Dave Ramsey Defends His Investment Advice
First, I’m a big fan of Dave Ramsey. He has helped turn me away from financial ignorance and misbehavior. Not only is his overall message sound (live below your means, avoid debt, save & invest, etc.), I believe that he is honest and that his intentions are to help people. When you listen to his radio show regularly you get a sense of his character, especially because he talks about his own life candidly. Since it seems unlikely that his apparent genuineness is a ruse, I think the occasional person who depicts him as a charlatan or snake-oil salesman are incredibly misguided. In his view – and I agree – capitalism is at its best when businesses serve people well, whether it is something as mundane as fixing their car or as life changing as helping them turn around their financial world. So I see no conflict of interest that Dave’s business is to help people achieve financial success.
Nevertheless, I disagree with Dave that actively managed funds are preferable to index funds.
Yesterday, March 11, Dave spent an hour on his radio show defending his investment advice against criticism, specifically the idea (as Dave himself describes it) that he is “an expert at getting people out of debt and an absolute moron when it comes to investing” (1:05). I do not wish to defend each of his responses, but if anything his sincerity. He may be wrong about some things, but it seems to me he has good intentions.
I’d like to start a constructive conversation that could clarify the precise ways that Dave errs. I’m not optimistic that Dave would change his mind, but it would be nice to put together a concise statement for Ramsey followers who may want to understand where he and the Bogleheads differ.
Here is the audio:http://a1611.g.akamai.net/f/1611/23422/9h/dramsey.download.akamai.com/23572/audio/mp3/itunes/03112013_the_dave_ramsey_show_itunes.mp3
(I do not claim 100% accuracy of my transcriptions below.)
Some summary and evaluation:1
. He spent much of the time on these areas: (a) defending stock market investing in general, primarily against those who are consumed by fear; (b) promoting a buy-and-hold strategy; and (c) criticizing market timing.
Apparently these are areas where some people fault him, but Bogleheads would find agreement. 2
. Dave defended his knowledge of investing: “[Investing is] not where I spend the vast majority of my time advising people, because most people don’t have any money to invest, because they have a freakin car payment and a student loan that’s been around so long they think it’s a pet. So I spend most of my time there instead of investing. But it doesn’t mean I have no knowledge of [investing].” (11:10)3
. Against those who criticize him for citing average 12% returns
, Dave cites the S&P 500, which “since the stock market began, has averaged a little over 11 percent” (14:30). He admits that past performance does not guarantee future results, but he sees no better way to forecast: “Yes, I understand that past performance does not guarantee future results. . . But if you’re not going to use that, what are you going to use, your wet finger in the air, which was just shortly before that in your ear? Is that your method for choosing your investing? . . . [Those of us who know investment analysis know that] the primary methodology for forecasting is to use past history, project it, extrapolate it into the future adjusting for whatever variables there are. It’s really not rocket science, folks.” (12:25) Later he claims that people are foolish to think they can predict the future better than the history can (39:00).
In context, it seems that Dave thinks those who challenge his 12% guidelines are the type of people who assume the worst for the economy (“only see a black cloud on the horizon”) and don’t believe that the market can repeat what it has averaged over many decades. For example: “When you quit believing in the market, you’ve quit believing in capitalism, believing in companies doing ok, and you’ve believed all the conspiracy theories, and really in essence you’ve quit believing in America. . . When you don’t believe that  good quality companies in this country as a group, known as the stock market, are going to continue to make money going forward into the future and thereby yield their owners a rate of return, you have given up on what we call the American way of life.” (36:25) Later he adds: “I don’t think this country’s best days are over.” 4
. Dave truly believes that actively managed funds
will outperform indexes. He says: “There are many, many mutual funds that outperform the S&P . Almost every mutual fund will give you as a part of their prospectus the S&P trendline and show you what they’ve done in comparison. And so if you’re looking at a mutual fund and it has not outperformed the S&P, then don’t buy it.”
