I should start this post off by saying I really enjoy listening to Dave Ramsey. He's on the radio every weeknight for 3 hours so I often listen to him coming or going from a shift. He is far better than the other two “gurus” on local radio, one of which sells his advisory services and the other of which is selling permanent life insurance.
I think he is a fantastic motivator at getting people out of debt and keeping them from screwing up the big things, like using credit cards for credit, spending more than you earn etc. You can do far worse than following his “baby steps” out of debt and toward financial independence.
I also like the advice he gives people about money and relationships. He does a great job advising those being hounded by creditors and facing possible bankruptcy. In fact, the worse the shape of your finances, the better Dave's advice is. His investing advice, however, leaves a lot to be desired.
4 Ways Dave Ramsey's Investing Advice May Be Leading You Astray
1) The Cost of Debt Aversion
Many people have a problem with Dave's absolutely rabid anti-debt stances. For Ramsey, there is basically no good debt. Dave's approach leans a little too far toward the behaviorally correct thing to do, and too far away from the mathematically correct thing to do.
For instance, it's nice to have no house payment and no risk of losing your house to the bank if you lose your job. So Dave recommends paying off your mortgage as soon as possible. Behaviorally, that might be the right answer. But mathematically, it often isn't.
Consider a 3% mortgage, 2% after the mortgage interest tax break. If inflation is 3%, the bank is basically paying you to borrow money after inflation. Even if you only expect 5% out of your investment portfolio, you're still far better off (mathematically) directing new money into the portfolio than toward paying down the mortgage early.
There are still lots of benefits to paying down the mortgage (less risk of losing home, ability to cut back at work, the feeling of being debt-free, improved cash flow etc), but you should probably calculate how much those benefits are likely to cost you before making that decision.
Consider $100K in your pocket that you can either pay down your mortgage with or put in your investment portfolio. Say the mortgage is costing you 2% after tax, and the portfolio (while riskier) returns 8% after tax and expenses. Over the next 10 years, putting that $100K toward the mortgage will save you something in the neighborhood of $94,000. I might be able to live with a little debt for a decade for $94K. You might too.
2) His Endorsed Local Provider List
Dave continually pushes his “endorsed local providers” for investing (as well as insurance, real estate etc.) Most of these, unfortunately, are commissioned salesmen who sell you loaded mutual funds. My local ELP says he discloses his fees and commissions to clients, but he doesn't do so on his website. He does, at least, recommend against permanent life insurance as an investment product.
Dave's attitude toward loads is that they don't matter over the long run. I disagree. I don't see any reason to pay a commission when commission-free products are available. Even if you view that as a way to pay for “good advice“, you should realize you are introducing a serious conflict of interest for the adviser, and likely getting crappier investments, even ignoring the load.
3) Good Growth Stock Mutual Funds
Dave often recommends you go out and get yourself some “good growth stock mutual funds” that will return you 12% a year. No mention of bond funds or any other type of diversification. Apparently, 3 or 4 growth stock funds will do you. Never mind that is exactly the type of portfolio you are most likely to bail out of in the event of a market downturn. For someone who is so concerned about the behavioral aspects of debt, he seems to ignore them in investing.
12% is an extremely optimistic long-term expected return, especially after paying the high ERs and loads you're likely to get from Dave's ELPs. The long-term return of the S&P 500 (good growth stocks) is on the order of 9-10%, and the return for the ultra-low-cost Vanguard Growth Index Fund is only 8% over the last 20 years. How likely do you think 12% is going forward?
4) The 8% Safe Withdrawal Rate
Dave often mentions that you should be able to spend 8% of your portfolio a year in retirement. Never mind that all the best minds in academia recommend a safe withdrawal rate between 3 and 5%.
In fact, the updated Trinity Study suggests that a withdrawal rate of 8% on a 50/50 portfolio has less than a 50% chance of lasting 20 years. Even if you stick with Dave's recommended asset allocation of 100% stocks throughout your retirement, you still have a 1 in 4 chance of running out of money in 15 years. That's hardly a safe withdrawal rate.
