Dave Ramsey has helped millions of Americans with debt, which is no easy feat. Over five million have participated in Financial Peace University, and four million high school students have participated in Dave’s personal finance program for high schoolers. Dave Ramsey has been able to help so many people get out of debt because he was formerly deep in debt himself, and he has a great understanding of the psychological impacts of debt, how it impacts our behavior, and how to overcome them.
I enjoy all of these articles! Thank you for confirming my thoughts about DR’s investment advice. I like listening to him (although of course not as much as the Money Guys) but I’ve always thought his investment advice was not very well thought out. I love low fee index fund investing and not worrying about trying to pick winners or beat the market. I personally diversify in my 401K and IRAs using a combination of S&P 500, mid cap, small cap, and international index funds. This has served me well over the past 20 years. I know I’ll need to cut back on equities in the future but it’s psychologically hard to do that due to FOMO on maximum gains.
Hi Hez, glad you liked the article! I'll copy a little bit of what I said above. The chart shows someone investing with a lump sum at the beginning of a bear market, and essentially shows sequence of return risk (in other words, the danger of retiring right before a bear market). For someone DCAing, or continuously investing over this time, the S&P 500 probably beats out the 60/40. Over longer periods of time the 60/40 would not be expected to beat the S&P 500. This chart should scare you a little if you are 65, retiring tomorrow, and your portfolio is 100% stocks and 0% bonds, but for younger investors growth, saving, and investing is more important than wealth preservation (because you likely don't have that much wealth to preserve yet!) and risk reduction. Someone many years from retirement with a large equity allocation shouldn't view this chart and think "I need to switch to a 60/40!"
Over this period of time, I'd expect the 80/20 to be somewhere between the 60/40 and 100% S&P 500. The 60/40 outperforms by so much in this illustration because we start with a lump sum investment and start essentially at the beginning of a bear market. The chart shows how sequence of return risk could affect someone approaching retirement with 100% in equities, but isn't as relevant for someone DCAing (not starting with a lump sum) and someone decades for retirement. Over longer periods of time the 60/40 would be expected to (and has) underperformed a mix of 100% equities, but wealth preservation and risk reduction is very important going into retirement.
Morningstar has done research and it is statistically proven that the cost of a fund is related to its predicted performance. The higher the cost (expense ratio) to lower the return if the market is indeed efficient. Also numerous academic papers (lack of obvious bias) decisively prove that actively managed funds trail index funds when looking across 10 and 20 year periods. They have to make up those 1 to 2 percentage points on top of the market to just cover their expense ratios. And you also have survivorship bias when analyzing active funds as they either die or get combined into other funds. Dave is awesome for debt management and holding yourself accountable but for investing he is compensated by pushing actively managed funds so it is in his best interest to say they are better but the scientific and academic community disagree with him and provide empirical data to support their positions. Just look up the Plain Bagel and Ben Felix YouTube channels or research Fama French papers.
At one point I came across a study, I think done in the '90s, that showed past performance of actively managed funds to be inversely correlated with future performance. Which means active funds that did well in the past would be expected to do worse than average in the future. The Yale study I cited in this article found past performance to be unpredictive of future performance, but this other study went a step further and found past performance to be inversely correlated to future performance. I read the study, found it interesting, and didn't save it. I've been unable to track it down since I initially read it, and it haunts me to this day! Definitely send any active fund research you find my way.
DR can take a more aggressive approach to investing due to his real estate holdings. The income from the real estate acts to some extent as a bond fund paying income so he would not need to touch the equities during a downturn. Those of us without real estate would be better off with a 60/40 or 70/30 approach, using index funds. Thank you Daniel for the insight.
Daniel, not sure who put together the comparison chart of the S&P 500 vs 60/40 stock-bond split; but somebody hasn't done addition and subtraction correctly. The S&P 500 column should lead to a return of over +570%.
Is it stands, the error makes your reasoning questionable.
Hi! I can clarify. Negative returns essentially "matter" more than positive returns when calculating total return. It's easier to show you what I mean with numbers...
An example: if you have $1 and it goes up by 100%, you have $2. If it then goes down by 50%, you are back to $1. Your total return = 0%, but if you add those returns together you should be at 50%. This is true no matter your sequence of returns (if your dollar lost 50% first and then gained 100%, you would still be back at $1).
Here's roughly how the math works on the S&P: $100,000 x (1-0.375) = $62,500 x 1.919 = $119,938 x (1-0.529) = $56,491 x 5.989 = $338,323 x (1-0.337) = $224,308 x 2.066 = $463,421 for a return of 363.4% (since I did this by hand it was a few dollars off). You can do the same exercise with the 60/40 portfolio.
Hope this helps clear things up! The example would look a lot different if we did not start with a large lump sum, had someone dollar cost averaging, or started at a different year. The illustration is meant to show the potential pitfalls of not reducing risk as you enter retirement (since Ramsey suggests the 100% equity four-fund portfolio regardless of age), and is less applicable to younger investors with decades to go.
