So this weekend there was a bit of a brewhaha on Twitter surrounding the investment advice given by one Mr. Ramsey, a very well known personal finance guru and the author of many debt-reduction, cash flow planning and general personal financial advice books, classes and seminars.
Things started off with a number of CFP® fee-only professionals commenting that while we had very high regard for his budgeting and debt reduction advice, we felt that his investment advice to readers/seminar attendees was more than lacking. Ok, it was a bit stronger than that.
— Bason Asset (@BasonAsset) May 31, 2013
— Carl Richards (@behaviorgap) May 31, 2013
— Carolyn McClanahan (@CarolynMcC) May 31, 2013
Apparently, Mr. Ramsey was paying attention and responded not-too-kindly.
Here’s the thing. Yes, I (and a few others) could have been more kind in my approach and comments about his investment advice. For that, I am sorry. And yes, I thought his response was beyond unprofessional. But that’s all in the past now. Here’s the crux of the issue for me:
For starters, Mr. Ramsey absolutely deserves recognition for helping many thousands of people learn to budget, live within their means and escape the burden of tremendous debt. I have had personal friends take his advice to much success. His “debt snowball” was some of the first evidence of behavioral finance: it is not the “best” mathematical way to reduce debt, but the emotional satisfaction from reducing small debts provides people with the motivation to continue attacking larger debts. Given that he personally filed for bankruptcy to escape some of his debt, a few have taken issue with his bankruptcy-is-never-the-answer approach, but I’ll direct you to Helaine Olen’s “Pound Foolish” for more on that.
Personally and professionally I would prefer that Mr. Ramsey’s financial advice end there. Instead, he makes two dangerous (and conflicted) assertions about what individuals can expect from investment portfolios.
The first is his suggestion that investors should expect 12% long term returns from long-term investments. Not only is this wildly unrealistic by historical standards (large-cap US stocks have AT BEST delivered 10% returns as the United States grew from an emerging economy to a developed nation), but no reasonable financial planner would build a long-term retirement projection around such an astronomical number. Such rosy return projections can easily lead to severe under-saving for retirement.
A 40-year old hoping to save $1,000,000 (nominal dollars) by age 65 needs to save $532 per month assuming a 12% return. If the saver earns a more realistic 8%, they will have accumulated just about half of the target and have $506,000 saved. Thankfully they are now 65 and only short $494,000 from their savings target! Right?
Coupled with his 12% return assumption is advice to investors that they can expect to withdrawal 8% per year from their investments. This number is absolutely unproven and twice what practically every academic study on long-term portfolio withdrawal rates show to be a safe rate.
The second dangerous lesson is Ramsey telling people that their investments will beat the market. Again, this assertion has been disproved by all academic research. There is no correlation of past outperformance and future outperformance and no readily identifiable consistent skill by investment managers. Perhaps, like the Prudential executive in Frontline’s “Retirement in America,” Ramsey has simply never bothered to actually research this. But there may be another theory. Ramsey touts his “Endorsed Local Providers,” a network of commission-earning brokers to whom he recommends his customers. At the moment I’ve been unable to determine with certainty, but there have been (quite unsubstantiated) claims that these brokers are paying up to $1,500 a month to be part of the program. So it is possible that Ramsey has a significant conflict of interest to recommend brokers who sell actively managed investments, as he may be ultimately benefiting from commissions generated.
I invite Mr. Ramsey to substantiate the 12% return assumption, 8% withdrawal rates, the superiority of actively managed funds and engage the professional financial planning community in civil discourse about these issues, and put to rest concerns about financial conflicts surrounding the ELP program.
Felix Salmon wrote a great long-form piece on the issues surrounding this topic, and you should make sure to read it. Save Like Dave, Just Don’t Invest Like Him.