Money expert Dave Ramsey
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Dave Ramsey has done a lot to help his readers and listeners with financial advice on debt, but a recent article about a colorful fool points out some places where it lags behind when it comes to retirement planning. I would argue that criticism does not go far enough after all. Let’s look at aspects of his advice that the article criticizes and see where this could have gone further:
You should choose mutual funds instead of ETFs and stocks.
Ramsey: Mutual funds are designed as long-term investments, can outperform the market and are often professionally managed.
Variegated fool: ETFs can also be held as long-term investments, they can outperform the market and they can be managed professionally. However, ETFs usually have lower fees which may lead them to outperform more actively managed mutual funds.
Both omit the benefits of ETFs and individual stocks that can be applied to specific investors. Not only do ETFs usually have lower fees, but they also tend to be much more tax efficient for those who invest in taxable accounts, especially compared to actively managed mutual funds. One study found that mutual funds in 2018 paid out an average of 4.5% of their net asset value as taxable capital gains compared to 0.2% for ETFs, and 90% of ETFs did not pay any capital gains at all.
For more active investors, individual stocks can be even more tax efficient because you don’t pay capital gains tax until you sell. This means you can hold valued shares for more than a year to qualify for a lower long-term capital gains tax rate or even keep them until death and erase all gains taxes during your lifetime with an increased base for your heirs. You can also sell individual shares that lose value and use the losses to offset other taxable income. Neither mutual funds nor ETFs allow you to isolate individual stocks in this way.
Investing in individual stocks can also allow someone to benefit from the potential effect of active management without having to pay management fees. Don’t want to choose stocks yourself? Pawn screens on sites like AAII and brokerage houses like M1 finance allow you to review stocks that meet the criteria you select or are recommended by various investment professionals. You can also use trading techniques like loss loss orders to limit your losses.
You can earn 12% of the average annual return.
Ramsey: The S&P 500 had an average return of 11.64% from 1998-2020.
Variegated fool: A more realistic measurement is the complex annual growth rate, which for that period was 10.04% for the S&P 500.
Expecting any rate of return for retirement planning requires you to invest 100% of your money in the S&P 500 and make the future look like the past. A low assumption is reasonable. Most people do not have enough tolerance for the risk of putting all their retirement money into stocks, and about 15-20% of that is usually international. Even if you put all your money in U.S. stocks, experts predict long-term yields below 6%. We might end up earning closer to the historical average, but I wouldn’t suggest you bet your pension on that.
Before investing in retirement, you should repay all your mortgage debt.
Ramsey: Repay all your mortgage debt and collect emergency savings to cover 4-6 months of living expenses before you save for retirement.
Variegated Fool: Once you have a start-up emergency fund of a few thousand dollars and repay all the loans you can have, it makes sense to give priority to maximum alignment in your employer’s retirement plan. You can also earn a higher rate of return by investing rather than paying off low-interest debt.
The colorful fool is pretty much in place here. My only addition is that it is possible to save for emergencies and retirement at the same time by contributing to the Roth IRA. This is because Roth IRA contributions (and money you turn into a Roth IRA) can be withdrawn at any time without taxes and penalties, so they can be considered part of your emergency fund. Only earnings are subject to taxes and penalties for early withdrawal, but contributions and converted money come first. Anything you don’t withdraw can become tax-free after 5 years and 59 years.
Just make sure you keep all the Roth IRA money that is part of your emergency fund in a safe and accessible place, like a savings account or a money market fund. Once you have enough emergency savings elsewhere, then you can invest all that Roth IRA money more aggressively to grow without a pension tax. If you wait until you get a fully funded emergency fund to contribute to the Roth IRA, you may miss long-term contributions.
The problem with both “financial gurus” like Dave Ramsey and financial sites like The Motley Fool is that they require simplicity because they are aimed at a wide audience. Involving too much information can be overwhelming for many people. It would be best to consult with a qualified and impartial financial planner who can provide you with personalized guidance at the level of depth you need. Your employer may even offer free access to one of them through a workplace financial wellness program. Just don’t assume that there are comprehensive financial recommendations that you can read or hear the whole story.
