Dangers of Dave Ramsey’s Investment Advice

Dangers of Dave Ramsey’s Investment Advice March 17, 2011

I started listening to Dave Ramsey in college and really found his show to be both encouraging and entertaining (in a good way mostly).  His principles can help people struggling with debt and I encourage anyone to read the book Total Money Makeover.

Like other financial writers, there are some things Dave says that I don’t agree with completely.  One of those issues in particular is his perception of potential returns in the stock market.  Here are a few good articles that break down the misconceptions of a 12% return:

Where Dave Ramsey and I Part Ways

The Good, The Bad,  The Ugly – Dave Ramsey

Five Ways I Disagree With Dave Ramsey

 

The Dave Ramsey blog most recently featured an article called The 12% Reality.  It attempts to explain how Dave comes up with his advice to seek out mutual funds that are returning 12%+.  I couldn’t believe he was still promoting the idea that investors should expect no less than 12% in the stock market.  I’d much rather expect 7-10% on average and be pleasantly surprised with the years of double digit returns.

The Dangers of Dave Ramsey’s Advice

Dave may be close in his estimates for a few select mutual funds, but to get anywhere near an 11-12% return you would need to first pick the solid performer and then stay put for 10 years or more to realize any long term averages that he’s claiming.  Dave’s suggestion that you SHOULD be earning 12% ultimately harms the investor because it causes investors to search for the ‘hottest’ mutual fund.  If you tell people to expect 12% on their mutual funds and they don’t achieve it, you are fostering the behavior of switching funds more frequently, which actually hurts investors.

I really didn’t like his article and disagree with most of his investing advice.  He is great at motivating people to get out of debt, but I think that his investment advice causes more harm than good.

What are your thoughts?  Have you read his latest article about the 12% return as a reality?

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  • Good post Tim. I’ve been reading a lot about Dave Ramsey lately because the church I attend in KC offers a course/seminar based on his work/principles. I’ve heard him on the radio a time or two, but I never paid that close attention.

    I wonder if he has some potential to cause churn in the market just by endorsing a particular fund, or if the 12% return becomes a self-fulfilling prophecy because all his listeners jump on it, sort of like whenever Kramer from Mad Money endorses or criticizes a company.

    I still don’t know enough about Ramsey to form an opinion on him, but at least he isn’t an adherent to the “prosperity gospel” that is so popular out there in some circles (http://www.desiringgod.org/blog/posts/why-i-abominate-the-prosperity-gospel)

    • Tim

      I’ve never really heard him promote a specific mutual fund – it’s usually just in generalities. This is another reason why I’m not a fan of his investment ‘insights.’

      Good point about the prosperity gospel…that would definitely make for a good article (or two).

  • Good post Tim. I’ve been reading a lot about Dave Ramsey lately because the church I attend in KC offers a course/seminar based on his work/principles. I’ve heard him on the radio a time or two, but I never paid that close attention.

    I wonder if he has some potential to cause churn in the market just by endorsing a particular fund, or if the 12% return becomes a self-fulfilling prophecy because all his listeners jump on it, sort of like whenever Kramer from Mad Money endorses or criticizes a company.

    I still don’t know enough about Ramsey to form an opinion on him, but at least he isn’t an adherent to the “prosperity gospel” that is so popular out there in some circles (http://www.desiringgod.org/blog/posts/why-i-abominate-the-prosperity-gospel)

    • Tim

      I’ve never really heard him promote a specific mutual fund – it’s usually just in generalities. This is another reason why I’m not a fan of his investment ‘insights.’

      Good point about the prosperity gospel…that would definitely make for a good article (or two).

  • I like how the article mentions 2009 and 2010 but what about 2007 where the market returned -36%ish?

    12% is a CRAZY number for ANYONE to bank on, because I don’t know that many people who are in the market for 80 or so years lol

    • Tim

      No kidding Evan! He talks about the spike in 2009 like it was above and beyond normal market returns…when it was the market trying to rebound back from where it had fallen from. Anyone can look to see these kinds of spikes following recessions and see that it happens because there was an equally negative DIP.

      12% IS crazy! So is Dave’s investment advice IMO :)

  • I like how the article mentions 2009 and 2010 but what about 2007 where the market returned -36%ish?

    12% is a CRAZY number for ANYONE to bank on, because I don’t know that many people who are in the market for 80 or so years lol

    • Tim

      No kidding Evan! He talks about the spike in 2009 like it was above and beyond normal market returns…when it was the market trying to rebound back from where it had fallen from. Anyone can look to see these kinds of spikes following recessions and see that it happens because there was an equally negative DIP.