I enjoy all of these articles! Thank you for confirming my thoughts about DR’s investment advice. I like listening to him (although of course not as much as the Money Guys) but I’ve always thought his investment advice was not very well thought out. I love low fee index fund investing and not worrying about trying to pick winners or beat the market. I personally diversify in my 401K and IRAs using a combination of S&P 500, mid cap, small cap, and international index funds. This has served me well over the past 20 years. I know I’ll need to cut back on equities in the future but it’s psychologically hard to do that due to FOMO on maximum gains.
Well said! I'll have to think about that 60/40 portfolio some more. Right now I'm 100% stocks (I'm many years from retirement).
Hi Hez, glad you liked the article! I'll copy a little bit of what I said above. The chart shows someone investing with a lump sum at the beginning of a bear market, and essentially shows sequence of return risk (in other words, the danger of retiring right before a bear market). For someone DCAing, or continuously investing over this time, the S&P 500 probably beats out the 60/40. Over longer periods of time the 60/40 would not be expected to beat the S&P 500. This chart should scare you a little if you are 65, retiring tomorrow, and your portfolio is 100% stocks and 0% bonds, but for younger investors growth, saving, and investing is more important than wealth preservation (because you likely don't have that much wealth to preserve yet!) and risk reduction. Someone many years from retirement with a large equity allocation shouldn't view this chart and think "I need to switch to a 60/40!"
I'm curious how an 80/20 portfolio would do compared to the S&P 500 and the 60/40 portfolio.
Over this period of time, I'd expect the 80/20 to be somewhere between the 60/40 and 100% S&P 500. The 60/40 outperforms by so much in this illustration because we start with a lump sum investment and start essentially at the beginning of a bear market. The chart shows how sequence of return risk could affect someone approaching retirement with 100% in equities, but isn't as relevant for someone DCAing (not starting with a lump sum) and someone decades for retirement. Over longer periods of time the 60/40 would be expected to (and has) underperformed a mix of 100% equities, but wealth preservation and risk reduction is very important going into retirement.
Morningstar has done research and it is statistically proven that the cost of a fund is related to its predicted performance. The higher the cost (expense ratio) to lower the return if the market is indeed efficient. Also numerous academic papers (lack of obvious bias) decisively prove that actively managed funds trail index funds when looking across 10 and 20 year periods. They have to make up those 1 to 2 percentage points on top of the market to just cover their expense ratios. And you also have survivorship bias when analyzing active funds as they either die or get combined into other funds. Dave is awesome for debt management and holding yourself accountable but for investing he is compensated by pushing actively managed funds so it is in his best interest to say they are better but the scientific and academic community disagree with him and provide empirical data to support their positions. Just look up the Plain Bagel and Ben Felix YouTube channels or research Fama French papers.
At one point I came across a study, I think done in the '90s, that showed past performance of actively managed funds to be inversely correlated with future performance. Which means active funds that did well in the past would be expected to do worse than average in the future. The Yale study I cited in this article found past performance to be unpredictive of future performance, but this other study went a step further and found past performance to be inversely correlated to future performance. I read the study, found it interesting, and didn't save it. I've been unable to track it down since I initially read it, and it haunts me to this day! Definitely send any active fund research you find my way.
DR can take a more aggressive approach to investing due to his real estate holdings. The income from the real estate acts to some extent as a bond fund paying income so he would not need to touch the equities during a downturn. Those of us without real estate would be better off with a 60/40 or 70/30 approach, using index funds. Thank you Daniel for the insight.
So as a young investor with not much invested yet, is the conclusion basically "invest everything in a low cost S&P 500 index fund"?
Daniel, not sure who put together the comparison chart of the S&P 500 vs 60/40 stock-bond split; but somebody hasn't done addition and subtraction correctly. The S&P 500 column should lead to a return of over +570%.
Is it stands, the error makes your reasoning questionable.
Hi! I can clarify. Negative returns essentially "matter" more than positive returns when calculating total return. It's easier to show you what I mean with numbers...
An example: if you have $1 and it goes up by 100%, you have $2. If it then goes down by 50%, you are back to $1. Your total return = 0%, but if you add those returns together you should be at 50%. This is true no matter your sequence of returns (if your dollar lost 50% first and then gained 100%, you would still be back at $1).
Here's roughly how the math works on the S&P: $100,000 x (1-0.375) = $62,500 x 1.919 = $119,938 x (1-0.529) = $56,491 x 5.989 = $338,323 x (1-0.337) = $224,308 x 2.066 = $463,421 for a return of 363.4% (since I did this by hand it was a few dollars off). You can do the same exercise with the 60/40 portfolio.
Hope this helps clear things up! The example would look a lot different if we did not start with a large lump sum, had someone dollar cost averaging, or started at a different year. The illustration is meant to show the potential pitfalls of not reducing risk as you enter retirement (since Ramsey suggests the 100% equity four-fund portfolio regardless of age), and is less applicable to younger investors with decades to go.