The Real Danger of Following Dave's Investing Advice
The problem with throwing these numbers out — “12% returns” and “8% a year withdrawals” is that if you really run the numbers, you'll arrive at the wrong amount to save.
Consider someone who wants to live on $100K a year in retirement in today's dollars. If you assume a relatively standard 4% withdrawal rate, and a portfolio that returns 5% real a year (some people would argue even these numbers are optimistic), you need a portfolio worth $2.5 Million at retirement. Assuming you acquired that over 30 years, you would need to save about $36,000 per year.
If you followed Dave's advice, and assumed a return of 9% real (let's make a big leap and assume Dave's listeners can adjust for inflation) and an 8% withdrawal rate, you'd need to save $1.25 Million in today's dollars at retirement, and somehow magically do that by only putting away $8500 a year. There's an awfully big difference between $8500 and $36,000 a year.
The truth is that someone following Ramsey's advice is not only highly likely to run out of money in retirement, but to be far short of his projected nest egg at retirement time.So, while I like how Dave recommends eating “Rice and Beans, Beans and Rice” until you're out of debt (similar to my recommendation to live like a resident for a few years after graduating), I'd be very cautious taking investing advice from him or his endorsed local providers.
In what ways has Dave Ramsey's advice helped you be a better investor? Do you agree with me that some of his investing advice is off base and detrimental to his followers? Comment below!
This was the most reasonable criticism of Dave Ramsey I’ve read in a long time.
I gotta agree.
If you are a poor young doctor in america, you can not go far wrong with listening to dave ramsey.
His advice is at least based on thousands of ‘case reports’.
However it is our view in Australia, that there needs to be more
prospective peer reviewed unbiased robust scientific research on wealth creation and doctors.
Here in Australia, we are therefore thinking of undertaking and publishing research which will include not just anecdotal case reports, historical data, but also large cohort studies and randomised controlled trials on doctors and wealth. It is envisaged there may also be international collaboration.
To this end, a journal for financial health for doctors and a university is being designed under the auspicious working-title of ‘ GET RICH QUACK’.
However, other suggestions for the title are welcomed!
If any one is interested in contributing please get in touch
Thanks for making me feel better about not paying off my student loans (2.75) and new refi (3.0) early. I think for many undisciplined folks out there, Dave’s baby steps are great. But for those of us who can balance the books and keep income well ahead of expenses, there is certainly no benefit to paying off low-interest loans early. If i die before my student loans do, I wont be all that upset (except of course for the dying part!). Thats why I have life insurance. I still feel like I’m letting Dave down somehow though:)….
I really enjoy your blog , even though I’m not a doctor or a high income person. I too also like to listen to Dave Ramsey. However, I will quibble with a couple of your criticisms, though I agree that his investing advice is a bit naive.
Not paying down a mortgage is only “mathematically correct” if you ignore risk. It is a safer “return” (the interest rate of the mortgage) than any investment (even U.S. T-bills), because it’s a guaranteed return by definition in what you save. Safe investments today pay next to nothing without even considering inflation. To me that as silly as saying junk bonds are mathematically a better investment than EE savings bonds. And even then my place of living is not at risk, though my principle would be. I doubt the numerous people foreclosed on take comfort in being “mathematically correct.”
Even so, Dave does not suggest stopping retirement or investing to pay down a house, as the post implies. He says that after 15% is being saved for retirement, to then concurrently pay down the house (along with saving for kids’ college). And after that build wealth. He claims that people on his plan pay off their house in around 7 years, I think, which is less than the 10 years in your calculations. After that period they would be able to save more and be more aggressive investing with no mortgage payment. Which to be fair, we should consider, since investing is more than a 10 year proposition. In 5-7 years (when a Ramseyite pays off his house) I don’t think we can assume any investment return with confidence. Though 20+ year out I agree with you more than Ramsey.
