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Dave's Investing Philosophy

from daveramsey.com on 14 Jul 2009

Want to know how Dave invests his money? Here’s your chance to find out! This guide is intended to help you understand what Dave has to say when it comes to the nuts and bolts of investing.

If you would like in-depth help to invest your money, contact your investing Endorsed Local Provider. Our investing ELPs are financial advisors that agree to help you invest the way Dave teaches. ELPs do not work for Dave but they are honest professionals and will make sure you understand your investments.

Special Note: Even though many people value Dave’s advice, you should not simply do what Dave does just because he’s Dave Ramsey. If you get the help of a financial advisor, even an ELP, you are responsible for making your own decisions. Never take a blind faith mentality when it comes to investing.

Dave's Investment Philosophy (printer-friendly) Dave's Investing Philosophy

Baby Steps: Don’t start investing prior to completing Baby Step 3.

$1,000 to start an emergency fund.
Pay off all debt using the debt snowball.
3-6 months of expenses in savings.
Invest 15% of household income into Roth IRAs and pre-tax retirement.
College funding for children.
Pay off home early.
Build wealth and give! Continue to invest in mutual funds and real estate.

Investing For Those Just Getting Started:

Be sure you have completed the first 3 Baby Steps.
Begin by doing pre-tax savings in (401k, 403b, TSP, Traditional IRA) and tax-free savings (Roth IRA, Roth 401k)

NOTE: If you receive a match in your (401k, 403b, TSP), invest here first up to the match. Then, fully fund a Roth IRA for you (and your spouse, if married). Then, come back to the (401k, 403b, TSP).
If you are still on Baby Steps 1-3, be patient; put off investing for now. Avoiding a crisis with a fully funded emergency fund and paying off high-interest debts is a fantastic investment!

Mutual Funds:
25% into each of these four types of funds:

Growth
Growth & Income
Aggressive Growth
International

A shares (front end load); funds that are at least 5 years old or older; solid track record of acceptable returns within fund category.
*If risk tolerance is low, put less than 25% in aggressive growth or consider adding a “Balanced” fund to the four types of funds Dave suggests.

Single Stocks:
I do not own single stocks and do not suggest single stocks as part of your investment plan. Single stock investors over long periods of time don’t consistently generate returns as high as mutual funds do. If you really want to own a stock for some reason (company stock, for fun, etc.), limit single stocks to no more than 10% of your investment portfolio.

Certificates of Deposit: (CDs)
I suggest using CDs only for savings (for a purchase, taxes if you own a business, etc.); not for long term investing. When using CDs, be aware of fine print for early withdrawals. CDs carry a low rate of return. As an investor, to get ahead you must earn a high enough rate of return to outpace inflation (3% to 4% per year) and to pay taxes on the gains if not inside a retirement account. Most investors need to average a minimum of 6% per year over time to do these two things.

Bonds:
I do not own any bonds and do not suggest them as part of your investment plan. Bonds carry the incorrect stereotype that they are safer with a slightly lower rate of return than equities. Not true. Single bonds can be very volatile and can actually go down significantly in value. Bond mutual funds can at least be tracked for historical returns, but do not offer the returns equity mutual funds do.

Fixed Annuities:
I do not own any fixed annuities and do not suggest them as part of your investment plan. Simply stay away from these!

Variable Annuities:
Variable Annuities (VA’s) cause more confusion than any other financial product. Here are some basics about VA’s
What is it?

VA’s are a savings contract with a life insurance company.
They offer tax deferred growth on an after tax investment.
They offer beneficiary designation, which allows the account to be transferred to a beneficiary outside of probate court.
VA’s carry penalties if the contract is broken prior to the agreed upon time period, usually a declining surrender charge that lasts from six to eleven years.
10% IRS penalty for withdrawing prior to age 59.5.
VA’s offer many bells and whistles, such as guarantees of principal, life insurance, etc.
VA fees vary widely.

Dave’s strong suggestions when considering VA’s:

Only consider VA's when you reach Baby Step 7. In other words, you're debt free including your home and all other tax deferred options have been used.
VA’s can be useful investment tools because they allow your investments to grow tax deferred.
When purchasing VA’s understand the fees, surrender period, and any riders or options you choose.
When purchasing VA’s, stay with the four types of mutual funds I suggest inside the VA.

High income earners:

If a person earns too much to do a Roth IRA and is limited to what they can contribute to a 401k plan due to top heavy rules (unable to contribute 15% into pre tax or tax free investments), I recommend using either low turnover mutual funds or a combination of low turnover mutual funds and variable annuities.
While an option for high income earners, I do not personally choose variable annuities at this point.

Worth mentioning:

Don’t commit to VA’s until you’re sure you are ready. Once you’re in, you’re in.
Never, ever, ever roll an IRA, 401k or 403b into a VA. These three things already have the benefit of tax deferred growth and you do not need a VA.
I, myself, fit all the pre-requisites for VA’s; yet I do not personally own any. I highly prefer mutual funds and paid for real estate for investors on Baby Step 7.

Investing For College:
I recommend investing the first $2,000 per year in an Education Savings Account, aka ESA, aka Coverdell Savings Account. ESA’s are very simple and work much the way a personal IRA does. When saving for a young child that will attend a public school, the ESA will usually be all you need.

