I’ve always liked Dave Ramsey’s advice. The 7 baby steps have definitely helped many millions of people. They are simple, understandable, and achievable. If you haven’t come across Dave Ramsey’s 7 baby steps, here they are;
- Save $1,000 for you starter emergency fund
- Pay off all debt (except the house) using the debt snowball
- Save 3-6 months of expenses in a fully-funded emergency fund
- Invest 15% of your household income for retirement
- Save for your children’s college fund
- Pay off your home early
- Build wealth and give
Great advice for anyone starting out. You probably don’t need to follow step 5 in New Zealand. College- which we call University is expensive in the U.S. where many young people are burdened with large interest-bearing debts. and although our students may come out with a large debt, we have the Studnet loan system, which is an interest-free loan.
So even if you exit university with a $30,000 loan, which is about what I had, you can get on top of it since there is no interest accruing. Whereas the average interest rate for a private loan in 2017 was 9.66%. The Economist said that in June 2014 that U.S. student loan debt exceeded $1.2 trillion with over 7 million debtors in default. So saving for your children’s University in the U.S. is sensible.
And on point 4, arguably, 15% isn’t enough for retirement but that’s not what I wanted to get into here. Being conservative, if you plug a 15% savings rate into a financial independence calculator with an expected average return of 5%, you can retire in 43 years. So depending on when you start working, you will be able to retire at around 65 if everything goes well- not much wiggle room there.
Dave Ramsey’s Investing Advice
As I said- I quite like Dave’s baby steps, but when it comes to his investing advice I disagree with some of it. Take this following quote from Dave on his Radio show. I’m not trying to take out Dave Ramsey- just to point out that I disagree. Here are some investing quotes from Dave.
Here’s the thing- Listen to this. If your expenses are up 1% higher average over a 10 year period of time. But you make 4% rate of return- you came out (on top). That’s why return is your primary measure of how you pick a fund. That’s your primary measure.
The last thing I look at is expenses- and very seldom do I find expensies being a deal breaker.
…My mutual fund groupins have beat the market. You just pick mutual funds that have out perform the S&P500, its not rocket sicence. Not all of them have beaten the S&P. alot of them haven’t. Over half haven’t. But don’t pick the ones that didn’t.
That’s all you doing when your picking a mutual fund. Did it beat the market? If it didn’t beat the market then don’t pick that mutual fund. It’s not rocket sicence- that horse just hasn’t won a race.Dave Ramsey
So Dave Ramsey promotes active investment fund on the basis of strong returns are better than low fees. According to Dave, you should focus less on the fee and more about the return.
And he’s right- in principle.
Active Vs Passive Investments
The problem is that you will have to pick an actively managed fund that will outperform over the long run thought. And you can’t use the historical performance to decide which fund is performing better than the average.
To be the active vs passive debate isn’t really a debate for me. And I’ll share with you why I think that.
Let assume you look at all the funds out there- both passive and active. All of them. They are all investing in shares and bonds and whatever else- it doesn’t matter. The point is- that they are all investing in the same stuff.
So, before costs- the average return on an actively managed dollar will equal the average return on the average passively managed dollar. Simply saying, when you look at the average active and passive are equal.
But then, if you include costs the average return on an actively managed dollar will be less than the return on the passively managed dollar.
So the way I think about it is that all fund is investing in the same shares etc. So on average, they are all making the same return. But when you include the difference in cost- the passively managed funds perform better over the long term.
Fees as a predictor
Dave suggests we should be looking at returns when we pick investment funds while looking at fees as a secondary measure.
I’ve looked into fees vs returns for many of the InvestNow Funds and haven’t been able to show whether high fees are associated with better returns- although I suspect since that data only went back 10 years over a bull market it isn’t robust enough. The one thing to point out is that two passive funds with a low fee outperformed the majority of all fund on InvestNow. The Smartshares NZ Mid Cap and the Smartshares NZ Top 50 fund.
When you look to the U.S. and the research that Morning Star performs, they come up with the same conclusion every time.
On Average, Funds with Lower Fees Have Better PerformaneMorningStar.com
Here’s what they concluded. “Investors should make expense ratios a primary test in fund selection, They are still the most dependable predictor of performance, Start by focusing on funds in the cheapest or two cheapest quintiles and you’ll be on the path to success”.
Research has shown that active managers could not achieve better returns than a passively managed index once fees are included, and the general conclusion is that there exist no skilled or informed mutual fund portfolio managers that outperform an index fund.
So fees matter, and don’t be persuaded by active funds that currently beat the market. And if you really want to beat the market- say the US500, have a look at what the actively managed fund is investing in. For instance- US small-cap and value stocks have outperformed the US500 for several decades- but there’s might be more risk involved.
Dave has some great advice, and his youtube channel is great to watch- but I don’t believe in his actively managed approach to investing in the share market. I don’t believe that you can pick winning active managers over the long run when compared to index funds when you include fees- although I’m always interested to see how well the funds at PIE funds are doing.
What do you think? Active or passive?- or is it all just about fees?
Credit where credit is due- much of this discussion is taken from Ben Felix youtube channel– a Candian investment portfolio manager, who has some great content on youtube.