We break down Dave Ramsey’s investing strategy. Can we all retire millionaires as he promises? Today we find out.
Dave Ramsey is a well respected financial guru. He has helped many people begin their personal finance journey. While we disagree with the math behind Dave’s snowball method of debt reduction, you will pay off debt if you follow it.
We reviewed Total Money Make Over and came away pretty (but not entirely) impressed. Today we take a look at his investment strategy.
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Dave Ramsey’s Guide to Investing is a free PDF available on-line. It’s not exactly a weighty tome, just 17 pages, two of which are the cover page and table of contents. Dave’s investing strategy consists of just three steps:
- Ask yourself specific questions. Things like at what age you want to retire, what kind of lifestyle you want to live, etc.
- Diversify. This section is just four sentences long, and two of them speak of eggs and baskets.
- Stay focused.
This is basically the sum total of Dave Ramsey’s investing strategy. It is heavy on cliches (I counted four) and light on advice or even basic information like explaining different types of investments. If you don’t know anything about investing, Dave’s advice won’t tell you much.
At LMM, we want our listeners and readers to be fully informed. That’s why we produce things like Investing 101: An Introduction to Simple Investing. Once you understand the basics, we’ll explain the various types of investments available.
The Rule of 72
The rule of 72 is a method Dave recommends as part of building your investment strategy; it identifies your investing timeline. You divide 72 by the rate of return you get on an investment. That number is about how many years it will take for your investments to double in value.
There are a few problems with this. Numbers and averages aren’t the same things. The bigger problem is that Dave uses 12% as the average return you can expect to earn. This number is exaggerated. At LMM, we use 7% which is a little lower than the average rate of return you can expect in the market over the long term.
He posits that if you invest $100 a month from age 25-35 with a return of 12%, you will retire with just over one million dollars. The backlash was immediate. Dave’s defense was that his advice was “inspirational and instructional.” He continued, “…if you save money over time, you’ll have some.”
Well, no shit Dave. I get the inspirational part. One hundred dollars a month doesn’t sound unreasonable, and a million dollars sounds like a lot. But I think most of us could do with a bit more of the instructional bit.
But you don’t need instructions because Dave will hand you off to one of his ELP’s! More on that to come.
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Buy and Hold
Dave encourages long-term investing. In order to play the long con, you have to tune out a lot of the coverage about the stock market and the economy. Good news doesn’t sell as well as doom and gloom, and if you jump every time you hear scary economic news, you will never be a successful investor.
An ELP is an endorsed local provider. This is a financial advisor. Dave can recommend one to you virtually anywhere in the country. And Dave makes a pretty good living doing that. For each referral, he makes $80.
Dave recommends getting a recommendation for an advisor from family and friends. That’s great! I hear Bernie Madoff got a lot of clients via word of mouth. He suggests making sure the advisor has the appropriate credentialing and certification. But what do you know about that? I mean, this little PDF is less than 20 pages. You’d think he could have thrown a few acronyms in there to give you a hint.
But he hasn’t taught you anything about investing. So how would you know a good one from a bad one? He seems to think using one of his ELP’s takes care of that. But how well are they vetted? You don’t know. If you don’t know anything about investing, you won’t know a good advisor from a bad one and you won’t know if an advisor is flat out ripping you off either.
His tips on avoiding fraud basically just reiterate what he wrote about choosing an advisor. Ask questions. Well, if you don’t know anything about investing you won’t know what questions to ask, and even if you googled a couple, you wouldn’t understand the answers or know if they were true or not.
No one will ever care more about your money than you and an advisor is not going to do anything for you that you can’t do for yourself for free, with a bit of education. Okay, not all of us love dealing with money.
In that case, you might choose to hire an advisor. But you still need to understand investing so you can choose a good one and make sure they aren’t ripping you off and charging you outrageous fees.
401k’s and IRA’s
Part of Dave’s investment strategy is to invest in your employer sponsored 401k. And we agree with that, especially if your plan offers matching. That is free money! It’s also an easy way to invest because it’s automated. The money is deducted from your paycheck before you even see it. And what you don’t see, you can’t spend.
But before you invest in a 401k, Dave wants you to complete his baby steps 1-3. They are:
- Save a $1,000 starter emergency fund.
- Pay off all debt using the debt snowball.
- Save 3-6 months of expenses for a fully funded emergency fund.
