Dave Ramsey deserves everything Brian Stoffel gave him — and then some

Rates of return are representative of actual dollars and cents. They are a sort of “pre-knowledge” in that sense. When you average the growth rates in, say, the S&P 500 and calculate it as a simple average return over a specified number of years, you’re only getting information about the percentage rate involved, not the underlying monetary value that that percentage rate represents.

Look at it this way: If you applied the average (3.167 percent) to a sum of $10,000 for the six years illustrated above, you would end up with a total dollar amount of $12,057.15. Yet, if you follow each year’s actual gains and losses (what you would actually experience each year through the six years of investing illustrated here), you would end up with a different number: $11,496.04. And, if you introduce variability in return (the order and manner in which you receive returns), that further skews the end result — sometimes in a strongly negative direction.

How can this be? Answer: It’s the geometric mean (AKA the compound annual growth rate or “CAGR”). Now, the geometric mean is very different from a simple average. To find the geometric mean of a series of numbers, you multiply those numbers together and then find the appropriate root of those numbers based on the amount of numbers in the series.

So, to find the geometric mean of 2 and 9, you would multiple 2 by 9 and then find the square root of the resulting number. If you had three in the series, 2, 5 and 9, you would multiply those together and take the cube root of the resulting number, and so on.

This is a critical concept in finance, because it’s the only way to know, objectively, how much money you have (or will have) when you’re dealing with compound interest products. To willfully advocate the arithmetic mean over the geometric mean is unconscionable.

But maybe this is all one huge misunderstanding. Could Ramsey simply have been mistaken about his math? We all make mistakes, after all.

Nope. Not a chance. He freely admits on the show that he understands the difference between geometric mean and arithmetic mean, but that he chooses one calculation over another because it’s his show. Honestly, math doesn’t care whether or not it’s your show. The arithmetic mean does not correspond to real rates of return and that’s that. No amount of browbeating or foot-stomping is going to change that.

Of course, it’s impossible to know why Ramsey really favors one over the other. But there is an interesting explanation that fits: The arithmetic mean is always equal to or higher than the geometric mean. It makes future financial assumptions look a lot more optimistic, and it also makes for better ratings. If you can show numbers that support a 12 percent average rate of return for your clients or customers, that’s a lot better than what the rest of us have to offer.

But, while using simple averages might be cool enough for pontificating, it won’t help you make an objective financial plan — not when reality is being obfuscated.

What many Ramsey fans, and even casual admirers, might have to face is that Dave ought to know better. He holds himself out as a financial planner, as an expert. He gives advice to people. He should hold himself to a higher standard, but he doesn’t. He should be held, by others, to a higher standard. Oddly, he isn’t.

Stoffel’s headline is very accurate. Dave Ramsey’s advice is harmful — objectively. Ramsey is misleading people by giving them a false sense of hope. It was painfully obvious that Ramsey was more concerned about being right than he was about the truth. That’s ironic given what he preaches about day in and day out across his brand.

David Lewis is the founder and owner of Monegenix. He designs insurance-based financial plans, financial calculators and apps for business owners and professionals. For more information, please visit https://www.monegenix.com.