



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.

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