If you’ve been reading this blog, you know that I am not a fan of gurus. Gurus are usually people with an easily-understood message that appeals to the desperate and inexperienced. Unfortunately, more often than not, key parts of the advice they give are harmful to the financial well-being of their adherents. This is especially true of ultra-popular faith-based financial guru Dave Ramsey.
Let’s look at a few of the whoppers Dave tells, and examine his possible motives for doing so.
Dave Ramsey’s Awful Advice
The Debt Snowball – Dave Ramsey advocates a “debt snowball” debt repayment method, where the person in debt arranges their debts from smallest to largest, paying them off in that order. Dave believes that this method is advantageous for those who are buried under crushing debt because it allows for an immediate psychological “win” as the smallest debts are paid off quickly.
The obvious problem with this method is that for those who are truly mired in debt, it may very likely extend the time needed to be debt free, and thus cost the person far more in the end. If our goal is truly to look after the financial health of others, we have a moral responsibility to teach them the best way to get there.
12% Average Returns – Dave Ramsey also likes to use 12% as the rate of return for all of his investing advice. On his own web site, he says that the average return of the S&P 500 since inception is 12% per year.
There’s just one problem. It isn’t. First off, the S&P 500 as we know it today has only existed since 1957, not 1926, as Dave states. If you look at the modern history of the S&P 500 (1957 to 2015) and reinvest all dividends, you get an annualized return of 9.98%. Even if you include the data from the first S&P index through today, you still only get about 10%. Adjust for inflation and you get about 7%. Try it for yourself!
This probably shouldn’t be that surprising, considering Dave doesn’t seem to actually know what the S&P 500 is. He claims that it’s the 500 largest companies on the New York Stock Exchange (which is closer to what the Fortune 500 is), while the actual inclusion criteria completely contradict that claim.
All Debt is Poison – Regardless of how sophisticated or unsophisticated one is financially, Dave is pretty absolute in his condemnation of debt. Regardless of the interest rate, Dave counsels his readers to pay it all down, and avoid it entirely in the future. He does not agree that credit cards (when paid off monthly, thus costing the user nothing) can be used effectively when disciplined, he does not see a low-interest rate mortgage as an inflation hedge.
On one hand, I like this advice because I too believe that debt is poisonous. However, I also recognize that if you already have a low-interest mortgage, it makes no sense to pay it down if the rate is at or near the rate of inflation.
This advice is really more inefficient than anything else. While it’s not optimal to pay down low interest rate debt before investing, it’s also not as damaging as some of the other advice.
Roth IRAs are better than Traditional IRAs – Dave pushes hard for readers to use a Roth IRA once they max out employer matching in a 401(k), but there are two vehicles that should probably come first: The HSA, and a traditional IRA. A Roth IRA is only better than a traditional IRA in retirement if you expect to be paying higher taxes in retirement– something almost nobody will be. If you want to see the (mathematically) optimal investment order, it’s on the early retirement infographic.
Why does Dave give this advice? I honestly can’t figure it out. It’s possible that he just doesn’t know any better. However, that’s not acceptable when you are peddling your advice via radio, literature, and online.
A More Self-Serving Motive?
In the “12% Average returns” section above, I told a little lie of my own. I said there was one problem with Dave Ramsey’s statement that the market returns 12% over time.
There’s actually a second problem. Dave doesn’t actually advise you to purchase products which beat the market over retirement-length timeframes. He refers his readers and listeners to his “Endorsed Local Providers,” an organization of financial counselors who, according to numerous accounts, generally suggest that people purchase expensive “front load” funds from American Funds. Sickeningly, Dave’s ELPs are all commission-based, and thus have absolutely no legal (fiduciary) responsibility to look out for their client’s best interests. They also aren’t legally obligated to divulge the referral fees that Dave receives from the fund companies.
If you are reading because you are trying to understand what the catch is with Dave Ramsey’s advice, you’ve found it. You will spend a fortune purchasing, owning, and ultimately selling these funds, and you are highly unlikely to match or beat the market. By contrast, you can match the market’s returns (and you should!) without paying any load, without paying huge ongoing costs, and without paying transaction costs when you get out.
Dave outright says that “mutual funds” (without naming names) tend to beat the market. This is a complete fabrication– almost no mutual funds beat the market over the medium term, let alone retirement-length time periods. Dave routinely claims that any suggestion to the contrary is false, which presents something of a problem: If you accuse those calling out your untruths of being liars, you muddy the water and create a situation in which you might salvage some business.
Most tellingly, Dave’s site advises against use of Exchange Traded Funds without ever explaining why. It simply states “Dave does not own ETFs and does not recommend them as part of your investment plan. ETFs are baskets of single stocks that are intended to operate like mutual funds, but they are not mutual funds.” Ramsey is ruling out ETFs, many of which outperform everything he does advise (while simultaneously costing the investor far, far less, in the case of Vanguard ETFs), and gives no legitimate reason for doing so.
Though it’s impossible to conclusively prove Dave’s specific motives without a supervillain-style monologue before he cuts me in half on the laser table, it’s difficult not to conclude that Dave uses some decent advice, charisma, and religious piety as the delivery method for a whole lot of potentially damaging suggestions.
Love Dave? Love Dave but disagree with his advice? Love Dave and currently soaking your torch in kerosene and wondering to whom you lent your pitchfork? Let me know in the comments!