When projecting how much you should be investing for retirement, your expected rate of return and withdrawal rate in retirement are two of the most important factors of the equation. Dave Ramsey believes it is reasonable to expect 12% returns and withdraw 8% every year in retirement. Is this a solid strategy?

Want to know what to do with your next dollar? You need this free download: the Financial Order of Operations. It’s our nine tried-and-true steps that will help you secure your financial future.

Like debt, investing also has many behavioral and psychological aspects. Dave does a great job guiding investors through the psychological minefield of investing. He believes in keeping a long-term perspective, and not getting caught up in day-to-day swings in the stock market. Much of his investment strategy is sound, but there is some room for improvement in a few key areas.

1. Dave isn’t a huge fan of index investing.

Dave Ramsey does believe it’s important to consider a fund’s expenses when searching for a suitable investment, but encourages investing in more expensive actively managed mutual funds. Dave recently said that “it’s fairly easy to study mutual funds and pick them that outperform.”

It would be easy to pick mutual funds that beat the market if the same actively managed funds beat the indexes year after year. Over the long-term (15-20+ years), index funds beat active funds around 85-90% of the time (or more, in certain sectors of the stock market). If the same 10% of actively managed funds beat the market year after year and decade after decade, it would be easy to pick actively managed funds that outperform.

A recent study from Yale analyzing data from 1994 to 2018 found that “a fund’s past performance is completely unpredictive of its returns in the future.” In other words, you’d have the same odds of beating the market in the future by investing in past losers instead of winners. This is what makes it so difficult to beat the market; not only do a small fraction of actively managed funds beat indexes over the long-term, the active funds that do beat the market don’t have better odds of continuing to do so in the future. It seems very difficult, if not impossible, to study mutual funds and pick those that will beat the market in the future.

Later in the call, Dave went on to say that, of first-generation millionaires, “almost all of them did it with their 401(k) with actively managed funds.” The stat Dave is referencing is from their own National Study of Millionaires, which found that “8 out of 10 millionaires invested in their company’s 401(k) plan.” 401(k)s and similar tax-advantaged employer-sponsored plans are extremely powerful vehicles for building wealth. Limits are higher than for IRAs and HSAs, and often employers offer “free money,” or matching contributions. Dave is right to cite 401(k)s as an important factor in creating first-generation millionaires, but his study does not provide data on which funds millionaires are invested in within their 401(k).

We do know that fund options in 401(k) plans can be limited and expensive. The average number of investment options offered in a 401(k) plan is just 28, and the average asset-weighted expense ratio for domestic equity funds across 401(k) plans is 0.43%. Even with limited options and funds with moderately high expense ratios, index funds in 401(k) plans are booming. 17% of all assets in 401(k) plans were invested in index funds back in 2006, and by 2017, 36% of all 401(k) assets were invested in index funds. While the majority of millionaires invest in their 401(k), and most might invest in at least some active funds, it is misleading to imply that first-generation millionaires reached that status because of actively managed funds. The vast majority of actively managed funds underperform indexes, so most millionaires that invested in active funds inside of their 401(k) likely would have been better off investing in index funds instead.

2. Dave’s balance of risk and reward isn’t for everyone.

In general, investors are willing to accept more risk for a greater reward, or greatly reduced risk for a slightly smaller reward. Dave’s investment philosophy doesn’t do a great job of balancing risk and reward. He suggests dividing mutual fund investments equally between four types of funds: growth, growth and income, aggressive growth, and international funds. Growth and income is synonymous with domestic large-cap, growth with domestic mid-cap, aggressive growth with domestic small-cap, and international is international.

We did a deep dive on Dame Ramsey’s investment advice last year, which you can watch below. In the show, we compared a theoretical portfolio of four funds, one in each of Dave’s suggested categories, to the S&P 500. We generously chose low-cost index funds for the Ramsey Portfolio instead of actively managed funds. We found that in good times, performance was similar; the best three-month, one-year, and three-year returns were nearly identical between the Ramsey Portfolio and the S&P 500, but the worst periods were much worse for the Ramsey Portfolio than the S&P 500. A closer look at the Ramsey Portfolio revealed it is riskier than the S&P 500, but there are no excess returns to justify any excess risk; in fact, the S&P 500 outperformed the Ramsey Portfolio over the last one-year, three-year, five-year, and ten-year time period.

