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While I wasn’t looking, it appears that a Twitter war broke out about Dave Ramsey and his mutual fund advice.  A Twitter thread started by financial planner, Carolyn McClanahan and joined by several financial professionals caused Dave Ramsey to respond by saying, “I help more people in 10 min. than all of you combined in your ENTIRE lives.”  This debate continued when Brian Stoffel of the Motley Fool took on Ramsey on his live radio show.  This debate is even discussed in Money magazine.

While I will be the first to say that Ramsey is wrong on his investment philosophies, such as his musings about 12% annual returns from stock mutual funds (link), I will defend some of his philosophies as it pertains to not investing in bond mutual funds and his equity allocations.

First, Ramsey says in his recent book, Complete Guide to Money, “I personally do not like bonds for several reasons.  First, it’s based on debt, and it’s no secret what I think about debt—borrowing or lending.”  I will support Mr. Ramsey on this point.  As a Christian, I recognize that debt is considered a sin, and to profit from this would not honor God.  Additionally, Christians are not the only faith that view debt as a sin, as devout Muslims also refuse to invest money that profits from debt.

Having said that, though, I will disagree with his next statement where he states, “Second, bonds are high-risk because the company’s ability to repay your investment is tied to their performance.  So in that sense, it’s like a single stock and has no diversification.”  I would say the Mr. Ramsey is completely wrong on this point.  First, he does not take into account U.S. Treasuries, nor does he understand tax-free municipal bonds.  These are generally very safe investments, and there are mutual funds which invest in these securities that have performed well over the past several years.  What is ironic, is that Ramsey says that one should avoid owning individual stocks, and chose mutual funds, but does not offer bond mutual funds as alternative to owning individual fixed income securities.  Knowing this, I always recommend that one owns a percentage equal to his age minus 10 to represent his bond allocation.

At the risk of contradicting myself, I do want to offer an argument that supports Ramsey’s equity mutual fund allocation.  Ramsey has been consistent in his approach when he says, “I still recommend you diversify a little further by spreading your investments out over four different kinds of mutual funds.  I tell people to put 25 percent in each of these four types:  growth, growth and income, aggressive growth, and international.”

A simple experiment with MFS Class I funds was conducted using these allocations.  The following funds were used:  MFS Value I (MEIIX), MFS Growth I (MFEIX), MFS International Growth I (MQGIX), and MFS New Discovery I (MNDIX).  $100 month was invested per month, with an annual rebalance.  Starting in 1997, this investment strategy would have yielded a 7.91% annual return.  The hypothetical report can be viewed here (MFS Hypo).MFS

At first blush, this falls far short of Ramsey’s 12%, but it still beats the market average, and is well beyond the ultimate enemy to investing, inflation.  As part of the suitability issue, one would have to understand that this strategy would have lost almost 38% in 2008.

I will have to confess that I have used these hypothetical models and know that using this kind of allocation for the equity portion of one’s portfolio is not a bad idea.  I’ve spoken to representatives from MFS, Franklin Templeton, American Century, and American Funds, and all have said that there is nothing wrong with this approach as it pertains to equity mutual fund investing.

The professionals need to give Ramsey some slack on this issue.  While his 12% premise is wrong, his equity allocation is not so bad, and is even approved by professionals in the field.  If one uses his approach, though, they just need to understand the volatility risks involved.


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