Dave Ramsey has for the longest time recommended a four category approach to investing in mutual funds. His approach keeps things simple, and according to Ramsey positions investors for the best outcomes as it pertains to diversification and investment growth. If you follow Dave Ramsey these categories will look familiar to you.
Growth | Growth & Income |
International | Aggressive Growth |
Let’s break things down.
Investment Categorization
“I don’t see ‘Aggressive Growth’ in my 401(k) mutual fund menu. What should I select?”
As a SmartVestor Pro we often observe the aftermath of poor investment selection. While people have the best intentions to follow a philosophy, the implementation can be tricky. The investment and financial services industry is notorious for making simple things seem complex. The complexity creates a frustrating barrier and keeps underperforming financial professionals employed. Luckily we are in the business of helping people reach their financial goals as a fiduciary. We would prefer you are just as confident as we are in your investment strategy. While Dave Ramsey highlights 4 categories of mutual funds, the specific funds you have access to or see in your account will have many different names.
Each category is recommended to be incorporated as a 25% holding of the entire portfolio but that amount may be spread over several funds for maximum growth potential and diversification. For example some mutual funds can partially fit into multiple categories (explained below).
Aggressive Growth
This investment category is geared towards maximizing growth by investing in smaller companies that generally have more upside potential than companies that have already reached maturity. Small-cap stocks can be attractive to investors looking for growth but they also come with added risk.
Pros | Cons |
- Higher growth potential: Small companies are not yet established and have room for significant growth. Their stock prices can soar if the company succeeds.
- Lower share price: Compared to large-cap stocks, small-cap stocks tend to be more affordable, allowing investors to buy more shares and potentially amplify gains.
- Greater variety: The small-cap market represents a wider range of industries and niches than large-cap stocks, offering more investment opportunities.
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- Higher volatility: Small-cap stocks are more prone to wild price swings, meaning your investment can fluctuate significantly.
- Lower liquidity: Small-cap stocks tend to have fewer buyers and sellers, making it harder to quickly buy or sell shares when you want.
- Greater risk of failure: Small companies are more likely to fail compared to established large-cap companies. Diversification is extremely important with Small Caps to mitigate this risk.
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Potential Fund Names for ‘Aggressive Growth’
Small Cap Blend | Small Cap Growth | Small Cap Value |
Mid Cap Blend | Mid Cap Growth | Mid Cap Value |
Growth
Growth companies have high revenue growth potential even if the stock price seems expensive based on traditional metrics. The goal is to achieve significant capital appreciation through future earnings growth. Typical growth companies are often young innovative companies in rapidly growing industries (technology biotech).
Pros | Cons |
- High growth potential: Growth stocks can outperform the market significantly if the companies they represent achieve their ambitious growth plans. This can lead to substantial capital appreciation for investors.
- Exciting investment style: Growth stocks are often in innovative and disruptive industries, making them exciting to follow and potentially offering a sense of satisfaction from being on the cutting edge.
- Focus on the future: Growth investing encourages research and analysis of future trends and technologies, which can be intellectually stimulating for some investors.
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- Higher risk: Growth stocks are often priced based on future expectations, not current financials. This means they can be more volatile and susceptible to disappointment if the company fails to meet those expectations.
- Potential for overvaluation: Because they're priced for future growth, growth stocks can sometimes become overvalued, meaning even if the company performs well, the stock price might not reflect that success.
- Lower dividends: Growth companies typically reinvest most of their profits back into the business for further growth, so they tend to offer lower or no dividends compared to value stocks.
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Potential Fund Names for ‘Growth’
Large Cap Growth | S&P 500 Index |
Large Cap Index | Nasdaq 100 Index |
U.S. Equity Index | Russell 1000 Index |
Growth and Income
The category of Growth & Income is mostly commonly associated with dividend investing. This involves buying stocks from companies that pay out a portion of their profits to shareholders on a regular basis as a cash dividend. It can be a good option for investors seeking income and capital appreciation. The goal is to buy stocks at a discount to its fair value to see the benefits of gradual growth and dividends combined. Typical companies are established profitable companies in mature industries (financials utilities).
Pros | Cons |
- Regular income: Dividend stocks provide a steady stream of income, which can be used to supplement your lifestyle, reinvest in your portfolio, or offset investment fees.