Are we really being fair by comparing the Ramsey Portfolio to the S&P 500? Sure, the Ramsey Portfolio is riskier than the S&P 500 and underperforms, which means the risk is not justified, but how does an all-stock portfolio compare to a more diversified portfolio with a large allocation to bonds? Perhaps in that situation the excess risk will generate a comparable excess return.

We recently showed an illustration on the show, which I’ve inserted below, comparing the S&P 500 (which beats the Ramsey Portfolio) to a more diversified portfolio consisting of 60% stocks (we used the S&P 500) and 40% bonds (here we just used the 10-Year Treasury).

Over the last 20+ years, a portfolio consisting of bonds and stocks outperformed the S&P 500. It wasn’t as exciting, though, and owning a diversified portfolio often feels disappointing. When the stock market goes down, your portfolio likely goes down as well, albeit hopefully by less than the total market. In good times, you don’t make as much as you could if you were invested completely in stocks. It may feel like you shouldn’t invest in risk-off assets at all, and instead invest everything in the market. Capturing all of the upside may feel better, but over the last couple of decades we’ve seen that diversifying your portfolio can potentially decrease the volatility of your portfolio and increase returns.

3. Dave has a one-size-fits-all approach to investing.

As you get older and closer to retirement, your portfolio will likely change to reflect your reduced capacity for risk. At younger ages, in the accumulation phase, you can afford to take on a greater amount of risk because you have a greater amount of time to make up for any potential losses. In retirement, you don’t have that luxury; one really bad year could derail your entire retirement, which is why reducing risk is so important. The money you take out of your portfolio to live on needs to be there when you need it, which is why retired investors typically have more cash on hand and have more invested in risk-off assets such as bonds.

A riskier allocation, like being 100% allocated to the S&P 500 or the Ramsey Portfolio, could be detrimental to an older investor. It would be much easier if there were a one-size-fits-all portfolio for everyone, like the Ramsey Portfolio, but there isn’t. Everyone has different goals, time horizons, capacities for risk, life expectancies, expenses, the list goes on. For investors just starting out, target-date index funds may be worth considering, and as your finances mature, you might feel the need to reach out to a fee-only financial advisor for a more personalized portfolio.

Dave Ramsey has done so much good in the personal finance space and has taught basic financial concepts and the importance of discipline to millions of Americans. There’s no doubt he’s helped make a significant number of lives meaningfully better, and it’s impossible to count the number of people impacted by his show, books, and classes. If you follow Dave Ramsey’s investment strategy by investing in actively managed funds and holding them for the long-term, you’ll still get to experience the magic of compounding interest. With a few key changes – investing in low-cost index funds, optimizing your portfolio’s balance of risk and reward, and opting for an investment allocation based on your personal goals and needs – your Army of Dollar Bills can work harder and more efficiently to build your Great Big Beautiful Tomorrow.

Correction: In the original version of the chart comparing the S&P 500 to a 60/40 portfolio, the total return values were calculated incorrectly for both the S&P 500 and 60/40 portfolio. The result is the same, the 60/40 portfolio outperformed the S&P 500 over this period of time, but the total return values and growth of $100,000 values have been updated. The S&P 500 return data was calculated using adjusted close values (including dividends and splits) of SPY, and 10-Year Treasury data is from Macrotrends.net.

Dave Ramsey has helped millions of Americans with debt, which is no easy task. Over 5 million have participated in Financial Peace University, and over 4 million high school students have participated in Dave’s personal finance program for high schoolers. Dave’s understanding of the psychological impacts of debt, and how it affects our behavior, has enabled him to help so many people. 