15% retirement savings plus whatever other investing, is not likely to put someone in “real danger,” in fact it would be quite good for the average Joe. Maybe not a doctor. He doesn’t extrapolate from the 12% investment return to a savings rate—that is fixed by him at 15%.
Where Ramsey is right on behavior trumping the math is that even mathematicians, engineers, and doctors can do the financial math, but usually do stupid things with money. Someone really following his plan, not that that’s the only way to build wealth, will not come out significantly different than someone like you. It is not interest rate knowledge or math skills that people lack but sacrifice, discipline, and focus—which paying off a mortgage fast takes.
Thanks again for you blog.
best regards,
phil
The only problem with that is that by paying off your mortgage sooner, you lose out on the compounding interest on the money you would have invested instead. And early in the career, compounding interest is very valuable.
Chelle,
I understand your argument, but it only “holds water” if your investments go up by more than the interest you are paying. There are many years where that has not happened. Also, there are likely a number of times where you might sell an investment that is down and never recover the loss. Early in your career losses compound exactly the same only in the wrong direction for the rest of your life. In fact, a $10,000 loss early in your 20’s is easily compounded to a smaller retirement fund after 40 years by $300,000 (at a 9% return).
I agree with most of what you said about Ramsey. For a large part of the public, he is a welcome respite from the spend spend spend credit card debt mentality. But often, his advise is inappropriate.
I’m a fee-only financial planner. Years ago, a new client couple comes in. They are both young attorneys, Ivy League Law School graduates and Dave Ramsey devotees. They are making, lets say about $140k (in today’s dollars) each. They are driving 20 year old cars and living in a rat infested (not exaggerating) apartment. All this while paying off their hundreds of thousands of dollars worth of government subsidized low interest student loans much faster than required. I felt like the first few meetings was spent reprogramming the brainwashed. Finally, I got them to stop paying down these absurdly low interest loans faster than required, save/invest some money, and look to buy a small house. The most important thing to this client should have been to protect their cash flow, not pay down student loans.
Dave Ramsey is great if your financial goal is security. The average American would do well listening to him. However, if your goal is wealth and financial freedom, I would not listen to Dave Ramsey.
First off, WCI is right about mortgages. Why would you pay that off at today’s interest rates. Additionally, there is a school of thought that says as long as interest rates are low, you keep debt on your house for asset protection reasons. Unfortunately, most states do not have unlimited homestead laws like Texas and Florida. So if you pay down a large mortgage on your house, that large sum is available to go after. For example, if you have a $775,000 home in Southern California, and you get in a car wreck and kill someone, that person’s family can go after your home if it is paid off (minus $75,000…that is the homestead limit in CA).
My biggest problem with Dave is that he does not like people to take debt to buy real estate investments. He seems to hate the concept of leverage. While I agree that leverage can be harmful if used incorrectly, it can also create large sums of wealth for those who use it wisely. The majority of the Forbes 400 wealthiest individuals made or retain their money in business and or real estate……not mutual funds.
Yes but tons of people lose their shirts in real estate and business. Most Americans can’t take on that risk successfully. It isn’t surprising that the wealthiest made their money this way. If we listed the top 400 based on amounts lost it likely would also be business and real estate.
Ramsey is great for the poor. He is a great motivator out of debt. The problem with being good at something is that people think you will be good at other areas especially if they seem similar. That just isn’t true and Ramsey’s investing ideas won’t work for most doctors.
Could someone explain the “Consider a 3% mortgage, 2% after the mortgage tax rate” comment. I’m not sure what the mortgage tax rate is? Is that some type of adjustment of your real interest rate after you factor in a tax deduction for your mortgage interest?
