What Dave Ramsey Should Explain About Mutual Funds
Most people are familiar with Dave Ramsey, the anointed financial guru who has built an empire upon espousing common sense financial advice based on discipline and prudence. Most of what he teaches is based upon sound financial principles, such as getting out of debt and building an emergency fund. He has a cookie-cutter system of foundational stepping stones towards financial freedom.
While these are important financial basics, at some point, it makes sense to move towards more complex and more effective strategies for wealth building and preparing for retirement. Dave is great at helping the masses achieve those first steps, but there comes a time when a more individualized approach is important.
According to Dave Ramsey, his only recommended financial vehicle is Mutual Funds. He even proudly displays this proclamation with a full page on his website. In two key sentences, he depicts a one-sided benefit of mutual funds that portray a very rosy picture – while comparing them only to cryptocurrency investments:
While I agree mutual funds may have a place for the new investor, Dave paints a picture with very broad strokes, while ignoring the possibility of other suitable investment vehicles with the same benefits! I do not believe mutual funds are always the best way to reach the goals of achieving greater wealth or providing a stable retirement. Here are some facts about mutual funds, so you can decide for yourself if they should be part of your investment portfolio.
Expenses
People often aren’t aware of the various expenses that are associated with mutual funds. Furthermore, it may be difficult for investors to discern the actual amount of fees and expenses that are paid. I always make sure that my clients understand these fees during the planning process. They are usually surprised by what they learn. Some of the fees incurred with mutual funds might include:
- Front- End Loads (Upfront Sales Charges): There are usually load fees that range from 2-8.50% of the amount invested. This is an upfront fee that is deducted from your initial investment and is usually used to compensate your investment professional for their services. For example, on a $100,000 investment, a 5.75% sales charge would equal $5,750, making your initial investment $94,250.
- No Load Funds: Although some mutual funds will present themselves as no-load funds, you can expect that fees will only be waived if the fund is held for a certain amount of time, such as five-years. In addition, all funds, including no-load funds, have ongoing expenses that are paid by investors for the costs of running the fund and other services. These costs are called “annual fund operating expenses”.
- Management Fee: This is an ongoing fee that is deducted from the total assets of the fund. This is in addition to any fees that may be charged for assets within the fund. The expense ratio fee is typically .5% to 1%, but can be as high as 2.5% annually.
- 12b-1 fee: This is the ongoing marketing or distribution expense. This fee can be up to 1% of funds net assets per year. It is used to pay for marketing and distribution expenses, such as compensating sales professionals.
- Back-End Load (Sales Charges When You Sell): This is a percentage that is deducted from any shares that are sold. This usually ranges from 2-8%. This fee, known as a “deferred sales charge,” is an alternative way to compensate financial professionals for their services.
It is often difficult for investors to discern the actual amount of fees and expenses paid with mutual funds.
Tax Consequences
A critical component to the wealth management services our team provides is an overall tax strategy. I even spent years preparing tax returns, and I recall how often we had clients that were shocked and upset they were paying capital gains taxes on a mutual fund that actually lost value in that year! This is beyond the control of the investor, because it can happen even if the investor didn’t sell any shares! That’s because with mutual funds, if the fund manager sells a holding for a gain within the fund, it generates capital gains that are passed on to the individual shareholders. This is independent of the value of the overall mutual fund, making it very difficult to control tax liabilities with investments outside of qualified retirement accounts.
And if you read the fine print at the bottom of a mutual fund statement, you will see that sellers of mutual funds are required to disclose the fact that they cannot offer tax advice.
Forced Redemption
Mutual Funds often are forced to sell when the market is down, and purchase when the market is up. Fund managers have cash reserve limitations, so they must buy and sell at the demands of the investors that buy and sell their shares, even if it’s poor timing. This buying high and selling low can hurt the performance of the overall fund. This can also lead to the tax consequences as stated above.
Over-Diversification
Whereas diversification is seemingly a benefit for a new investor, the over-diversification nature of these investments lends itself to issues. With mutual funds averaging over 150 holdings, the funds are so diverse, they can operate much like an Exchange Traded Fund (ETF) within the mutual fund’s classification. This over diversification not only prohibits taking advantage of individual stock opportunities, but it also limits the personalization of an individual’s personal financial goals.
An Alternate Option
While mutual funds might have a place for some investors, there are many reasons why I would recommend different investment vehicles. I prefer using a professionally managed Exchange Traded Fund (ETF) portfolio to achieve the client’s specific goals. ETFs offer diversification like a mutual fund, are more tax efficient than a mutual fund, and often have lower fees. ETF’s can offer diversification in domestic equities, international equities, and fixed income. It’s imperative to make sure the portfolio is balanced for the client’s individualized risk tolerance. Finally, if the client wishes, we can balance out an entire portfolio and provide guaranteed retirement income annuity products intended to help clients to achieve their overall financial goals. Most of those products can be utilized with no expense to the client.
I would encourage investors to do their own independent research from a variety of sources and seek the help of a financial professional. Ultimately, when it comes to investments, there’s no ‘one-size-fits-all’. Seek a relationship with a financial advisor who can provide nurturing and guidance for pursuing financial goals over the years leading up to retirement and for the many years after.
Krista McBeath is an Investment Advisor, Chartered Financial Consultant, a Licensed Insurance Advisor, a Fiduciary, and an experienced tax advisor who specializes in financial planning, investments, and insurance. She utilizes advanced tools for in-depth calculations that analyze tax and retirement scenarios to help her clients avoid a future tax time-bomb. Whether this means enjoying more of your hard-earned money in retirement or passing along assets to loved ones with less tax burden, planning makes the difference.
Her Amazon best-selling book, The Generational Wealth System outlines a holistic approach to preserving lifestyle, wealth and legacy.