Like debt, investing also has many behavioral and psychological aspects. Dave does a great job of guiding investors through the psychological minefield of investing; he believes in keeping a long-term perspective, and not getting caught up in day-to-day swings in the stock market. Dave doesn’t think it’s wise to invest in single stocks, either. Much of his investment strategy is sound, but we think there is some room for improvement.

1. Dave isn’t a huge fan of index investing.

Dave Ramsey does believe it’s important to consider a fund’s expenses when searching for a suitable investment, but encourages investing in actively managed funds. Chris Hogan, a Ramsey Personality, wrote that “Index funds won’t beat the market. Listen, average is okay. But do you want to settle for “okay”? I don’t think so!” It is true that index funds will never beat the market because they are the market. If your sole investing objective is to beat the market, index funds will not achieve that goal. We disagree that index funds are average investments, though.

Index funds are typically more tax-efficient than active funds because they don’t tend to change very much. The goal of an index fund is to mirror a broad market index, such as the S&P 500, and it doesn’t require much trading or turnover to do that. Active investments, on the other hand, aim to beat market indexes. Attempting to beat the market often involves more trading and investment turnover, which in turn could generate more taxes.

Index funds are also cheaper than actively managed funds, which makes sense. Active managers need to spend more time and energy managing their investments because they are trying to beat the market indexes. Index fund managers need to only mirror their index, which keeps costs down. The Investment Company Institute studies trends in mutual fund and ETF expenses, and their most recent annual report, released in March, found that index funds still have much lower expense ratios than their actively managed counterparts. The median expense ratio for domestic equity index funds (such as S&P 500 indexes) is 0.42%, and domestic equity active funds sit at 1.12%. World equity index funds median expense ratio is 0.49%, compared to 1.25% for active funds in the same category, and index bond and hybrid funds come in at just 0.20%, compared to 0.88% for actively managed bond and hybrid funds.

Okay, so actively managed funds might not be as tax efficient and might be a little more expensive to invest in, but their higher returns are worth the trouble, right? Data from SPIVA finds, time and time again, that passive investments outperform active investments the majority of the time. In their most recent report, market indexes outperformed over 80% of active funds over the past 15 years in every single category of domestic funds that SPIVA tracks, from small-cap to large-cap to real estate. In some categories, over 90% of actively managed funds were outperformed by their respective benchmarks.

To beat the market, one would have to overcome the tax efficiency and low cost of index funds, in addition to picking an active fund that can consistently outperform its respective benchmark. Index funds might not look so average after all.

2. Dave doesn’t balance risk and return.

Investors may be willing to accept more risk for a greater reward, and they may accept a smaller reward in exchange for reduced risk. Dave’s investment philosophy does not do a great job balancing risk and reward. We know that Dave divides his mutual fund investments equally between four types of funds: growth, growth and income, aggressive growth, and international funds. Growth and income is synonymous with domestic large-cap, growth with domestic mid-cap, aggressive growth with domestic small-cap, and international is, well, international.

On our most recent show, where we took a closer look at Dave Ramsey’s investment philosophy, we compared a theoretical portfolio of four funds, one in each of Dave’s suggested categories, to the S&P 500. In good times, performance was similar; the best 3-month, 1-year, and 3-year returns were very close, but the worst periods were much worse for the so-called “Ramsey Portfolio” than for the S&P 500. A closer look at the portfolio reveals that it is indeed riskier than the S&P 500, but there are no excess returns to justify any excess risk; in fact, the S&P 500 outperformed the Ramsey Portfolio over the last 1-year, 3-year, 5-year, and 10-year time period.

3. Dave has a one-size-fits-all approach to investing.

As you get older and closer to retirement, your portfolio will likely change to reflect your reduced capacity for risk. At younger ages, in the accumulation phase, you can afford to take on a greater amount of risk because you have a greater amount of time to make up any potential losses. In retirement, you don’t have that luxury. The money you take out of your portfolio to live on must be there when you need it, which is why older investors typically have more cash on hand and may have more invested in risk-off assets such as bonds.

