— Dave Ramsey (@DaveRamsey) June 1, 2013
Back in June, Dave Ramsey declared war on professional financial advisers via Twitter. One thing led to another, and the upshot, now, is that I’ve published a 3,000-word article on Ramsey’s investment advice in Money magazine.
Who is Dave Ramsey? If you’re a member of the coastal elite, you might remember him from Megan McArdle’s feature about his budgeting advice, which ran in the Atlantic a few years ago. If you’re a more typical flyover-state American, on the other hand, you probably know his radio show at first hand: he’s the third-most-popular radio personality in the country, behind Rush Limbaugh and Sean Hannity but ahead of Glenn Beck. Ramsey’s show is a potent mixture of god and mammon: his Financial Peace University claims to present “a biblically based curriculum that teaches people how to handle money God’s ways”.
The problem is that when it comes to investing, God would seem to be something of a financial illiterate. For instance, in his Total Money Makeover book, Ramsey writes that “Aggressive Growth funds get the last 25 percent of my investment. (They are sometimes called Small Cap or Emerging Markets funds.)” Given that another 25% of Ramsey’s asset allocation goes to International funds, followers of Ramsey’s advice could end up putting 50% of their money in international stocks.
Ramsey also claims — falsely but repeatedly — that it’s reasonable to expect a 12% return on your investments, and that therefore it is reasonable to take out 8% of your savings every year, after you’ve retired. This is a recipe for disaster: over the course of a 30-year retirement, the 8% withdrawal rate, adjusted for inflation as Ramsey recommends, would run out of money 56% of the time. Here, for instance, is a sample worksheet from his book, calculating that if you want to live on $30,000 per year, you’ll need a nest egg of just $375,000:
All of which would make it very easy to hate on Ramsey, and to side with the financial advisers he aligns himself against. But the fact is that it’s more complicated than that. The fact is that, realistically, the overwhelming majority of people who follow Ramsey’s advice are never going to reach the point at which they invest a penny. (Before they get there, they have to pay down all their debts, and then build up an emergency fund containing six months’ worth of expenses.) Ramsey isn’t harming people who don’t take his investment advice: if anything he’s helping them, by giving them something to aspire to.
Meanwhile, financial advisors cater to the rich, not to the mass market. If you sign up with Dave Ramsey, you will get financial advice, and it won’t cost you much if you’re not investing much. Yes, you’ll be steered into wildly inappropriate funds which carry up-front fees of somewhere north of 5%. And yes, Ramsey will get highly disingenuous when it comes to defending those indefensible fees. But, once again, Ramsey isn’t talking to people with seven-figure sums to invest: he’s talking to people who could never get past the front door at most financial advisers. A highly-recommended and beyond-reproach adviser like Galia Gichon charges $250 per hour: if you have just three sessions with her, that’s $750. And $750 is 5.75% of $13,000: if you’re investing less than that, in a weird way you’re saving money by paying up-front commissions.
To put it another way: there’s a tiny subset of Ramsey clients who do invest, and nearly all of them invest less than $10,000 per year. Those people neither can nor should be shelling out $250 an hour for financial advice — especially seeing as how they’ve already got themselves in a pretty good place by following Dave Ramsey. What they really need is someone to talk to, someone to hold their hand and encourage them to keep on saving, even after they’ve paid off their debts and built up their emergency fund.
Investing, no less than paying down debt, is all about discipline and goal-setting and having a clear idea of why you’re doing what you’re doing. But in some ways, investing is harder than paying down debt. Debt hangs over you; it’s a nasty, omnipresent cloud which never makes you feel better and often makes you feel worse. Under Ramsey’s plan, you budget carefully, cut up all your credit cards, and use only cash, pre-distributed into different envelopes dedicated to different types of expenses. Everything is worked out from your budget, and since your budget involves living within your means, there’s money left over to steadily pay down your debts. It’s an efficient and effective system, and once you’ve paid off a couple of your smaller debts, you can see that it works and that you’re on your way to becoming debt-free.