      12% IS crazy! So is Dave’s investment advice IMO :)

  • I commend Dave Ramsey for all the work that he has done in helping listeners improve their financial situation.

    But I think that any discerning listener will find a handful of things that they disagree with, including investing principles.

    I think that is it difficult for anyone giving generic advice to millions of people. You cannot fit some of the unique strategies and investment options that are available, because it is impossible to know everyone’s personal situation.

    As an investment advisor, I’m somewhat stumped on his asset allocation advice to divide 1/4 of your portfolio between small/medium/large growth and international funds.

    Where exactly does value investing fit? Why not adjust the allocation as different assets are moving in and out of favor? Why always be long the allocation instead of defensive? These issues cannot be addressed because he is giving generic advice to the multitudes.

    But I’ll try not to be too hard on him…he’s been instrumental in changing many financial lives

    Derrik Hubbard, CFP

    http://www.yourfinancialpurpose.com/blog

    • Nancy Darnall

      Twelve percent is hard to get every year, but look at this from http://www.highyieldmutualfunds.net/top-100-mutual-funds/

      The top 25 mutual funds as of 3/18/2011

      Fund Name 5-yr Annualized Yield

      Van Eck Intl Investors Gold I 28.77

      T. Rowe Price Latin America 27.43

      BlackRock Latin America I 26.65

      BlackRock Latin America A 26.31

      USAA Precious Metals and Minerals 26.21

      BlackRock Latin America C 25.32

      BlackRock Latin America B 25.27

      Van Eck Intl Investors Gold A 24.76

      Dreyfus Greater China I 24.29

      Dreyfus Greater China A 23.96

      Van Eck Intl Investors Gold C 23.93

      Franklin Gold and Precious Metals Adv 23.86

      Franklin Gold and Precious Metals A 23.56

      Dreyfus Greater China C 23.01

      Dreyfus Greater China B 22.97

      Oppenheimer Gold & Special Minerals A 22.85

      Matthews China 22.66

      Franklin Gold and Precious Metals C 22.64

      Franklin Gold and Precious Metals B 22.63

      Oppenheimer Gold & Special Minerals N 22.46

      Fidelity Latin America 22.19

      Fidelity Advisor Latin America I 22.10

      Evergreen Precious Metals I 21.98

      Oppenheimer Gold & Special Minerals C 21.93

      Oppenheimer Gold & Special Minerals B 21.86

      • Devin

        Nancy, you’re doing the same thing Ramsey does: cherry picking and back testing. These are a few funds out of thousands in an up year.

        • Nancy Darnall

          When we invest in mutual funds, we use this kind of data. “Back testing and cherry picking” is research. I look at a ten plus year record before I go into a new fund. We also have a fiduciary who works with another asset management tool which has been working well for us. I agree that Dave Ramsey’s strength is in helping people find their way out of debt and into financial responsibility. The nice thing about radio personalities is no one HAS to listen to them. I cherry-pick those.

          • Petunia 100

            It isn’t very useful to identify outperformers AFTER they have outperformed. To consistently get those double digit returns, we must identify outperformers BEFORE they have outperformed. Can you give me that list, Nancy? If not, you are merely advocating jumping from hot fund to hot fund and buying high. This is exactly the behaviour which leads to investors earning LESS than the market and should be avoided. The idea is to buy low sell high, not the other way around.

          • Nancy Darnall

            Past performance is the best indicator of future performance. I did not say I jump from fund to fund, but that I use this data before going into a “new fund.” You can get the list yourself by subscribing to or accessing Morningstar at your local library or your broker’s office. Our fiduciary has several programs to identify such funds. Just because a fund outperforms the market does not mean new investors are going in at the highest price. You apparently have a talent for prediction if you can identify outperformers before they outperform, but you should read what is in a post (and not infer things not there) before you go on the attack.

          • James

            Nancy,

            How much did YOUR portfolio return this year? Last year? Last 3 -4 years on average?

            What a business did in the past is important, but it’s not the best way to judge their future performance. Just look at companies like Circuit City – great in the past, now they’re gone! There are a lot more just like that. Yes, I know we’re discussing mutual funds, but these companies are what makes up these funds.

            Hindsight is always 20/20. It’s very unlikely that an average investor can return 12% in this investment environment.

          • Nancy Darnall

            Overall, for the past four years (1/1/2008 to date), 20.37%. This includes our daughter’s 529, all retirement investments, and non-retirement investments. Real estate is excluded.