For investing more than this amount or if your income exceeds $200,000 annually, choose a 529 plan. The challenge with 529’s is that every state has a different 529 plan and they all vary in mechanics. Some allow you to pick mutual funds, some require you to choose funds based on your child’s age, while others are pre-paid tuition programs.

When choosing a 529 plan, I strongly suggest picking a plan that allows you to choose the funds up front and to keep those funds all the way up until time to use the funds for education. Remember to stick with the four types of funds I suggests. (Don’t use the pre-paid plans or ones that do age based asset allocation.)

Long Term Care Insurance:
I strongly recommend LTC as part of your plan at age 60. Sales people in the LTC industry can be very enthusiastic about purchasing it prior to age 60. Even so, I will be purchasing when I am 60.
Also, it is OK to purchase LTC even if you do not have a sizable estate to protect as long as the premiums are well within your budget. An example might be a 60 year old couple with a plentiful current income; but not a large estate. This couple may choose LTC simply for the quality of care it will provide them.

Disability Insurance:
I strongly suggest purchasing long term disability insurance as income replacement in the event you are disabled if affordable. The cost of long term disability depends heavily on your occupation. White collar employees carry less risk than blue collar employees and therefore are less expensive to insure. For short term disabilities (90 to 180 days), I suggest having a fully funded emergency fund and do not recommend purchasing short term disability policies.

Life Insurance:
I strongly suggests purchasing 15 year (or longer) level term life insurance. Purchase life insurance equal to 8 to 10 times your annual income. The logic behind this is that a beneficiary could invest the entire amount into mutual funds, and draw 8% to 10% annually as income without actually consuming the original insurance amount. Effectively, this replaces the income that was being generated by the deceased person. Never purchase any type of cash value or permanent insurance such as whole life, variable life, universal life, etc. Never cancel any old policy until the replacement policy is fully in force.

Exchange Traded Funds: (ETFs)
I do not own ETFs and do not recommend them as part of your investment plan. ETFs are baskets of single stocks that intend to operate like mutual funds; but they are not mutual funds.

Separate Account Managers:
SAM’s are third party investment professionals that buy and sell stocks or mutual funds on your behalf. Put simply, I'm never going to get near this. I'm sticking with the team of manager’s in large, old, experienced mutual funds.

Real Estate Investment Trusts: (REITs)
I do not own any REITs and do not suggest them as part of your investment plan. As a category, REITs just don’t stack up to good growth stock mutual funds. If you really want to invest in REITs, limit this to no more than 10% of your total investment portfolio.

Equity Indexed Annuities
I do not own Equity Indexed Annuities and do not suggest them as part of your investment plan. Equity Indexed Annuities agree contractually to limit your loss while you agree to limit your gains. I suggest investing directly into index funds if you want to follow an index such as the S&P 500 or similar.

Thrift Savings Plan: (TSP) Dave’s suggestion is to invest:

60% in C fund/plan
20% in S fund/plan
20% in I fund/plan

Values Based Investing:
I do not use a values based investing approach. Long discussion made short:

I agree with the concept. If you can pick between two similar mutual funds; one invests in things you agree with and the other in things you do not agree with, it makes sense to pick the one that aligns with your beliefs.
However, few of these funds stand up to my criteria for picking mutual funds (5 years old or older, long history of strong rates of return; professionally managed by a team of mutual funds managers, etc.)
This is a very personal decision you will have to make. It’s what’s known as a slippery slope: If you no longer invest in funds that might invest in a company that supports abortion, to be consistent, you will need to stop shopping at the grocer that sells pornography. You would also need to stop banking because nearly all banks contribute to United Way, which supports Planned Parenthood.
Do not choose these funds out of guilt. Do not make poor investment decisions to choose these funds.

Pay a Pro or Do it Yourself?
Pay a pro. I still choose to use a pro and suggest you do to. Statistics show that "do it yourselfers" are quick to jump out of funds when they begin to under perform. A good professional advisor will remind you why you chose the fund and prevent you from buying high and selling low.

Commissions and Fees:

I suggest choosing A shares (upfront commissions). Long term, class A shares are much less expensive than B shares or C shares.
I do not personally choose fee based planning. (paying 1% to 2.5% annual fees for a brokerage account). With an A share mutual fund, I pay an upfront load of 5% to 6% once. But with a fee based account, also known as a wrap account, you agree to pay a 1% to 2.5% fee every year - forever. As your account grows, the 1% to 2.5% fee will really add up.

Working With Your Advisor:
They advise, you make decisions. This is very important. You are paying them for advice and the ability to teach you enough to make smart decisions about your investments. You are not handing over this responsibility because they are a professional or even because they are trusted by Dave Ramsey. Retain ownership and responsibility for all final decisions. Don’t invest in anything unless you can easily explain how the investment works to your spouse. If you cannot communicate easily with your financial advisor, find one that does a better job of communicating. Take your time and make wise decisions.

Seem too simple? Investing doesn’t have to be complicated. Dave fits all the profiles of a wealthy, knowledgeable investor; but he really does keep it as simple as you hear him teach on The Dave Ramsey Show each day. Wealthy people find simple ways that work, and then do them over and over and over. Happy Investing!

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