The Dave Ramsey Asset Allocation

Editor: I haven’t held my opinions about why much of Dave Ramsey’s advice isn’t right for physicians. On this week’s Saturday Selection originally posted on the Whitecoat Investor, Jim Dahle, MD will share his views on the Ramsey approach asset allocation.

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Dave Ramsey has the third most popular radio show in the country and the largest one with a financial focus. It is also far from the worst financial shows out there which tend to be thinly-disguised infomercials put on by insurance agents and loaded mutual fund salesmen. He is generally regarded as fantastic at getting people out of debt and fired up about saving money and less than fantastic at giving investing advice.

Due to his reach, a lot of people have heard of his recommended asset allocation. Unfortunately, this asset allocation, while it sounds very specific, is actually incredibly vague. It usually goes something like this:

• 25% Growth and Income
• 25% Growth
• 25% Aggressive Growth
• 25% International

In addition, Dave also recommends, at least for those who are “real estate guys”, to invest a portion of the portfolio (up to 100%) in paid for, income-producing real estate.

That doesn’t seem crazy, does it? Most of my own portfolio looks an awful lot like that. (For new readers, my portfolio is 40% US stocks with a small value tilt, 20% International Stocks with a small tilt, 20% bonds, and 20% Real Estate/Small Businesses.)

I’ve long advocated that there is no perfect portfolio. You can only know the theoretical “efficient frontier” retrospectively. The most important thing is to pick something reasonable, fund it adequately, and stick with it for the long term. (If you want to see what reasonable looks like, check out 150 Portfolios Better Than Yours.)

The problem with Dave’s recommended portfolio is the terminology. I think it was a lot more common in past decades like the 1990s to use terms like these. Nobody really uses them anymore as they have opted for more precise terminology. Ramsey is very good at keeping things EXTREMELY simple and sometimes when you do that you make the mistake of making things overly simple. As Einstein said, “Everything should be made as simple as possible, but not simpler.” Most of the criticism appropriately leveled at Dave is that he makes things simpler than he should have.

The Dave Ramsey Portfolio

So let’s see if we can decipher the terminology. Since these terms are quite vague, let’s start by simply asking Dave what he means. Luckily, his website has an article by one of the “Ramsey Personalities” Chris Hogan (the retirement guy). The funny thing is that Chris Hogan had to find a mutual fund broker (Brant) to help him define what Dave means. The fact that neither Dave nor Chris could write this article on their own and had to rely on someone else is obviously concerning given how many people are taking their asset allocation recommendation.

Growth and Income: These funds create a stable foundation for your portfolio. Brant describes them as big, boring American companies that have been around for a long time and offer goods and services people use regardless of the economy. Look for funds with a history of stable growth that also pay dividends. You might find these listed under the large-cap or large value fund category. They may also be called blue chip, dividend income or equity income funds.

So he apparently means Large Blend Stocks or Large Value stocks. Bear in mind that is NOT how every mutual fund company on the planet uses the term “Growth and Income”.

While the Vanguard Growth and Income Fund is 100% stock and mostly a blend of very large Growth and Value stocks, it leans more toward the Growth side than the Value side. On the other hand, the Fidelity Growth and Income Fund is mostly Value Stock and in fact, has 12% of its fund invested overseas. The Calamos Growth and Income Fund is a balanced fund, with 5% bonds and a bunch of convertible notes. Sometimes, just to keep things interesting, mutual fund companies call them Income and Growth funds, like the offering from Allianz which is 33% stock, 31% bonds, and 30% “other”.

The bottom line is that “Growth and Income” is a catch-all term that can be used by anyone for anything. So best to just ask Dave what he means if you want to do what he says. He means Large Cap stocks with perhaps a tilt to Value.

Growth: This category features medium or large U.S. companies that are still experiencing growth. Unlike growth and income funds, these are more likely to ebb and flow with the economy. For instance, you might find the latest gadget or luxury item in your growth fund mix. Common labels for this category include mid-cap, large-cap, equity or growth funds.

Okay, the explanation on the website is a little more useful. He’s talking about Mid Cap and Large Cap Growth stocks. Next category.

Aggressive Growth: Think of this category as the wild child of your portfolio. When these funds are up, they’re up. And when they’re down, they’re down. This volatile growth usually accompanies smaller companies. “So small-cap funds are going to qualify—or even a mid-cap fund that invests in small- to mid-sized companies,” Brant says. But size isn’t the only consideration. Geography can also play a role. “Aggressive growth could sometimes mean large companies that are based in emerging markets,” he adds.

Okay, this one is bizarre. It’s either small-cap stocks, small and mid-cap stocks, or emerging market stocks. That should be easy to replicate. Just pick whatever you want I guess.

International: International funds are great because they spread your risk beyond U.S. soil. That way your retirement fund doesn’t totally tank if America goes through an unexpected downturn. It also gives you a chance to invest in big non-U.S. companies you already know and love. You may see these referred to as foreign or overseas funds. Just don’t get them confused with world or global funds, which group U.S. and foreign stocks together.

Okay, that one is more straightforward. Dave is recommending you invest your mutual funds in 100% stocks, split 75/25 between the US and international (unless you decide your “aggressive growth” portfolio is going to be all in Indian large-cap stocks).

So if you put it all together, perhaps the Dave Ramsey portfolio looks like this:

• 12.5% Large Value
• 12.5% Mid Cap Growth
• 12.5% Small Blend
• 12.5% International
• 50% Real Estate

Easy peasy, right? Now, if you’ve wisely chosen to ignore Dave’s advice to use a loaded mutual fund salesman as an advisor, his advice to chase performance and ignore costs, and his advice to choose an active manager “who can beat the S&P” you might end up replicating the portfolio like this:

• 12.5% Vanguard Value Index Fund
• 12.5% Vanguard Mid Cap Growth Index Fund
• 12.5% Vanguard Small Cap Index Fund
• 12.5% Total International Stock Market Fund

and then go buy some rental properties.

But before you do that, you might want to run those domestic funds through the Morningstar X-ray tool and compare it to just buying a Total Market Fund and possibly tilting it to small or value (or growth?).

Here’s what the Vanguard Total Stock Market Fund X-ray looks like:

Here’s what a portfolio of 1/3 Value Index, 1/3 MC Growth Index and 1/3 Small Cap Index looks like:

See the tilts? A slight tilt to large value, mid growth, and small. That’s apparently Dave’s favored portfolio. Doesn’t look so special now, does it?

Is it reasonable? Sure. However, I would describe it as quite aggressive. Not only is it 100% stocks, but it has significant small and value tilts as well. Make sure you can tolerate that kind of volatility before you follow Dave’s recommendation. My personal US domestic stock allocation is 25% Total Stock Market and 15% Small Value Index. Its x-ray looks like this:

Those aren’t really going to perform very differently and NO ONE can predict in advance which will do better so if you like one more than the other, knock yourself out.

But if I were you, I’d do a bit more reading and settle into an asset allocation that you like, fund it adequately, and stay the course.

What do you think? Do you use the “Dave Ramsey” asset allocation? How have you interpreted it? Comment below!