Following this advice by Dave Ramsey could get you into financial trouble.
Dave Ramsey is one of the most popular financial gurus in the country, and his Baby Steps program has helped millions of people to take control of their finances. But while there are merits to much of his advice, there are a few things that Dave Ramsey is simply wrong about.
Unfortunately, if you follow all of his advice you could end up getting into some financial trouble in the long run. Here are four of the key things Ramsey is wrong about that could lead you astray.
1. S&P 500 returns
Dave Ramsey has repeatedly insisted that you can expect to make a 12% return on your investments. He claims this is based on the “historic average annual return of the S&P 500.”
Here’s the problem. This 12% figure is based on the simple average return of the S&P market between 1926 and 2019 — not the Compound Annual Growth Rate (CAGR). While this may sound technical, here’s what it means.
Let’s say a $10,000 investment went up 25% one year and down 25% the next year. The simple average return would be 0%. But, in reality, your investment would’ve been down around 6.25%. Here’s why:
- $10,000 + 25% of $10,000 = $12,500
- $12,500 – 25% of $12,500 = $9,375
Dave’s use of the simple average return of the S&P 500 makes it appear there was a 12.1% average annual return on the S&P because it doesn’t take into account the actual annual growth of your money. Instead, the CAGR for that period, which is a better measure of how an investment actually grows over time, is 10.2% for the S&P 500.
Unfortunately, if you base your retirement projections around Dave’s assumption that you’ll earn 12% per year instead of around 10% over time, you could find yourself with far less money than you expect. In fact, investing $5,000 per year for 30 years with an average annual gain of 12% would give you $1.21 million while investing the same amount at a 10% average annual gain would leave you with just $833,470.
You can’t afford to make an overly rosy assumption about how investments will perform when you’re setting savings goals.
2. Mutual funds beat out ETFs
Dave Ramsey recommends mutual funds rather than ETFs. An article on his website gives a number of justifications for this position including the following:
- Mutual funds are designed to be invested in over the long term rather than traded like ETFs
- You lose the “personal touch” that you’d get in an actively-managed mutual fund
- Choosing the right mutual fund allows you to beat the market
Unfortunately, Ramsey casually dismisses the fact that ETFs tend to have much lower fees than mutual funds. And that matters. Investment fees cost you big time — tens of thousands of dollars in lost returns over time, especially when investing on a long timeline.
As far as losing the personal touch, the basics of mutual fund investing tells us that almost all actively-managed mutual funds fail to consistently outperform the stock market. Since there are multiple ETFs that aim to track the performance of the market as a whole, chances are good investing in one of those would provide better returns than an actively-managed fund.
You also have the option to invest in ETFs for the long term if you want to. Nothing requires you to sell them just because you have the option to actively trade them. And while Ramsey’s website suggests a growth stock mutual fund could be a smart way to outperform the market, there are plenty of growth ETFs to buy (often at lower fees). In fact, the best ETF brokers will have specialized niche ETFs you could explore if you hope to beat the market.
There’s no excuse to urge investors to pay higher investment fees for mutual funds that are likely to underperform when ETFs typically present a simpler, cheaper alternative.
3. Putting retirement savings before all debt payoff
Ramsey is most famous for his “baby steps,” which involve, in order:
- Saving up a small emergency fund
- Paying off all debt except your home
- Saving up three to six months of living expenses in an emergency fund
- Saving for retirement
- Saving for children’s college
- Paying off your mortgage
- Building wealth and giving
Taking these steps can be a smart move. But the idea that you should both pay off all debt except your home and save up a six-month emergency fund before you get serious about retirement savings is misguided.
Some debt comes at a very low interest rate — well below what you could earn in the stock market. Focusing on paying those types of loans off early could come as a huge lost…
Read More: 4 Things Dave Ramsey Is Dead Wrong About