How do you find the right one? This part will be like fingers on the chalkboard to Bogleheads: “I don’t understand why some of you that are supposedly trained or actually purport to your readership that you know something about investing, why you can’t find a mutual fund that has a 50-year or 70-year or 20-year track record of 12% average returns. They’re all over the place. Does every [fund] do that? No. . . but a simple subscription to Morning Star or calling virtually any broker that’s been out of school 30 minutes can find it. So why you [critics] can’t find it is beyond me.” (14:40)
Although I am optimistic that what the “the market” has done over decades gives us an idea of what it may do in the future over decades, Dave applies this principle to individual (actively managed) mutual funds, believing that the past performance of a mutual fund gives us a good idea of what it will do long term in the future. This is a fundamental mistake. 5
. Dave is not absolutely against index funds
. In one place he states that it’s “not a bad thing” to “dump all your money into an S&P index fund” to get (over the long haul) the historical returns of the stock market. In fact, I infer from another statement that the majority of his own assets outside of tax-advantaged accounts – which for someone as wealthy as him would be the majority of his assets – is in S&P 500 index funds: “I personally don’t buy only loaded funds. I buy some S&P 500 – because it’s got a low turnover ratio and there’s some tax advantages to that – in addition to my other investing, my Roth IRAs, my 401Ks, etc.” (28:14) But Dave does this for tax reasons, not because he believes the S&P will outperform his “good growth stock mutual funds.” On the simplicity of getting an index fund: “If you can buy a book on Amazon, you can buy an S&P 500 fund. It’s no more difficult than that” (14:10).6
. Dave believes in loaded funds
with a clear conscious because he believes in the value of an advisor teaching you about investing and helping you find “good mutual funds.” In his words: “(Good advisors) do this with the heart of a teacher. Because they get paid a commission does not automatically mean they are evil. Everyone gets paid a commission for serving you. . . You [aren’t] mad about other [jobs] that get paid a commission, but now you’re worried about an investment advisor getting a commission when they give you investment advice. (Quoting his naysayers:) ‘Well it’s a conflict of interest.’ So is a real estate agent, but proof is in the pudding that a quality real estate agent will make you more on the sale of your real estate than they cost you. Tons of studies show that. Well, the investment community is no different.” (22:56)
In addition, Dave believes that another benefit of an advisor from a loaded fund is that most people need someone between them and their investments to keep them from selling in a down turn: “Here’s the big thing . . . a good investment advisor will talk you off the ledge. And there’s study after study done by the industry that shows that people who invest with a broker and the broker says, ‘calm down, don’t take your money out,’ [they make more money] versus having no one to coach you and you wake up in the middle of the night and you’re freaked out and you watched too much Fox or CNN . . . and so at 1:00 am you hit click on the web and take your money out of your no-load investment. You have no counsel; you have no one to teach you, no one to guide you, no one to talk to you. Consequently no-load investors without the benefit of a professional helping them cash out almost twice as often as loaded investors. So the commission that you pay is ‘ledge insurance.’ It talks you off the ledge. . . On average several different studies show that investors using an investment professional assist them in their purchase makes an average of 3% more on their money. They choose better funds [and] they stay in when the market turns down.” (24:53)
“These idiot advisors out there who are supposed consumer advocates who tell you that you should only buy no-loads, that anybody who’s charging you a commission is ripping you off, you have not read the studies. . . Investing is about behavior management as well as understanding the mathematics. And so I’m proud to endorse our ELPs [Endorsed Local Providers] . . . Yes, they pay us an endorsement fee and I’m proud to collect it because I did you a service by directing you to good people. And if you don’t want to use them, then that’s fine. But we’re not evil and we’re not taking advantage of anyone and we’re not scamming anyone.” (28:50)
To conclude, here is my take:
Dave needs to learn the reason that index funds are better than actively managed funds: fund managers cannot beat the index long term. In my opinion, he truly believes in the ability of these actively managed funds to outperform the market over time. That’s why in his mind promoting his ELPs is not immoral. They help investors find the best funds, thus providing a useful service. And like other services, they deserve a commission for doing so. If
actively managed funds were better than index funds and if
advisors could help novices find good funds, then Dave is right that paid advisors would be beneficial and worthwhile, not evil. So even though we may believe that Dave is wrong about actively managed funds, he promotes his ELPs believing that he is helping people with their investing.
Having an impression of Dave’s character, I give him the benefit of the doubt that he has noble intentions. And if he profits from helpful service, that is capitalism at its best.
Of course, there are other questionable aspects of his advice, including (a) 100% equities (which I suppose in his mind a broker protects you from cashing out); (b) deciphering his four recommended types of funds, and (c) his 8% withdrawal rate, based on the 12% expected return minus inflation. The 12% number may be fine as a teaching point or rhetorical tool to encourage people to invest, but it gets incredibly dangerous when used as a basis for withdrawal rate.
20% Large (VV); 20% Small (VB); 20% Inter'l (VXUS); 10% Inter'l Small (VSS); 10% REIT (VNQ); 20% Total Bond (BND)