t.
Overall, Dave seems to be unaware of the findings of a huge variety of academic research from the psychology of markets to behavioral finance to asset allocation. Consequently, I would not recommend following Dave’s investing advice. Instead, I recommend you pay a visit to the Bogleheads forum and check out some of the better investment books out there, among which The Bogleheads Guide To Investing by Taylor Larimore et al, Unconventional Success by David Swensen, All About Asset Allocation by Rick Ferri, and especially The Intelligent Asset Allocator by William Bernstein (from which the inspiration for the name for this website was drawn) are a few of my favorites.