Dave Ramsey is a popular personal finance personality, and he has great debt repayment advice. But his advice on retirement planning leaves a lot to be desired.
Specifically, there are three ways Ramsey misdirects his readers and listeners in preparing for their later years. And the advice he gives on these matters could be costly and damaging. Here are the three worst retirement tips he gives.
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1. You should choose mutual funds over ETFs or stocks
Ramsey recommends mutual funds over exchange traded funds (ETFs) because:
- Mutual funds are designed to be invested for the long term
- It is possible to outperform the market by selecting the right mutual funds
- ETFs have costs, and while the fees are generally lower than mutual funds, ETFs do not offer the professional management of mutual funds.
But here is the problem.
AND F can too be invested for the long term. While you have the option of trading them like stocks, you don’t have to – you can keep them in your portfolio for decades. And there are a large number of different ETFs out there, many of which also give you the opportunity to try to outperform the market.
You do not have invest in an ETF that just follows S&P 500 – you can choose one Growth ETF, a Dividend ETFs, or even ETFs that track specific industries or sectors such as marijuana industry or the health industry.
So, mutual funds don’t really have these two advantages over ETFs. Ramsey is right about one thing, however – mutual funds to do generally cost more than ETFs. These additional charges may really add up by saving over decades for retirement, and there is little reason to pay them. Over time, history has shown that passively managed funds tend to outperform actively managed ones, especially after taking into account the costs.
Without any clear benefit to investing in mutual funds, Ramsey’s advice that you pay more to put your money in instead of choosing cheaper ETFs could end up costing you unnecessarily thousands in additional overheads over the course of time. of your career as an investor.
2. You can get an average annual return of 12%
Ramsey promises that it is possible to earn an average annual return on investment of 12%. But if you listen to this advice, chances are you will have a significant shortfall when you retire.
Ramsey’s “12% reality” is based on the simple average returns of the S&P 500, which he reports at 11.64% from 1928 to 2020. The problem is, simple average returns aren’t the most accurate way. to measure the performance of your investments. Here’s why.
Suppose you invested $ 5,000 and your investment increased 20% the first year and decreased 20% the following year. Your simple average return is 0% since your investment has increased and decreased by the same percentage. Corn you don’t end up with $ 5,000 at the end of year two. Your 20% gain after the first year left you with $ 6,000. But, when you lose 20% off $ 6,000 – or $ 1,200 – you end up with $ 4,800 at the end of year two. Your actual return on investment is -4%, not 0%.
As you can see, using simple average returns won’t paint a very realistic picture of how your investment is likely to perform. Instead, you should use the Compound annual growth rate (CAGR), which shows a more realistic 10.04% average return on the S&P 500 from 1928 to 2020.
Overestimating expected returns by almost 2% is really damaging, especially when it comes to retirement planning over several decades. You’re going to end up with a lot less money than you expected if you take this advice from Ramsey.
3. You should pay off all non-mortgage debt before investing for retirement
Ramsey argues that you should do the following things before you start investing for retirement:
- Pay off all your debts, except for your mortgage
- Save an emergency fund that covers three to six months of living expenses
Here is the problem. It might take years. And all the while you’d be missing out on an employer 401 (k) matches, which are literally free money. You would also miss out on tax assistance to invest in a 401 (k) or IRA. And you would lose the chance to earn returns in the stock market.
In other words, you will be giving up huge opportunities to consolidate your financial security as a retiree. And, if you do this to pay off low-interest auto loan debt, which could be at around 4%, you are unnecessarily limiting your return on your investment.
Paying off debt and saving for emergencies is a priority, but not necessarily at the expense of your retirement funds.
In general, it’s a good idea to pay off very high-interest debt, like payday loans, and have some emergency cash in the bank before you start investing for retirement. But once you have a few thousand dollar emergency seed fund and have paid off your payday loans, prioritizing getting a 401 (k) match can make a lot more sense than to put all save dollars towards other debts. And there is usually little reason to pay off low-interest loans sooner when you have a good chance of getting a higher return on your investment.
Instead of listening to this Ramsey retirement planning advice, make investing for retirement a priority, set realistic expectations for your return on investment and focus on both historical returns and fees when choosing investments – which usually means choosing ETFs over mutual funds. If you do, you’ll probably end up doing a lot better.
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