A riskier allocation, like in the Ramsey Portfolio, could be detrimental to an older investor. There is not a one-size-fits-all portfolio out there that is right for everyone because we all have different goals, time horizons, risk tolerance, and so many more differences. For investors just starting out, index funds and target-date retirement funds might be worth considering, and as your finances mature, you might feel the need to reach out to a fee-only financial advisor for a personalized portfolio. 

In our latest show, “Deep Dive on Dave Ramsey’s Investment Advice! (Financial Advisors React),” we took a closer look at Dave Ramsey’s investment philosophy and found a few areas where they might be some room for improvement. It’s not all about Dave, either; learn more about our tenets of investing and our philosophy, all on our most recent episode. Watch it now on YouTube below.

Dave Ramsey is the best resources for getting out of debt. He has done incredible good for the financial world and millions of people across America. But there is one element of Dave’s advice that deserves a closer look. How effective is Ramsey Solutions’ investment advice? Let’s do a deep dive on why it might not be as prudent as you think – and how to fix it!

This was a highly requested episode! We hope it’s helpful and inspiring.

In this episode, you’ll learn:

• How Dave’s portfolio performs over time
• Downfalls of Dave’s strategy to watch out for
• How to maximize your investment strategy for optimal performance
• The Money Guy tenets of investing to guide your financial strategy and behavior

Research and resources from this episode:

• Dave Ramsey Fact Sheet
• Dave’s Investing Philosophy (Dave Ramsey)
• How to Choose the Right Mutual Funds (Dave Ramsey)
• Investment Company Fact Book p. 74 (ICI)
• Trends in Expenses and Fees of Funds, 2019 (ICI)
• SPIVA: 2020 Active vs. Passive Scorecard (Q1) (IFA)
• Risk-Return Tradeoff (Investopedia)

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Ever wish you had permission to spend guilt free?

As financial advisors, people expect us to advise on saving money and spending less, but one of our favorite parts is being that voice of reason and letting people know when they can take their foot off the brake and start living like no one else! Let’s walk through 3 surefire signs that you’re ready to start spending a little more on the things you love. We cover financial priorities, making memories, and keeping your life balanced.

In this episode, you’ll learn:

• What boxes to check before you splurge
• How much you should be saving and investing each year
• Embarrassing ways The Money Guy team has saved money
• The mentality that makes millionaires successful
• The downsides of living like you’re broke (when you’re actually rich!)

Research and resource in this episode:

• #171: The Biggest Study Of Everyday Millionaires in 25 Years (Afford Anything)
• 78% Of Workers Live Paycheck To Paycheck (Forbes)
• Survey: Most Americans wouldn’t cover a $1K emergency with savings (Bankrate)
• Survey: Nearly 4 in 10 Americans would borrow money to cover a $1K emergency (Bankrate)
• Failure To Launch (FA)

Enjoy the Show?

• Get FREE downloads full of financial advice from our Resource Page!
• Subscribe on YouTube or wherever you listen to podcasts.
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If you have any questions (or just want to say hi!), join the conversation on Facebook, Twitter, or Instagram!

When you get serious about taking control of your finances, one of the first names or resources you may come by is Dave Ramsey. He is a beast in the personal finance industry. Dave has undoubtedly impacted millions – MILLIONS- of people’s lives through his Financial Peace University, radio show, best-selling books, and the plethora of other financial education resources available through Ramsey Solutions. 

But what happens after you take control of your money and climb out of the “dungeon of debt” as Bo calls it? Well, here is where we think that our Financial Order of Operations parlays nicely with Dave Ramsey’s 7 Baby Steps. 

Tune in to this week’s episode of The Money Guy show to find out how you can maneuver your finances to even greater success as we apply, compare and contrast Dave’s 7 Baby Steps to our Financial Order of Operations. 