Great post WCI. I have to attribute my getting interested in the financial world and getting out of debt to listening to Dave Ramsey starting in my last year of medical school. I think he is great for the people that call into his show and have really ended up in a bad situation because of stupid mistakes. Being a Christian, I also appreciate his incorporation of Biblical teachings into a lot of what he teaches in his books/radio program/seminars, etc. I have noticed a lot of the holes in his philosophy, especially with investing, that you mentioned in the post and tend to take more of a Boglehead approach with investing (major props to WCI to introducing me to that!).
Yes it’s just considering the deduction.
Of course it’s nice to get a standard deduction once you don’t have any deductions.
Rex, I agree with many of your comments. I also agree that many people shouldn’t own real estate. However, this is a doctor blog and I do believe that all of us should have some real estate in our portfolio. It’s a hedge against inflation and quantitative easing makes inflation a near guarantee. I also would respectfully disagree with your characterization of risk. First, shelter is a basic need. Second, population cycles are favorable for renters. Lastly, the fact that banks will lend 70% – 80% of the money for a property lends to the safety profile of apartment investing. You’d never get a bank to loan for stock. There are ways to buy on the margin, but nowhere near 70% – 80%. Assuming a person knows how to find a good real estate deal (big assumption I realize), the risk lies in the day-to-day operations of that property. For that reason I will agree that most doctors should not manage their own real estate.
Most doctors own a sizeable home to begin with. thus they have some real estate in their portfolio.
Bank lending doesn’t reduce your risk. Banks like to loan to doctors to reduce their risk. Since most of us are easily employable they can come after our wages if necessary.
Basic shelter isn’t the typical investment and if that is the only market you are looking at then it’s a tough crowd to work with at times.
Currently I’m vacationing in a home that was purchased in foreclosure and was previously owned by an oral surgeon. I imagine he never dreamed he could lose money.
With that said, I’ll look at adding some additional once our house is closer to being paid off. I don’t believe excessively leveraging is wise even though I might be able to make more money doing so. I’ll probably be looking at rentable vacation homes but might consider closer to basic shelter situations.
James-
You don’t need life insurance to cover student loans. They disappear with your death (but not your bankruptcy.)
Richdrpoordr-
I’m not sure it’s even possible to do controlled financial studies as you “envisage.” I’d be interested to see what you come up with though.
Phil-
Keep in mind I’m not saying don’t do as Dave Ramsey suggests (i.e. make paying down low interest debt a priority.) I’m saying calculate the likely (but not guaranteed, as paying down debt is indeed risk free) cost to you of doing so and make a conscious decision about it. And you are correct that Dave does say put 15% toward retirement before paying down the mortgage early. I should have mentioned that earlier.
Barry-
I often recommend “living like a resident” for a few years. But you are correct that moderation in all things is key. You should feel absolutely no guilt about spending 80% of what you make. Thanks for sharing the great example.
Dennis and Rex-
I have mixed thoughts about using leverage for investment properties. There are definitely pluses and minuses both ways. Dave recommends buying them out right, but your expected return is obviously quite a bit lower doing it that way. I suspect a good way to do it is the middle way, neither debt free nor highly leveraged. It seems to me that at about a loan to value ratio of 70% or so you start getting a cash flow positive property. That seems like a reasonable cushion to me. Most docs don’t need this “second job” though. I don’t know that I have a strong opinion either way on the “basic shelter vs vacation property” debate. I suspect the price you buy at matters far more than what type of property it is.
RB- Sorry for the confusion. Should have read “mortgage interest tax break.” (I fixed it.) I enjoy Dave’s “ministry” as well.
WCI….Thanks for the input and the article. Your blog is great. You and Rex are two smart guys and I’m sure you two have done far better than me in paper assets….I very much agree that we doctor’s shouldn’t be managing our real estate holdings. Let me take your 70% loan-to-value leverage scenario and show you why I like real estate so much. For ease of numbers, lets use a $1,000,000 asset that returns 6% a year.