          • Rittmann

            Nancy, I’m guessing that 20.37% return is a total return not an average annual return. Because, if you got 20.37% for the past 4 years and you didn’t contribute any money to these accounts, then these accounts should have more than doubled.

          • Rittmann

            To put a finer point on it, if your accounts have gained 20.37% over the last 4 years, then your average annual return has been 4.65%.

          • Past performance is absolutely not the best indicator of future performance. This is why it is required by law for every advertisement containing historical returns to state the following “Past performance is no guarantee of future results”.

            Morningstar has determined that the best indicator of future performance is costs.

            http://www.cbsnews.com/8301-505123_162-37640470/the-best-predictor-of-future-fund-performance/

            BTW, anyone can access Morningstar at morningstar.com. If you have internet access, you do not need to go to the library or your broker’s office.

            And no, I do not have a talent for predicting outperformers. This is precisely why I buy and hold index funds, but only the ones with rock bottom expense ratios.

            I have not attacked you. I strongly disagree with your claim that future outperformers can be identified by looking at past performance. All available evidence contradicts your claim. Some unethical salesperson must have fed you that notion in order to make a sale.

  • I commend Dave Ramsey for all the work that he has done in helping listeners improve their financial situation.

    But I think that any discerning listener will find a handful of things that they disagree with, including investing principles.

    I think that is it difficult for anyone giving generic advice to millions of people. You cannot fit some of the unique strategies and investment options that are available, because it is impossible to know everyone’s personal situation.

    As an investment advisor, I’m somewhat stumped on his asset allocation advice to divide 1/4 of your portfolio between small/medium/large growth and international funds.

    Where exactly does value investing fit? Why not adjust the allocation as different assets are moving in and out of favor? Why always be long the allocation instead of defensive? These issues cannot be addressed because he is giving generic advice to the multitudes.

    But I’ll try not to be too hard on him…he’s been instrumental in changing many financial lives

    Derrik Hubbard, CFP

    http://www.yourfinancialpurpose.com/blog

    • Nancy Darnall

      Twelve percent is hard to get every year, but look at this from http://www.highyieldmutualfunds.net/top-100-mutual-funds/

      The top 25 mutual funds as of 3/18/2011

      Fund Name 5-yr Annualized Yield

      Van Eck Intl Investors Gold I 28.77

      T. Rowe Price Latin America 27.43

      BlackRock Latin America I 26.65

      BlackRock Latin America A 26.31

      USAA Precious Metals and Minerals 26.21

      BlackRock Latin America C 25.32

      BlackRock Latin America B 25.27

      Van Eck Intl Investors Gold A 24.76

      Dreyfus Greater China I 24.29

      Dreyfus Greater China A 23.96

      Van Eck Intl Investors Gold C 23.93

      Franklin Gold and Precious Metals Adv 23.86

      Franklin Gold and Precious Metals A 23.56

      Dreyfus Greater China C 23.01

      Dreyfus Greater China B 22.97

      Oppenheimer Gold & Special Minerals A 22.85

      Matthews China 22.66

      Franklin Gold and Precious Metals C 22.64

      Franklin Gold and Precious Metals B 22.63

      Oppenheimer Gold & Special Minerals N 22.46

      Fidelity Latin America 22.19

      Fidelity Advisor Latin America I 22.10

      Evergreen Precious Metals I 21.98

      Oppenheimer Gold & Special Minerals C 21.93

      Oppenheimer Gold & Special Minerals B 21.86

      • Devin

        Nancy, you’re doing the same thing Ramsey does: cherry picking and back testing. These are a few funds out of thousands in an up year.

        • Nancy Darnall

          When we invest in mutual funds, we use this kind of data. “Back testing and cherry picking” is research. I look at a ten plus year record before I go into a new fund. We also have a fiduciary who works with another asset management tool which has been working well for us. I agree that Dave Ramsey’s strength is in helping people find their way out of debt and into financial responsibility. The nice thing about radio personalities is no one HAS to listen to them. I cherry-pick those.

          • Petunia 100

            It isn’t very useful to identify outperformers AFTER they have outperformed. To consistently get those double digit returns, we must identify outperformers BEFORE they have outperformed. Can you give me that list, Nancy? If not, you are merely advocating jumping from hot fund to hot fund and buying high. This is exactly the behaviour which leads to investors earning LESS than the market and should be avoided. The idea is to buy low sell high, not the other way around.

          • Nancy Darnall

            Past performance is the best indicator of future performance. I did not say I jump from fund to fund, but that I use this data before going into a “new fund.” You can get the list yourself by subscribing to or accessing Morningstar at your local library or your broker’s office. Our fiduciary has several programs to identify such funds. Just because a fund outperforms the market does not mean new investors are going in at the highest price. You apparently have a talent for prediction if you can identify outperformers before they outperform, but you should read what is in a post (and not infer things not there) before you go on the attack.

