Dave Ramsey is a popular financial guru and author who hosts a nationally syndicated radio show and has a sizable following of listeners and readers. Ramsey is especially popular among Christians because many of his financial principles are rooted in Christian values and biblical teachings. Ramsey has been open about his volatile business career prior to becoming a finance pundit, which included building a $4 million real estate portfolio and then losing it all to bankruptcy before age 30.
[Sign up for stock news with our Invested newsletter.]
Since then, Ramsey has been a financial success in his personal life and now has an estimated net worth in the $200 million range. He encourages his followers to emulate his techniques, which include avoiding any individual stocks and instead buying top-performing mutual funds. Ramsey’s critics say that some of his financial advice is questionable, however, and building wealth using Ramsey’s techniques may be more difficult or risky than it seems.
Here’s a look at Ramsey’s investing philosophy and how it compares to common financial advice:
— Who is Dave Ramsey?
— Beating the market with mutual funds.
— The ideal retirement withdrawal rate.
— Takeaway.
Who Is Dave Ramsey?
Dave Ramsey’s career as an entrepreneur began when he was 12 years old and started a lawn care business in his hometown. When he turned 19, Ramsey immediately became a licensed real estate agent and used his real estate sales commissions to pay for his college tuition. After graduating from college, Ramsey began flipping properties, relying on family connections at local banks to secure financing for his deals. By age 26, he had a large real estate portfolio and a net worth over $1 million.
Just two years later, Ramsey was forced to file for personal bankruptcy protection when one of his bank lenders demanded he pay back a $1.2 million loan within 90 days. The downfall of his early real estate business led Ramsey closer to Christianity, which became the centerpiece of his financial philosophy. He started a company called The Lampo Group that provided personal finance counseling, and his business grew to more than 350 students after only a few years.
Continuing on the momentum of his counseling business, Ramsey published his first book, “Financial Peace,” in 1992. He also began co-hosting a finance-focused radio show called “The Money Game” and his own radio program called “The Dave Ramsey Show.” The show has since been renamed “The Ramsey Show” and more heavily features “Ramsey personalities” (read: team members who aren’t Dave) as the company takes a more proactive view towards succession. Dave Ramsey is 63 years old.
Ramsey’s personal finance principles are generally sound and simple, such as avoiding or eliminating debt, investing 15% of income in tax-advantaged retirement accounts, focusing on long-term returns and being consistent with your contributions. He also often weaves Bible verses into his financial recommendations. For example, Ramsey has quoted Proverbs 21:20 to highlight the importance of saving and living below your means: “In the house of the wise are stores of choice food and oil, but a foolish man devours all he has.”
While Ramsey’s simple, Christian-inspired personal finance teachings certainly resonate with a large audience, critics have pointed out that some of his recommended techniques when it comes to investing and retirement may not be as simple and straightforward as he makes them seem.
Beating the Market With Mutual Funds
One of the cornerstones of Ramsey’s investing philosophy is to buy and hold a mix of equity mutual funds, including growth and income funds, growth funds, aggressive growth funds and international funds. His Ramsey Solutions website makes the following suggestion:
“When looking for mutual funds to invest in, keep an eye out for funds with a long track record (at least 10 years) of strong returns that consistently outperform the S&P 500.”
Ramsey encourages his followers to find these top-performing mutual funds, but he doesn’t mention specific funds or where to find them.
It turns out it’s extremely difficult for even the best professional fund managers to consistently beat the performance of the S&P 500 over the long term. A recent study of 2,132 actively managed mutual funds by S&P Dow Jones Indices found that not a single fund managed to achieve consistent, top-quartile returns over a five-year period. Unfortunately, even if a fund does manage to outperform for several years in a row, that’s no guarantee the outperformance will continue in the future.
Dr. Roger Silk, CEO of Sterling Foundation Management and co-author of the book “The Investor’s Dilemma Decoded,” says there are examples of mutual funds that have consistently outperformed the S&P 500 for long stretches in the past. However, a Yale study of mutual fund performance from 1963 to 2018 highlights the difficulties.
