In honor of the Academy Awards, I thought it would be fun, to host celebrity week here at Gen Y Wealth. During this week, I will be giving you my opinion on financial celebrities Dave Ramsey, Suze Orman, and Robert Kiyosaki. Let’s begin…
Introduction to Dave Ramsey
Dave Ramsey is a radio host, author, television personality, and motivational speaker.
His radio show is broad casted on over 450 stations throughout the U.S. His TV show, “The Dave Ramsey Show” is weekdays on the Fox Business Network.
He has authored a few books, including a favorite of mine, The Total Money Makeover.
For more on his background, you can visit his Wikipedia page.
As with many financial celebrities, Dave recommends a simple course of action for everyone. Lets dig into his teachings and I can explain what I think is good, bad, and ugly about Dave Ramsey.
The Good
Baby Steps
Ramsey’s teaching are centered around what he calls “The Seven Baby Steps“. The 7 steps are:
- Build a $1,000 emergency fund
- Pay of all non-mortgage debt
- Build a full emergency fund
- Save 15% into tax-advantaged accounts
- College funding for children
- Pay off home
- Build wealth and give
I happen to like the Ramsey’s baby steps. They give an easy to follow plan for a majority of his followers. While it might not be the best plan for everyone, you’re not going to get yourself into a lot of financial trouble if you follow the steps.
Motivation
Ramsey has helped more people get out of debt than anyone in the U.S. One factor that has led him to become so popular is that he is very motivating. Listen to Ramsey’s podcast or read The Total Money Makeover and you will feel empowered to start taking action.
Hates Any Type of Debt
Any advice from Ramsey will never end with going into debt. He even advises you to stop using credit cards, in favor of debit cards, even if you have always paid off the balance in full at the end of the month.
Ramsey is also a big fan of paying in full for a house or going with a 15 year mortgage.
The Bad
Concrete Rules
While I love the baby steps, they shouldn’t be as concrete as they are. I understand that he is giving advice to so many people in so many situations, that it’s hard to talk about all possible scenarios that can arise. However, from what I can tell, Ramsey is very adamant about everyone following his baby steps.
For example, should you contribute to a retirement fund with an employer match or should you pay off your student loans? According to Ramsey, you should always pay off your student loans.
From my perspective, you need to dig deeper into your personal situation before you commit. Let’s say you had $20,000 in student loans at 5% interest and an employer that matches 50% up to first 6% of your contributions to their 401K.
That is a large opportunity cost if you choose to forgo 401K contributions until you pay off all your debt. If you have displayed responsibility with managing money in the past, there is no reason to suffer that opportunity cost.
Should Everyone Stop Using Credit Cards?
This is another gray area, where I don’t think there can be one answer.
Personally, I get many benefits from my credit card company. Just last year, I got about $2,000 back from Chase, my credit card provider, for an unfulfilled contract with my wedding photographer. If I paid with cash, check, or debt card, there is no way I get this money back.
If you’re someone who is out of debt and has displayed financial responsibility in the past, there is no reason why you can’t take advantage of the rewards your credit card company offers.
12% Rate of Return
Ramsey advises that if you put your retirement savings into stock mutual funds, you can earn 12% rate of return a year.
According to Morningstar there are 704 total U.S. large-cap growth mutual funds (growth is his most preferred asset allocation) available today.
Over the past 10 years, here are the top 5 performing funds in that category and their ten year annualized returns:
- CGM Focus = 19.11%
- Century Share Institutional -= 7.96%
- Calamos Growth & Income A = 4.41%
- Prudential Jenneson 20/20 Focus A = 4.39%
- CGM Mutual = 4.27%
The category average over the past 10 years was negative 2.63%.
The category average for international large-cap growth stock mutual funds, another one of Ramsey’s asset allocation recommendations, was a little better at 2.37%.
As you can see, it’s dangerous to assume that you can get 12% rate of return a year. This can cause you to significantly underfund your retirement portfolio.
8% Withdrawal Rate
Even worse than the 12% expected rate of return, Ramsey advises that you can then withdrawal 8% of your portfolio for spending each year during retirement.
Luckily we can use a calculator like Firecalc to see what the success rate will be. For this example, I’m going to assume you have 30 years in retirement, have a $1,000,000 portfolio all in the S&P 500 (Unfortunately I can’t put the exact asset allocation that Ramsey recommends into Firecalc, so the S&P would have to do) , and spend $80,000 each year, adjusted each year for inflation at 3%.
Here are the results from Firecalc…
The success rate that you will be able to maintain this withdrawal rate based upon the history of the stock market is, 16.5%. In other words you have an 83.5% chance of failure.
The advice that you can count on 12% return and an 8% withdrawal rate, is extremely dangerous.
Asset Allocation
Moving on with his investment advice, Ramsey advises for you to allocate your assets into:
- 25% Growth Stock Mutual Fund
- 25% Growth & Income Stock Mutual Fund
- 25% Aggressive Growth Stock Mutual Fund
- 25% International Stock Mutual Fund
While this portfolio could be considered to be diversified among stocks, it’s lacking in asset allocation among other classes such as bonds, TIPS, and REITS.
This is a lot of risk to take on for someone who is close to retirement, in retirement, or even someone in Gen Y who has a low risk tolerance.
The Ugly
Loaded Funds & ELP’s
Dave explains, on his investment philosophy page, how he pays 5-6% every time he buys into a mutual fund. Instead of investing by himself and paying no fees, he chooses to “go with a pro.” Isn’t he a pro?
One area where his business makes money is by endorsing local providers. Therefore, you can go to his website and search your zip code and get a list of investment, real estate, insurance, and tax advisers that he recommends. These advisers pay Ramsey to be listed as an ELP. In return, advisers get referrals from Ramsey’s, who happen to think paying a 5-6% up front load is OK.
I have searched his site for an example showing what a typical portfolio would do paying 5% to invest, assuming a return of 12%, and withdrawing 8%. Unfortunately, I can’t find this evidence he continues to mention.
Conclusion
Dave Ramsey is great a getting you out of debt and interested in finance. If you need some motivation to get started, download his podcast or read his book.
Just be careful to follow all of his advice, especially investment. I see a conflict of interest between his endorsement of ELP’s and your best interests as an investor.
What are your thoughts on Ramsey? Do you agree or disagree with my opinions of him? Have you followed his investment advice? Let me know in the comments…
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