          • James

            Nancy,

            How much did YOUR portfolio return this year? Last year? Last 3 -4 years on average?

            What a business did in the past is important, but it’s not the best way to judge their future performance. Just look at companies like Circuit City – great in the past, now they’re gone! There are a lot more just like that. Yes, I know we’re discussing mutual funds, but these companies are what makes up these funds.

            Hindsight is always 20/20. It’s very unlikely that an average investor can return 12% in this investment environment.

          • Nancy Darnall

            Overall, for the past four years (1/1/2008 to date), 20.37%. This includes our daughter’s 529, all retirement investments, and non-retirement investments. Real estate is excluded.

          • Rittmann

            Nancy, I’m guessing that 20.37% return is a total return not an average annual return. Because, if you got 20.37% for the past 4 years and you didn’t contribute any money to these accounts, then these accounts should have more than doubled.

          • Rittmann

            To put a finer point on it, if your accounts have gained 20.37% over the last 4 years, then your average annual return has been 4.65%.

          • Past performance is absolutely not the best indicator of future performance. This is why it is required by law for every advertisement containing historical returns to state the following “Past performance is no guarantee of future results”.

            Morningstar has determined that the best indicator of future performance is costs.

            http://www.cbsnews.com/8301-505123_162-37640470/the-best-predictor-of-future-fund-performance/

            BTW, anyone can access Morningstar at morningstar.com. If you have internet access, you do not need to go to the library or your broker’s office.

            And no, I do not have a talent for predicting outperformers. This is precisely why I buy and hold index funds, but only the ones with rock bottom expense ratios.

            I have not attacked you. I strongly disagree with your claim that future outperformers can be identified by looking at past performance. All available evidence contradicts your claim. Some unethical salesperson must have fed you that notion in order to make a sale.

  • Devin

    I have a lot of problems with Dave Ramsey. His program is largely self promotion. He has a great number of conflict of interest issues: promoting his “providers” and doing ads for companies. He is always calling people names. I believe in saving and am against debt but I don’t care for him.

  • Devin

    I have a lot of problems with Dave Ramsey. His program is largely self promotion. He has a great number of conflict of interest issues: promoting his “providers” and doing ads for companies. He is always calling people names. I believe in saving and am against debt but I don’t care for him.

  • I’m a Dave Ramsey fan, but this is one area where I think he is not the best advisor (that and credit cards). The impression is that he’s talking 12% annually while he means over the long haul.

    • Petunia 100

      He may be talking about the long haul, but when one is retired one will be making withdrawals every year (assuming one would like to eat and not be homeless every year, not only when the markets are performing well). If the markets don’t return 12% every year, then his withdrawal strategy will not work. And if his withdrawal strategy does not work, an investor will run completely out of money and be broke in their old age. According to the Trinity Study, DR’s withdrawal strategy will fail 70% of the time.

      His advice is irresponsible at best.

  • I’m a Dave Ramsey fan, but this is one area where I think he is not the best advisor (that and credit cards). The impression is that he’s talking 12% annually while he means over the long haul.

    • Petunia 100

      He may be talking about the long haul, but when one is retired one will be making withdrawals every year (assuming one would like to eat and not be homeless every year, not only when the markets are performing well). If the markets don’t return 12% every year, then his withdrawal strategy will not work. And if his withdrawal strategy does not work, an investor will run completely out of money and be broke in their old age. According to the Trinity Study, DR’s withdrawal strategy will fail 70% of the time.

      His advice is irresponsible at best.

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  • SJ

    Liked the article, Tim. Others have taken Dave on as well:

    http://bucks.blogs.nytimes.com/2011/05/13/dave-ramseys-12-solution/

    http://my.brainshark.com/dave-ramsey-blue-paper-132848448

    The 2nd link is to a 17-page paper (and a 4-page update written in March to address the same article you addressed) reviewing the soundness of Ramsey’s financial advice. The 1st link is to a NY Times article which references the 17-page paper.

  • SJ

    Liked the article, Tim. Others have taken Dave on as well:

    http://bucks.blogs.nytimes.com/2011/05/13/dave-ramseys-12-solution/

    http://my.brainshark.com/dave-ramsey-blue-paper-132848448

    The 2nd link is to a 17-page paper (and a 4-page update written in March to address the same article you addressed) reviewing the soundness of Ramsey’s financial advice. The 1st link is to a NY Times article which references the 17-page paper.

