On Monday night, I stumbled upon the Dave Ramsey Prime Time on Fox Business Network Show, and stopped channel surfing to watch it. I heard about Dave Ramsey through my friends — many of whom greatly admire him (e.g., Ana, Randall, Lynnae, Gibble, and Mrs. Micah). Personally, I like how he helps thousands of people get out of debt and live financially healthier lives. So, what I am about to tell you was a shocker to me.
Toward the end of the show, a viewer asked about the best way to save for college. I don’t recall the exact words used, but Dave’s advice went something like this:
For college savings, I recommend Education Savings Account (ESA). This is similar to your retirement IRA. You can contribute up to $2,000 per year, you can invest it anyway you want, and it grows tax free. If you want to contribute more than $2,000, then I recommend that you look into 529 plans. However, there are a lot of bad 529 plans out there and they are not very flexible. With an ESA, you can choose whatever funds you want to invest in. If you don’t like it, you can roll it over to another fund as many times as you like.
The above is not an exact quote, but I think it accurately captures the gist of Dave Ramsey’s college savings advice. When I listened to this, I thought, “No way! that’s a terrible advice.” Granted, I understood the limited time, and how difficult it is to provide a well thought out answer when you have to do it spontaneously. So nothing against Dave, but I’d like to dig into this college savings advice, and tell you why I thought it was bad.
Note: When I talk about 529, I refer to direct plans because that’s type I prefer.
Assuming the viewer was an inexperienced investor, advising him to choose ESA over a 529 College Savings Plan to take advantage of broader range of investment options is actually more harmful. I believe that inexperience investors are better off choosing a good 529 plan — i.e., ones managed by TIAA-CREF or Vanguard — and stick to broad index funds that passively track the market.
Yes, Dave is right about the presence of bad 529 plans. There are some out there, but it’s still easier to find a good 529 Plan than learning how to properly invest in the stock market via an ESA. There are plenty of helpful resources like the comparison chart from SavingForCollege.com and Kiplinger Top Plans, that will make choosing a good 529 College Savings Plan easier.
I am afraid that someone who’s not knowledgeable about investing could run into some of these common pitfalls:
By choosing a good 529 plan that offers no-load, low cost funds — i.e., New York’s 529 College Savings Program — a lot of these potential pitfalls could be avoided.
You’re kidding right? That’s the kind of advice that will make an investor lose his shirt. High turnover trading is plain old bad money advice. There are many costs, hidden and not so hidden, associated with changing mutual funds, or worse actively trading stocks and ETFs. Some example of these costs include:
Personally, I believe the best strategy for inexperienced investor is to invest in low-cost passive mutual funds using asset allocation, regular contribution, and rebalancing to enhance performance. In general, these three things are easier to do with a 529 plan:
Broader investment options was the main reason why Dave liked ESA better than 529. But there are so many advantages to using 529 that Dave didn’t mention. Here are five of them:
So there you have it. I think Dave is a great guy and I love his 7 Baby Steps, but even he is not infallible — we all make mistakes right?
More on 529 Plans versus Education Savings Account: