ELPs: Expensive Local Peddlers?
One of the hazards of being a well-paid, highly-opinionated, public figure is the fact that your pronouncements and claims will (and should) be subject to scrutiny. In the financial media, there are few more well known than nationally-syndicated radio host, Dave Ramsey.
Dave’s debt-focused program is the third most popular commercial talk radio show in America with more than 8 million listeners each week. So, his advice is incredibly influential. If Dave limited himself to dispensing debt reduction advice, this article wouldn’t need to exist. It’s Dave’s forays into investing advice that warrant serious examination.
Before sharing particulars, most serious fiduciary investment advisors share the same opinion of Dave Ramsey’s investing advice: It’s beyond bad. Fee-only advisors quoted in a 2013 Money magazine article referred to Dave’s investing advice as “malpractice” or, even more bluntly, “crap.”
Dave’s claims of an average 12% annual return for a portfolio of growth-oriented mutual fund has been thoroughly disproved. I recently created a hypothetical portfolio of 4 very well managed mutual funds from the American Funds group – a family of funds often sold by Dave’s legion of “Endorsed” Local Providers (ELPs):
According to data from Vanguard and Morningstar, a portfolio of these funds, in equal percentages, posted an average annual return of 10.0% per year between 4/1/1990 and 3/31/2015. Over that same 25-year period, the Standard and Poors 500 Index returned 9.8% per year. An average annual return of 12% might have occurred in some fund, somewhere, but I was unable to find a single Ramsey-style mutual fund portfolio that delivered on his promise.
That brings me to the truth behind the Ramsey “endorsed” financial “advisers.” Dave claims that he personally “recommends” these “professionals.” Don’t take my word for it, it’s in his Investing Minute e-mail newsletter:
“Endorsed local providers are the only professionals Dave Ramsey recommends.”
Dave’s ELPs are, and legally must be (more on that later), something other than fiduciary registered investment advisers. This means that they are almost exclusively commissioned stock brokers who have agreed to pay Dave’s firm, Lampo Group, a fee for every lead they receive. In 2013, Money magazine estimated this fee to be about $80 per lead.
That means that the ELPs have a huge motivation to sell something to every single person sent their way. Since no stockbrokers ever close anything near 100% of sales, there is an obvious disincentive to providing the best advice. An ELP, who closes one out of five leads provided, needs to sell between $100,000 and $200,000 (depending on the commission split with heir firm) in 5% loaded mutual funds to merely cover the cost of Dave’s leads.
Are 5% load funds in the client’s best interests or are lower cost alternatives better? Most financial professionals agree that the less you pay, the more you’re likely to make. In Dave’s wacky ELP alternate universe, a sales commission is apparently good for you. In Dave’s most recent Investing Minute e-mail, Tripp Hook, a Washington state ELP states, “Most investors are better off paying a higher commission up front and having lower ongoing fees…”
If paying a commission and having lower fees is good, then wouldn’t no-load funds with the same or lower fees be even better for you? Not necessarily, according to Dave. While he agrees that front load funds charge “a significant expense to get started," he goes on to claim that "the ongoing costs are usually lower than no-load or back-load funds…”
This statement includes a complete fabrication (often referred to simply as a lie). No-load funds usually have similar or lower ongoing costs than front-end load funds, particularly if the no-load funds used are index or passively managed funds.
Let's compare. Some of the least expensive loaded funds come from American funds. Their Growth Fund of America has a front load of 5.75% and charges 0.66% per year. Not too terrible, but when compared with Vanguard’s no-load Total Stock Market Index fund’s annual expense ratio of 0.17%.
Another Ramsey ELP, Clayton Shearer, states in Investing Minute that “Obviously, the higher the fees and the cost of the fund, in general, the lower the return is going to be…” So, while the Vanguard Total Stock Market fund has lower fees than any fund sold by Dave’s merry band of ELPs, I can pretty confidently state that there is next to no chance an ELP will ever recommend Vanguard funds to a prospective client. They would go broke.
So, why would Dave’s minions apparently lie about loaded funds costing less than no-load funds on an ongoing basis? There are two possibilities. One, they just lied. Two, they actually fell for the brokerages industry’s commission sleight-of-hand.
For decades, all mutual funds were offered with an up-front commission. When no-load funds became popularity in the late 1980s, the brokerage industry grew concerned about their future profits. In response to the no-load menace, the industry (with the blessing of regulators) created with former SEC Chairman, Christopher Cox referred to as funds with a “sales load in drag.” Front load funds gained a new letter designation “A” shares. The new hidden-load funds were called “B” shares or “C” shares. They both made up for the lack of an obvious commission with substantially higher annual fees.
For example, the “A” shares of Growth Fund of America have a 5.75% front-load and annual expenses of 0.66%. If your broker places your money in the “C” shares of Growth Fund of America there is no front-load, instead the commission paid to the salesperson is recovered through higher annual fees of 1.45% per year. For a long-term investor, these fake “no-load” can cost investors far more than the front-load version.
Dave continues to claim that broker-sold, fully loaded mutual funds are better for you when true no-load funds are better for investors? He believes, as do I, that most investors need an advisor “…for their time and expertise in helping you choose your funds and maintain your retirement plan over the years.”
Are commissioned brokers the best choice for ongoing portfolio advice and planning? As Dave states in his Investing Minute letter. “Just like anything else you do from grocery shopping to buying a car to going to the dentist, there's a price of doing business.” Let’s compare the two most popular ways to pay for that advice:
Brokers get paid when they make a sale. Rarely is there any form of meaningful ongoing compensation, so there is a considerable incentive to sell you an investment and then move on to the next prospect. When I was a broker, the only time we were encouraged to call an existing client was to “churn ‘em.” In other words, ongoing advice is typically only available when it’s time to sell one thing and buy another (paying another commission in the process).
Fee-only investment advisors do not get paid to sell; they are compensated for ongoing service. Good advisors meet with clients regularly, and those meetings should not involve making a sale. A fee-only advisor has the incentive to help you meet your goals at a reasonable cost, or you will go elsewhere.
Plus, fee-only advisors have a legal obligation to act in your best interests. That means it’s an advisor’s fiduciary duty to select the best investments at the lowest possible cost. For example, if a fiduciary advisor has two, otherwise identical, mutual funds, they would be obligated to recommend the least expensive of the two.
On the other hand, a broker does not have a fiduciary duty to a client. If the investment is merely suitable, it’s okay. That means that selling you a 5% load fund with 2% annual fees might be suitable, even if a substantially identical fund is available with a 3% commission and 1% annual fees.
If he wanted what is best for his audience, you would think Dave would “endorse” fee-only advisors. The problem: The law does not allow him to charge them a fee unless his firm is also a registered investment advisor (RIA) and fully discloses his compensation to those he refers. Becoming an RIA could be a problem for Dave from a couple of perspectives:
First, he would be required to provide the underlying data for any claims he makes about potential investment returns.
Second, he would have to act as a fiduciary to his listeners.
Third, he would not be allowed to “endorse” the advisors he recommends. Registered investment advisors are prohibited from using any type of testimonial.
Finally, it would put a serious crimp in his massive compensation, as many listeners would be shocked to discover exactly how much Dave gets for each referral to a “professional.”
It will continue to be in Dave’s best interests to prevaricate and obfuscate about investing. While it is almost impossible to reach even a fraction of his massive audience, I feel it’s only fair that at least some of his listeners are aware of the low quality of Dave’s investing advice and the potential conflicts inherent in his Endorsed Local Provider program.