Step one should be completed before you do anything else, even pay off debt. We disagree with this. That $1,000 is sitting in your checking or savings account earning less than 1% interest. Meanwhile, your credit card debt is racking up double digit interest. Your debt is an emergency and paying it off should be your sole financial focus.
Step two is to pay off debt with the snowball method, but the math doesn’t work out. If you want to save money paying interest on debt, the stacking method is superior.
Step three is 3-6 months worth of expenses saved. We believe that 2.5 times your monthly expenses are enough money to leave sitting in your checking or savings account earning nothing. Our idea of an emergency fund is $25,000 invested in a low-risk investment fund like Betterment, Vanguard’s Admiral Fund (if you have at least $10,000) or Vanguard’s Lifecycle Fund which has a minimum of just $1,000.
Dave suggests investing 15% of your income (which is a lot more than $100 a month). We recommend 20%. Dave suggests paying your house off early; we think that money should be invested. If you need money fast, selling a home is not the way to get it. A home is not a liquid investment.
Picking a Mutual Fund
Dave recommends doing your own research and not just trusting your advisor’s recommendation (does that apply to his hand picked ELP’s?). You should base your decision on the fund’s past performance over at least the last five years and not invest in funds that have been around for only a few years.
He also wants you to research the fund manager, the longer they have been around, the better. He warns you to beware of excessive fees, but he doesn’t tell you what constitutes excessive. To the uninformed investor, a fee of 1.25% sounds small. We regularly pay more than that when we use an out of network ATM to withdrawal cash.
The average fee charged by an actively managed fund charges is just that, 1.25%. In the realm of fund fees, it’s a lot! If you invest $100,000 in a fund with a 1% annual fee, which is less than average, it will cost you nearly $28,000 over twenty years, according to Securities and Exchange Commission calculations. If you had that $28,000 to invest, you would have earned another $12,000.
If you don’t know what fees you’re paying, you can use FeeX to find out.
The best time to start investing was when you were 18; the second best time is now. It’s almost never too late to start saving for retirement, but if you’re late to the party, you have some work to do. Dave recommends delaying retirement by two years.
Even if you’re 40 or 50, Dave claims you can put just $2,000 into a mutual fund a year and retire with more than $300-400,000. But he’s using that magical 12% return which we know is exaggerated.
Retirement is a numbers game, but you need to know what your number is. How much money do you need to retire? One way to get that number is to use the 4% rule. You can withdraw 4% of your retirement money for at least 30 years and not run out of money. If you have $500,000 saved, you would withdraw and live on $20,000 a year.
Once you have a number, it’s easier know what you need to do to ready yourself for retirement. You may need to work longer than you would like, to cut expenses, so you have more money to throw at investments or find a way to bring in side income.
Protecting Your Wealth
This part of the investment strategy is making sure you have adequate insurance coverage. Most of us have home owner’s and auto insurance, but most are limited liability policies and only provide coverage up to $500,000. Dave suggests and umbrella policy that will provide additional coverage and protect your wealth if you were to be sued.
He also recommends long-term care insurance to cover the cost of things like nursing homes and in-home nursing care. Medical bills are one of the leading causes of bankruptcy so making sure you have adequate coverage matters.
If you’re insurance shopping, Policy Genius will make it easy to compare lots of different rates in one place.
Dropping a Fund
This part of the investment strategy is basically a rehash of the advice given when you are choosing a mutual fund. Stay in for the long term even if the fund has a bad quarter and of course, trust your advisor.
Give it Away
Money isn’t just something to be pursued until you have the biggest pile possible. That kind of mindless accumulation doesn’t make us happy. You can’t take it with you and all of that. Dave veers into religion here as he often does and I’m not going to touch that.
But he’s right that being charitable has been proven to make us happier. Using your money to buy experiences rather than things also makes us happier. You worked hard for your money and you are allowed to spend some of it on things that give you and other people happiness.
Decide for Yourself
Dave Ramsey does some good things, but he’s not the be all end all in the personal finance world nor is he infallible. He’s an industry. Read his strategy and our Investing Blueprint in the show notes and let us know what you think.
LMM’s Investing Blueprint: Our much more detailed financial plan.
Dave’s Investing Philosophy: Seven easy steps you guys!
Betterment: A user friendly investing tool. Use this link and get six months free.