Once your debts are paid off, however, the temptations of the hedonic treadmill return. Without the dark cloud of debt, you’re free to spend every last penny you earn: free to buy that shiny bicycle, take that much-deserved vacation, replace that sagging mattress. Putting that sixth month’s salary into your emergency fund doesn’t feel as though it’s nearly as much of an achievement as does paying off your credit-card debt in full. And it’s hard to get support from your peers: personal finance is the last taboo subject, the one thing we never talk about in polite company.
So once you’ve paid off your debts, once you’ve put tens of thousands of dollars in the bank, who’s going to keep you on the straight and narrow? Who’s going to persuade you that continuing to pay for everything in cash, out of envelopes, is a good idea, rather than being an infantilizing embarrassment?
Some financial advisors might pretend that they’re charging money because they’re smart at picking investments, but really that’s the least valuable thing that they do. Ramsey’s advisors will accept anybody, and they will do the valuable thing — just being there, mainly, in a world where it’s incredibly difficult to find someone to talk honestly to about money — for what in dollar terms can be a very low sum.
I don’t like Ramsey’s investment-advice model any more than I like his investment advice. It’s based on hidden kickbacks from advisors to Ramsey himself, and the income Ramsey gets from the investment-advice arm of his empire is clearly a large part of the reason why his investment advice is so bad. If you’re disciplined enough to follow Ramsey’s advice on getting out of debt, then you’re disciplined enough not to need to pay an advisor 5.75% of your savings just to hold your hand. And you should be treated with respect, which means that you shouldn’t be lied to about the returns you can expect or the amount of money you’ll really need in retirement.
But I can’t hate Ramsey in general just because of the small part of his empire which gives investment advice. The rest of what he says is very solid — and he’s clearly done a great job of reaching a very wide audience. On top of that, there are lots of people who sincerely feel that they need individual investment advice — and most of those individuals are simply not catered to by the existing financial-services industry. Dave Ramsey’s advisers surely have their problems. But there’s a colorable argument that they’re better than nothing.
With a financial advisor, it’s that much harder to fall off the Dave Ramsey wagon: you’ve got a friend, now, whom you’re accountable to, every time you go over budget on your spending or fail to make a planned deposit into your investment portfolio.
And ultimately, when it comes to investing, that’s what really matters. It’s easy to get caught up in the narcissism of small differences, to argue whether it’s more realistic to tell people to expect 4% returns rather than 8% returns or even 12% returns. It’s even easier to extrapolate those returns over many decades, to make the difference in the end result look as large as possible.
But the fact is that the amount you end up with, at retirement, is not really a function of your investment decisions — not to a first approximation, and not even to a second approximation, either. The first and biggest driver of your total wealth at retirement is simply the amount of money that you managed to save, in total, over the course of your working life. The more money you put away, and the less money you spent, the more you’ll end up with at the end of the day.
After that, the secondary driver — and it’s much smaller than the primary driver — is general market returns, the market beta. If you’re lucky enough to be investing over the course of a thirty-year bull market, then you’ll end up with substantially more money at the end than if you were stuck in a nasty bear market for most of your working life.
Last, and very much least, comes the question of which specific investments you make: whether you’re in mutual funds, or in stocks, or in ETFs; whether and how you pay commissions; how tax-efficient your investments are; how much you pay in fees; how much your investments outperform or underperform the market; and so on. These questions tend to be the ones which investment professionals concentrate on, since they’re the questions where they have a professional advantage and can, in theory, make a difference.
But let’s keep things in perspective, here. Ramsey is good at the main thing, which is encouraging his followers to save as much as possible. He’s bad at telling them how to save, and of course he has no control at all over how well the market as a whole performs. But if you asked me to predict which person was likely to end up with the greater sum of money at retirement, I might well pick the person on the Ramsey program paying a 5.75% up-front fee on all of her investments, over a self-directed individual following first-rate advice from Jack Bogle. And the reason is that Ramsey’s followers are disciplined spenders. Which can make much more of a difference than any kind of investing strategy ever will.