Asset Value $1 million $1 million
(unleveraged, stock, MF, etc.) (leveraged real estate)
Cost to Investor $1 million $300,000 (non-recourse loan)
Risk (Exposure $1 million $300,000
to Potential Loss)
6% Annual Return $60,000 $60,000
Return on Investment 6% 20%
Liquidity Event 15% cap gains 1031 exchange (tax deferred)
Cost tax Refinance (tax free)
There are many more benefits to real estate like depreciation, accelerated depreciation, principal paydown by renters, appreciation through optimization of operations, etc. etc. etc.
Sorry, the posting didn’t turn out as I had hoped…….There should be spacing, but the first number is an unleveraged asset and the second number is leveraged real estate. Its hard to read as it posted without my spacing.
I see your point, despite the formatting. But you also have to run it both ways…..run it with a negative 6% annual return. 🙂 Leverage cuts both ways.
You are absolutely right. Leverage is a tool that in the wrong hands can be destructive. That is why finding a good deal is not good enough. First one has to find the right market and then the right submarket within that market. Going to places that have consistent population growth and employment growth is a good start. However, there is a whole science to market and submarket selection that include dozens of different variables. Your point is well taken.
All those variables you mention aren’t exactly a science that you can study and accurately predict. I have no doubt big money could be made but you seem to trivialize the risks involved with leveraging. Many people have felt housing was bulletproof until the last few years. Few states are non recourse.
http://www.forecloseddreams.com/recourse_states
Rex, you are correct and that is my fault for not clarifying. It is rare to get non-recourse lending for residential properties (1-4 units). I’m not speaking about residential. I invest as a fractional owner in large apartments (100 – 250 units). We only take non-recourse loans which is the standard in commercial investing. One of the many reasons I don’t like residential is that you cannot take advantage of economies of scale. You also cannot utilize the best properties managers, so you are stuck with all of the headaches of operating.
Sorry I had not clarified earlier……Hope you are enjoying your vacation.
WCI –
Thank you for sharing this information with your readers. I hadn’t heard of Dave Ramsey or Clark Howard prior to establishing my firm and unfortunately, their names come up far too often in initial client conversations. I refuse to listen to them and continue to be surprised by the intelligent, high-earning professionals who reference them in my office. Their brand of advice is akin to me spending several months reading as much material as I could on webMD then establishing a radio show to give medical advice. Is there any difference?
Why spend any time at all listening to Ramsey and Howard when there are thousands of CFPs working at fee-only firms? Many of them share your belief in passive investing and don’t charge AUM fees. I implore prospective clients to find a CFP for their financial planning needs and a CFA for their investment needs. It’s that simple. I would have more respect for Ramsey and Howard if they at least got the CFP.
Ramsey and Howard give great advice compared to most of the hooligans on the radio.
Those thousands of CFPs working at fee-only firms don’t have free radio shows I can listen to while commuting. I suspect Dave Ramsey will have 1000 times more impact on the finances of Americans than a typical CFP working in a fee-only office.
And financial advisors aren’t physicians. Using the “you wouldn’t do your own surgery so why would you do your own finances” argument sounds really dumb when it becomes “you wouldn’t do your own surgery so why would you do your own lawn?”
https://www.whitecoatinvestor.com/financial-advisors-arent-doctors/
All that said, I do recommend physicians looking to hire a financial advisor hire one with at least one of the more respectable credentials- CFP, CFA, ChFC.
WCI –
I agree that Ramsey and Howard have a larger impact on Americans than advisors who have been trained in financial planning and investments. The question is whether that is a good thing. I would argue that for a portion of the population Ramsey and Howard serve a useful function but for another segment, they do not.
I used to work at The Motley Fool. Since my time there, I’ve become programmed to be respectful when communicating online. There’s a thin line between “really dumb argument” and “you’re really dumb for making that argument.” Unsubstantiated, flawed, illogical, weak, erroneous are a few replacements for dumb. Moving on…
I didn’t realize there was a body of knowledge associated with mowing lawns. Assuming there is, I would certainly prefer to have someone with the CLM designation (Certifed Lawn Mower) than someone who neglected to endure the rigors of that grueling examination.