  • Derek D

    It’s been a while since I’ve listened to Dave (something tells me he’s still preaching the same stuff, though), but I seem to recall several instances where he said to divide your income producing nest egg into the 4 stock market segments and start making 8% to 10% withdrawals for income.

    IMHO, that’s pretty “dangerous” advice. The math says the first few years of doing this are critical. If you have a negative year early on, you’re doomed. If you have a nice jump, the odds are better this strategy might work. It’s just a bit too “risky” for most folks…especially if they have limited investment experience.

    “honey, we lost 25% last year in the market and it’s time to take out our 8% income again….yikes. Our $500K is now worth about $350K….All we need is for the investments to do is jump about 45% next year and we’re back to even” …… OUCH!

  • Derek D

    It’s been a while since I’ve listened to Dave (something tells me he’s still preaching the same stuff, though), but I seem to recall several instances where he said to divide your income producing nest egg into the 4 stock market segments and start making 8% to 10% withdrawals for income.

    IMHO, that’s pretty “dangerous” advice. The math says the first few years of doing this are critical. If you have a negative year early on, you’re doomed. If you have a nice jump, the odds are better this strategy might work. It’s just a bit too “risky” for most folks…especially if they have limited investment experience.

    “honey, we lost 25% last year in the market and it’s time to take out our 8% income again….yikes. Our $500K is now worth about $350K….All we need is for the investments to do is jump about 45% next year and we’re back to even” …… OUCH!

  • Joel

    I use edward jones. They tell me 7% is a good return? I too love Dave Ramsey. I would like to know his stocks. He is as honest as they come. What would he have to gain to say 12% if it was not true. He does not sale stocks. I would just like to see his stocks he buys.

    • Nancy Darnall

      Dave Ramsey says he does not buy single stocks, just mutual funds. He also buys real estate as investments, apparently primarily apartment buildings based on his ads/endorsement of the window blinds company.

  • Joel

    I use edward jones. They tell me 7% is a good return? I too love Dave Ramsey. I would like to know his stocks. He is as honest as they come. What would he have to gain to say 12% if it was not true. He does not sale stocks. I would just like to see his stocks he buys.

    • Nancy Darnall

      Dave Ramsey says he does not buy single stocks, just mutual funds. He also buys real estate as investments, apparently primarily apartment buildings based on his ads/endorsement of the window blinds company.

  • Joel

    Yes, I agree Nancy. I just owe on my house. I plan to have it paid off in 2013. I want to put my money in Ira/ mutal funds and then save for a rental. I just didn’t know if the 7% return was a good return when I read about 12%. I do believe like Ramsey we all need to spread out our investments like rentals etc… It is so tempting to go borrow against my home to buy it now. I keep thinking it would pay for itself. Ramsey says no! What do you guys think? I would like to buy a duplex. Tempting tempting. I hate debt!! More then that I hate intrest when it is working against me. Lol.

  • Joel

    Yes, I agree Nancy. I just owe on my house. I plan to have it paid off in 2013. I want to put my money in Ira/ mutal funds and then save for a rental. I just didn’t know if the 7% return was a good return when I read about 12%. I do believe like Ramsey we all need to spread out our investments like rentals etc… It is so tempting to go borrow against my home to buy it now. I keep thinking it would pay for itself. Ramsey says no! What do you guys think? I would like to buy a duplex. Tempting tempting. I hate debt!! More then that I hate intrest when it is working against me. Lol.

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  • Kari

    I think you guys are being too hard on both DR and Nancy. Dave says in FPU that historically the market has returned 12%.

    And while Nancy’s listed funds are largely emerging markets and high risk commodities, the fact remains that there are lots of funds performing in this range, but proprietary companies may not have access to them.

    And investors have to be willing to take risks in order to get the reward.

    I do agree that his allocation is off the mark, and not necessarily can you do for a 50 y.o. Millionaire what you do for a 25 y.o. Just starting out.

    But for the most part, I think generally speaking it is a valid percentage.

  • Kari

    I think you guys are being too hard on both DR and Nancy. Dave says in FPU that historically the market has returned 12%.

    And while Nancy’s listed funds are largely emerging markets and high risk commodities, the fact remains that there are lots of funds performing in this range, but proprietary companies may not have access to them.

    And investors have to be willing to take risks in order to get the reward.

    I do agree that his allocation is off the mark, and not necessarily can you do for a 50 y.o. Millionaire what you do for a 25 y.o. Just starting out.

    But for the most part, I think generally speaking it is a valid percentage.