Here is what you will learn in today’s episode:

• The difference between The Money Guy Financial Order of Operations and Dave Ramsey’s 7 Baby Steps 
• A review of each of Dave Ramsey’s 7 Baby Steps
• How many American’s actually don’t make it passed Dave’s first Baby Step of saving $1,000 in cash for emergencies
• How to go beyond the first $1,000 in savings and cover yourself more completely
• What Dave Ramsey’s ‘Debt Snowball’ of Baby Step #2 means and how to apply it to your life
• The average income by American household and average debt (by type of debt)
• Why we think you need to get the employer match while you’re working on paying down your debt
• The Money Guy stance on credit cards
• How to prioritize paying off your debt according to our Financial Order of Operations
• Why we’re in agreement with Baby Step #3 and how to determine how much emergency reserves you need
• How to take ‘Baby Step #4: Invest 15 percent of your income for retirement’ and why we think you should aim for more like 20 to 25 percent!
• The types of accounts you can invest in, how they work, and when they may be most beneficial
•  Deep dive into Baby Step #5: Save for Your Children’s College and guidance on how to save for your child’s education
• What may be more valuable than saving up a big fat college savings fund
• Do we agree or disagree with Baby Step #6: Pay Off Your Mortgage Early?
• Why Baby Step #7: Build Wealth and Give is so valuable to your financial well-being and overall well-being

Resources and Research Cited in this Episode

• 58% of Americans Have Less Than $1,000 in Savings, Survey Finds (Yahoo Finance)
• A Foolish Take: Here’s how much debt the average U.S. household owes (USA Today)
• A growing percentage of Americans have no emergency savings whatsoever (Bankrate)
• The Average Retirement Savings by Age
• College is No Free Ride (Fidelity)
• Brain Imaging Reveals Joys of Giving (National Institutes of Health)
• Six Reasons Why People Give Their Money Away, or Not (Psychology Today)

Related Money Guy Shows

• Financial Order of Operations
• Should You Pay Off Debt or Invest?
• How Much Does it Cost to Buy Happiness?
• Average Debt by Age (and what to do about it)

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• ?Get your FREE copy of The 30-Minute(ish) Financial Plan

?Tune In and Go Beyond Common Sense with the Money Guys

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Consider his popularity: Ramsey’s syndicated radio program, The Dave Ramsey Show, is heard on over 325 radio stations throughout the United States and Canada. Besides being a radio personality, he’s written almost 15 books, three of which have been on the New York Times Bestseller list. More recently, Ramsey’s also launched a popular show on the Fox Business Network, The Dave Ramsey Show. And yes, he’s a semi-regular on Oprah 😉

Ramsey’s core message is consistent. More than anything, he evangelizes his seven steps to financial independence:

1. Start an emergency fund
2. Pay off all consumer debt from smallest balance to largest
3. Three to six months of expenses in savings
4. Invest 15% of household income into Roth IRAs and pre-tax retirement accounts
5. College funding for children
6. Pay off home early
7. Build wealth by investing

Simple, no? And yet, many find Ramsey’s advice simplistic, misguided, or just wrong. Ignoring conventional wisdom on many topics, he draws upon his personal experiences to craft financial and life advice that’s often, to say the least, controversial.

So where do I stand?

I’ll surprise some with this, but I’d say I agree with about 90% of what Ramsey talks about. While he sometimes strays too far from what he knows best — human psychology — I still feel that Ramsey offers an incredibly valuable service to his listeners. While we pride ourselves here for going “beyond common sense”, we shouldn’t forget those just starting the personal finance journey. Kudos to Ramsey for seeing this group’s need for straight advice and the honor in serving them.

In this show, I’d like to take some of Ramsey’s thoughts and processes, expand on them a bit, and even go a little farther in depth than he does on some investing topics. I’ll share my feelings on his steps to financial independence, his approach to investing, the difference between risk tolerance and risk capacity, the emotions associated with investing, and some of the benefits of saving for retirement early.

Thanks for listening! If you enjoyed the show, please visit the Apple iTunes website and leave us some positive feedback. They often feature shows like this one that have consistently good feedback. If we can do a better job, drop me a personal email. See you next week 😉