“In the period 1963 to 1993, there was evidence of performance persistence,” Silk says. “But in the period 1994 to 2018, it would not have helped an investor to know that a particular fund had outperformed, because that did not predict future outperformance.”
In other words, the few funds that consistently outperformed over a 30-year period failed to continue to outperform over the following 25-year period. So Ramsey’s advice of simply picking the mutual funds that “consistently outperform” the S&P 500 isn’t as simple or as straightforward as he makes it seem, no matter how much Ramsey chastises listeners for overcomplicating what he asserts is a simple way to beat the market.
While fond of championing this general investing method on air, Ramsey is loathe to mention the specific funds he buys that reliably beat the market. Doing so, of course, would allow listeners to backtest his strategy to objectively show how it has played out.
The Ideal Retirement Withdrawal Rate
Another piece of financial advice that recently landed Ramsey in hot water was his recommendation that retirees withdraw 8% per year of their retirement portfolio’s starting value. On his radio show, Ramsey called a proposed 3% withdrawal rate “ridiculous,” and recommended an 8% withdrawal rate that is double the industry standard of a 4% withdrawal rate.
“If you’re making 12% in good mutual funds, and the S&P is averaging 11.8%, and if inflation for the last 80 years has averaged 4%, if you make 12% and you need to leave 4% in there for inflation raises, that leaves you 8%. So I’m perfectly comfortable drawing 8%. But if you want to be a little bit conservative, 7%, but sure not 5% or 3%,” Ramsey said.
Morningstar subsequently backtested Ramsey’s recommended strategy using rolling 30-year periods going all the way back to 1926. Morningstar found retirees using Ramsey’s 8% suggested withdrawal rate would have run out of money within 20 years in 32% of test cases. In 45% of test cases, retirees would run out of money within 30 years. In 6% of cases, retirees would have burned through their entire nest egg in less than 10 years. As Morningstar concludes, Americans with severe health issues or those that retire in their mid-70s may be comfortable with this amount of risk, but most retirees likely don’t want to take a gamble when it comes to managing their life savings.
Michael Hills, financial advisor at Apex Wealth, says Ramsey’s 8% withdrawal rate recommendation has some serious red flags when it comes to risk management.
“If retirees were to follow Ramsey’s 8% guideline and experience early losses, their portfolios might never recover — even if the markets later perform well. This could result in financial insecurity and potential shortfalls when the savings are most needed,” Hills says.
Sean Lovison, founder and lead advisor at Purpose Built Financial Services, says it’s more realistic to assume closer to 7% average annual returns for retirees when accounting for inflation and market volatility.
“The 4% withdrawal rate, widely regarded as a safer standard in the industry, reflects a more sustainable approach for maintaining portfolio longevity,” Lovison says.
“A higher withdrawal rate, like 8%, could expose retirees to significant risks, especially during market downturns, unless perhaps if the retirement period is expected to be much shorter, such as starting at age 75 or later.”
Takeaway
Dave Ramsey’s practical personal finance philosophy has unquestionably done a lot of good for thousands of his readers and listeners. Ramsey’s recommendations of eliminating and avoiding debt, consistently investing in diversified mutual funds, taking a long-term approach to your finances, living below your means and working with a financial advisor can serve as a strong backbone to any wealth-building plan.
That being said, the lack of details of Ramsey’s specific investment recommendations, his questionable risk management and his seemingly overly optimistic return assumptions suggest investors shouldn’t blindly follow every piece of advice Dave Ramsey gives without at least getting a second opinion from a qualified financial advisor.
More from U.S. News
9 Best Growth Stocks to Buy for 2024
9 Best Cheap Stocks to Buy Under $10
6 Best Biotech Stocks to Buy for 2024
Do Dave Ramsey’s Stock Market Claims Make Sense? originally appeared on usnews.com