And though “you wouldn’t do your own surgery so why would you do your own lawn” sounds silly so does “you wouldn’t repair your own transmission so why would you do your own lawn” or “you wouldn’t
sell your own house so why would you do your own lawn” or “you wouldn’t defend yourself in court so why would you do your own lawn.” Implicit in your tone is a lack of appreciation for the financial profession. Aside from being off-putting to many of us who work hard to be knowledgeable and serve our clients, it is overly simplistic. You’re better than that.
It also seems contradictory that personal finance is so simple but you always have new material for your site. One might argue your site’s very existence – or at least the dynamic, ongoing nature of it – undermines that premise. You can’t have it both ways, right?
I’m curious…how does the ChFC meet your stringent criteria when it does not require a comprehensive exam? Why not the PFS which does require an exam? I would think exams would matter to you.
Are you suggesting I have a lack of appreciation for the financial profession?
Guilty as charged. 🙂
There are many things in life that are reasonable to do yourself. Managing your finances is one of them. Major surgery is not. That’s just the way it is. Doesn’t mean a financial advisor can’t be useful, but I certainly don’t think everyone has to have one.
As I understand the ChFC designation, it actually requires more coursework than the CFP. Correct me if I’m wrong. Take a look at this link:
http://www.moneycrashers.com/chartered-financial-consultant-requirements-chfc-vs-cfp/
Don’t you think it’s odd that the highest credentials the financial advisory profession offers can be acquired in less than 4 months for less than $5400? Why would you expect people to consider that comparable to a CPA, a JD, an MD or other Master’s and Doctorate level degrees? They don’t and they shouldn’t. I’m not saying you and other advisors like you wouldn’t get some higher designation if there was one, I’m just saying there isn’t and there should be.
Why not submit a guest post on why you think the CFP is the best designation to look for in an advisor rather than making all these comments on various threads on the site? I’m likely to publish it.
WCI –
Let’s do better with the analogies. All doctors aren’t surgeons. I think general practitioners and psychiatrists would be a better comparison. Many individuals may choose to do their own research and rely on other sources to make a diagnosis instead of consulting a general practitioner or engaging a psychiatrist. I might equate surgeons to the institutional side of the financial business. Bill Gates and the Harvard Endowment aren’t going to spend much time consulting with the local broker who cold calls them.
If you find just ONE financial advisor who will publicly state that he/she believes the ChFC is a “more challenging credential to obtain” than the CFP, I will lay out a case. You need to do more research in this area.
I’m not discussing comparability or whether the CFP is more difficult than the CFA or CPA or JD, etc. My argument is simply this: I think you should permanently replace financial advisor with CFP. To me, this isn’t a case of semantics but one of changing the financial services lexicon. This is a very basic screen I suspect the vast majority of your readers would be able to apply. Slightly adjusting the verbiage explicitly acknowledges your readers’ options.
I’m not going to do it so quit asking. There are plenty of good advisors without the CFP credential. You may submit a guest post arguing your point as I previously suggested.
Those who hold the ChFC say the same stuff you do….our credential is better. If you want to find one to argue about it with feel free to do so. You might start looking here.
[Rude comments deleted] I looked into the ChFC a bit and will ask around to get feedback from advisors with both credentials. I never said the CFP was better, just more difficult to obtain; I thought that might resonate with you. You seem to have a modicum of respect for the CFA which I attribute to the difficulty of the exams.
From my understanding, since I’m a CFP I could get the ChFC after taking just 3 of the 9 courses. There are short exams at the end of each module just like the CFP but no comprehensive exam.
I’ll get a guest post to you soon. Hopefully, you won’t quell a dissident voice. [Not if it’s civil.]