Concerns With Dave Ramsey's Of Mice and Mutual Funds

This is the only time I will part company in a substantive way with Dave Ramsey. I am reluctant to do this since I am presenting Dave Ramsey’s viewpoint, not my prejudices and beliefs. However, I have grave misgivings over some aspects of what he teaches about investments even though much of it is of value and many of his suggestions constitute a good way for a young person to begin an investment program. Where are the problems with this analysis and advice?

First Dave Ramsey is suggesting a one size fits all investment strategy with no backstop.

Here is the text of an email I sent my point of contact at Dave Ramsey’s organization. He replied with the aforementioned article that restated Dave’s opinions.

I am continuing to consider Dave’s somewhat iconoclastic recommendations concerning growth only mutual funds. I find it odd that Dave does not consider age in his risk calculations. Traditional conventional wisdom recommends the investor’s age in bonds. The new conventional wisdom recommends 115 minus your age in bonds to better protect against the risk of inflation. Hence, at my age 60, I should have somewhere between 40% and 55% of my investments in individual stocks, stock mutual funds, or exchange traded funds. 2008 would have simply massacred my 85 year old mother in law’s portfolio if it was invested exclusively in growth funds. As of 2011 there are still many empty apartments in her senior high rise. A lot of formerly rich old folks are now living with their children. Whether or not the stock market will recover in the next decade is a moot point at 85. The home health care agency wants payment for providing that aide 24 hours a day right now. Fortunately, the vast majority of her holdings are in commercial CDs (some are pretty old and pay a good rate of return), bond funds, and annuities.

I find it interesting that there is a disconnect between what Dave says and what Dave does on this particular issue. He balances his growth fund portfolio with income producing real estate. Functionally, this is identical to (but probably better in the current investment climate) using bonds, bond funds, annuities, and CDs to produce a steady income stream with limited concern as to the present value of the equity.

I would really like to hear more from Dave on this subject.

As an addition, let me add that in the decade starting in January 2000, the return on bonds exceeded the return on stocks.

My second problem involves an expected rate of return of 12% from retail mutual funds. Here is the text from my email to my contact on a variety of topics. He answered with a restatement of their position.

Dave is projecting a 12% annual return on retail mutual funds. Given his conservatism on every other issue, this strikes me as wildly optimistic. Heavyweights like John Bogle, the founder the Vanguard Funds, and John Hussman are projecting after tax and inflation returns of 0.5% to 3.0% for the foreseeable future (next ten years). Again, I am an engineer. I understand that the past is not necessarily a predictor of the future. Extrapolation beyond the last known point on a graph is a recipe for disaster. There is another problem with expecting a 12% annual return. Returns are extremely sensitive to actual start and end dates. From 2000 to 2010, for example, the return on an index fund could well have been zero. The latest study, “Revisiting Retirement Withdrawal Plans and Their Historical Rates of Return” by Christopher O'Flinn, Felix Schirripa examines this problem in great detail.

After the dotcom crash and the crash of 2008, does Dave still believe in projecting a 12% return over any five year period? If you could get an answer from him, I would very much like to hear it.

As I dig further into this number, I become even more skeptical. In the book Financial Peace Revisited which is included in the course material, Dave Ramsey states, “However, by leaving your investment alone in any possible ten-year period in the last sixty nine years, you would have made money 97% of the time and would have averaged 12% per year.” The footnote reference an article published in 1994 as the source of this information. This data ignores the last 18 years and two major stock market crashes! It also includes the great bull run from the beginning of World War II until 1970. During those years, America possessed the only industrial infrastructure that did not experience serious war damage. During those decades, we produced something close to 50% of all the manufactured products in the entire world. Those days will never return. Those years are totally irrelevant as the basis for future predictions on stock market returns over the next decade, now that we have exported 20,000,000 factory jobs to foreign countries.

After posting this article I received further information from my point of contact that provides more recent data supporting Dave's arguments. This data is much more relevent, but I still fear overly optimistic.

http://www.daveramsey.com/article/the-12-reality/lifeandmoney_investing

Dave dismisses gold as an investment using similar supporting data. He observes that“From 1833 to 2001, the compound annual growth rate of gold was only 1.54%. That’s pretty rotten.” That argument is bizarre. Until 1971 when Nixon took us off the gold standard, the price of gold was fixed by the Government. In 1971 the price of gold was $35.00 an ounce. This morning the price of gold stands at $1,542.00 per ounce, a little better than 1.54%. On January 4, 1971 the Dow stood at $904.37. This morning the Dow stands at $12,136.12.

The final problem I have with Dave Ramsey’s investment suggestions concern commissions and fees. Dave minimizes the importance of up front sales commissions. He is willing to pay such charges to obtain an excellent return on his money. He states in Dave’s Investment Philosophy. “Generally I recommend choosing A shares (upfront commissions). This is problematic as Dave recommends Endorsed Local Providers, investment salesmen with the heart of a teacher who puts the client’s needs first. These brokers and financial advisers are not considered “fiduciaries” under current law. What this means is they are under no legal obligation to act in your best interests. They can put their interests or the interests of their firm ahead of your interests. They can not legally sell an inappropriate product to a client, but they can feather their nest at your expense. Dave Ramsey also receives a fee for listing these salesmen as Endorsed Local Providers, a troubling conflict of interest.

In conclusion, let me provide the text of my final email to Dave’s staff member on this subject. Since I didn’t receive a reply, I called up this individual. He states that Dave Ramsey keeps his personal finances personal. So I will not be able to tell you how he actually divides up his own personal wealth.

I have continued to study and consider Dave Ramsey’s unusual investment advice. The Of Mice and Mutual Fund class is scheduled for this coming Friday. It occurred to me to look deeply into what Dave Ramsey does rather than focusing on his statements.

Dave does own stock in an individual corporation, The Lampo Group Inc. I suspect that significantly more than ½ of Dave’s net worth is held in these shares. By the way, you may be pleased to learn that the Lampo Group carries an A+ rating from the Better Business Bureau. I also noted the Lampo Group 401K program is rated only a little above average by Brightscope. It was down graded by below average Investment Menu Quality and Participation Rate.

Dave Ramsey’s remaining net worth is actually held in a group of widely diversified balanced funds, incorporating Growth and Income Funds, Growth Funds, International Funds, Aggressive Growth Funds, and a privately held portfolio of income producing real estate, essentially a personally held REIT.

As I have told people for a very long time (Dave says it too), don’t listen to what people say, watch what they do. In this case I would conclude if you wish to be a wealthy man, become an entrepreneur. This is probably very good advice for your generation, as the number of “good jobs” in this country continues to decline.