Listened to a few Dave Ramsey shows recently. Overall pretty sound advice to most of his callers but he misses wide some of the time and it seems to me that a lot of his investing advice is bad at best, and dangerously self serving at worst. I’d be very curious to see how his money is really invested.
A big part of his show involves pushing investors to his “Endorsed Local Providers” who just happen to pay him for an endorsement. It is claimed that in order to be an ELP they cannot reject people due to low investment balances; to serve the new investors listening to his show. Additionally he loudly endorses the use of loaded funds which he claims to know beat the market and will continue to beat the market. As evidence of their worth he notes that he himself has money in loaded funds, although he also invests a lot in S&P 500 index funds.
During a recent show I heard him roundly denounce the common wisdom to avoid loaded funds. When compared to some funds with high annual fees, a front loaded fund with low annual fees is a deal (obviously a true statement that would balance out at some future point assuming matching returns). To this point, a front load of 5% (common) for a fund that costs half as much annually will take 5 years or so to make up the difference. But ignore that completely! Why are we even comparing expensive managed funds. As Ramsey points out, index funds often have annuals fees much lower than managed funds, sometimes on the order of 1/20th the cost, a 95% savings annually! Not only that, but they beat 75% of actively managed funds after fees, case closed, right?
No! Ramsey claims to know which actively managed funds are going to beat the market, and his ELPs do too. Right…. Try reading your Bogle Ramsey. Not only do indexed funds beat the majority of active funds every year, but the funds beating the index are rarely the same. Bogle discusses this reversion to the mean in depth. In fact, there is between no and negative correlation between morningstar ratings and return. Despite Dave’s stubborn insistence, past performance is not an indicator of future performance, or at best it is an inverse indicator. Not to mention how fund companies roll over or close underperforming funds to look better. Oiye… Well I can’t summarize all of Bogle’s work here, but it is a good read and explains in depth why actively managed funds are ill-advised.
Dave then launches into a laughable comparison of the housing market to actively managed funds. A good neighborhood is like an actively managed fund which has outperformed the market for some amount of time… Maybe sounds good superficially, but people don’t buy into nice neighborhoods because of the past return on the housing. The reasons are too many and complex to go into why this isn’t a sound comparison. To state just a few however, like outperforming funds, nice neighborhoods are expensive. Unlike expensive neighborhoods, where it is clear how to spend that money to maintain the edge (hire better teachers, maintain nice public areas), high cost funds must constantly try to outsmart the market and clearly do not have a formula to turn high costs into high returns. Instead most that find their way above average come crashing back down.
So why would Dave push these front loaded actively managed funds so hard? My best guess would be that most of his ELPs would lose money on low value clients pushed to them by Dave Ramsey if they put them in low cost funds. Instead, with Dave’s blessing they can front load them and get some guaranteed money before they pull it out to buy some consumer BS. The evidence for index funds’ dominance is so overwhelming it’s surprising that advisers with fiduciary duty can even put people in front loaded funds. The only positive thing I could say about front loaded funds is that they’re better than spending the money. Again I would be very curious to know how much he has in these types of funds? Just enough to honestly say he owns them and recoup the cost through “endorsement” fees, or is it a majority of his invested assets? Also, if he’s so confident in these funds why does he bother with the indexes? Could it be because they are so much cheaper with a significantly better risk to return ratio?
I’d also be remiss if I ignored Dave’s crazy 12% investment return projection. The biggest error with his logic is that it appears he averages the annual market returns instead of taking the compound long term rate of return. As an example, if you invested $10,000 and had one year of 10% returns, then the next year had a -10% return. You’d have $9,900 but Dave’s math would tell you that the return was 0% (average of 10 and -10). NOT GOOD MATH!!! Secondarily, and not specific to Dave’s math is the idea that the last 100 years during which the US was largely the world’s lone super power are not very likely to be representative of the next 100 years; no one can say, but world domination is not often long lasting, and therefore neither are the associated returns. High returns are good if they entice people to invest (which they should) but are bad if they create outsized expectations and deter people from investing when it fails to meet their expectations? Fortunately it takes many years to be able to honestly determine whether your returns are meeting expectations, at which point people hopefully will be so used to investing and will be happy enough with their returns (my guess would be more like 5% real rate)