- Potential for capital appreciation: In addition to dividends, dividend-paying stocks can also experience price growth over time. This offers the potential for total return, combining income and capital gains.
- Lower volatility: Dividend-paying companies tend to be more established and have a history of profitability, which can lead to lower stock price volatility compared to high-growth stocks.
- Sign of company health: Companies that consistently pay dividends are generally considered financially healthy and well-managed, as they prioritize returning profits to shareholders.
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- Lower growth potential: Dividend-paying companies often prioritize returning profits to shareholders over reinvesting heavily in future growth. This can translate to slower stock price growth compared to non-dividend paying growth stocks.
- Tax implications: Dividends are typically taxed as ordinary income, which can be less tax-efficient than capital gains, especially for investors in higher tax brackets. There are tax-advantaged accounts like IRAs that can mitigate this somewhat.
- Focus on past performance: A company's history of paying dividends doesn't guarantee future payouts. Economic downturns or changes in company strategy can lead to dividend cuts or suspensions.
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Potential Fund Names for ‘Growth & Income’
| Growth & Income | Equity Income | Large Cap Value |
International
International investing also known as global investing broadens your investment horizons beyond your home country’s stock market. International stocks offer exposure to different economies, currencies, and industries compared to your home market. This helps spread risk. If your home market experiences a downturn international holdings might perform better mitigating overall portfolio losses. It offers a variety of benefits but also comes with its own set of challenges.
Pros | Cons |
- Diversification: The key advantage is diversification. By including international stocks in your portfolio, you spread your risk across different economies and currencies. This can help mitigate losses if your home market performs poorly.
- Growth potential: Emerging markets often have higher growth prospects than developed markets. Investing internationally allows you to tap into these potentially high-growth economies.
- Exposure to unique industries: International markets offer access to industries that might be underrepresented in your domestic market. This can provide opportunities for investment in sectors with strong growth potential.
- Currency appreciation: Fluctuations in foreign currency exchange rates can work in your favor. If the value of a foreign currency strengthens relative to your home currency, it can boost the returns on your investment.
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- Currency risk: The flip side of currency fluctuations is currency risk. A weakening foreign currency can erode the value of your investment even if the underlying asset performs well.
- Higher fees: Investing internationally often involves higher fees compared to domestic investments. These can include foreign transaction fees, custodian fees, and potentially higher expense ratios for international mutual funds or ETFs.
Less information transparency: Information about foreign companies might be less readily available or transparent compared to domestic companies. This can make it more challenging to research and evaluate potential investments.
- Political and economic instability: Some foreign markets are subject to political or economic instability, which can increase investment risk.
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Potential Fund Names for ‘International’
While you might see ‘International’ as an exact match to this category, it’s important to note the differences of International, Emerging Markets, and Global funds.
International Funds | Emerging Markets Funds | Global Funds |
- Invest in stocks from developed countries outside the investor's home market.
- Think: Europe, Japan, Canada, Australia.
- Provides diversification within developed markets, which are generally considered to be more stable than emerging
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- Focus on stocks from countries with developing economies that are transitioning to more mature, industrialized economies.
- Think: China, India, Brazil, South Africa.
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- Invest in a mix of stocks from developed and emerging markets, including the investor's home country.
- Offers the broadest diversification across various economies and industries.
- May have some overlap with the investor's U.S. holdings, so be mindful of redundancy.
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Potential Fund Names for ‘International’
International | International Growth | International Value |
Emerging Market | Developed Markets | Developing Markets |
Global | | |
While we can’t endorse any general approach to investing as the best for every person, Dave Ramsey’s recommendation is a great start for investors looking for maximum returns. As a Dave Ramsey Smartvestor Pro we often refer to Dave’s investing philosophy as a means for establishing familiarity with current or prospective clients; however, given our knowledge of financial markets and individual investors’ needs, we craft our portfolios slightly differently than his general approach.
These four categories are a great starting point for any investor, but implementation can be confusing and hard to put into practice correctly without an advisor. We hope this information helps you make better decisions with your investments and stay informed.
References:
- Dave’s Investing Philosophy
- How to Choose the Right Mutual Funds
- Dave’s Investing Philosophy & Mutual Funds
- What Does Dave Ramsey Invest In?
- Dave Ramsey & Mutual Funds: The Debate Unraveled
