in Retirement Income Planning on December 8, 2023
Dave Ramsey is well known in the personal finance space, but at times he gives bad money advice. Sometimes his financial advice is, frankly, out of touch with reality. Such was the case on one of his November 2023 broadcasts, when he served up some bad math on retirement withdrawal rates that would virtually guarantee people will run out of money.
During the show, Dave Ramsey said that retirees could safely withdraw 8% from their portfolios each year and never touch their principal. That is assuming that you see 12% returns per year, have 100% of your assets invested in “good mutual funds,” and keep 4% in your portfolio for inflation. Inflation has averaged 4% for the last 80 years, according to Ramsey.
Apart from unrealistic numbers, the real downside is how Ramsey completely overlooks the danger of sequence of returns risk. What is sequence of returns risk? It’s the possibility of suffering investment losses during a crucial period: in the years just before or in early retirement.
During retirement, you will count on your assets to generate income for you. Average returns don’t matter, but rather the order of your returns. If your assets take a hit in the time just before or early into when you are retired, your window for recovery isn’t what it was during your working years.
Even worse, what if you are withdrawing money during a down year? Your investments will have compounding losses – whatever initial drop they had, snowballed by the money you took out of your account.
In this article, we will go over why Dave Ramsey is completely wrong on his 8% withdrawal rate rule – and why other retirement withdrawal rates, and withdrawal strategies for that matter, might be worth a look for lasting financial security.
What Happened on the Ramsey Show Where 8% Withdrawals Came Up?
On this particular broadcast, Dave Ramsey had a meltdown at the suggestion of using a 3% withdrawal rate for retirement spending.
During the show, one caller talked about how Ramsey’s co-host, George Kamel had put out a video on sustainable withdrawal rates for people who retired early. Based on an analysis by HonestMath.com, Kamel said that a 3% withdrawal rate over 35 years in retirement would still leave you with a very healthy account balance. Even at 45 years in retirement, a 3% withdrawal rate would leave you with a net-positive balance.
Ramsey had a strong reaction to hearing of Kamel’s withdrawal rate discussion. He publicly criticized Kamel for posting the video and said that a 3% withdrawal rate was much too low. He then lambasted well-respected financial researchers and economists who have advocated for 4% as a sustainable withdrawal rate.
“There are all these goobers out there who have always put this 4% crap in the market. I’m just irate now that we have joined the stupidity…” Ramsey said a few minutes into the clip.
Ramsey’s daughter, Rachel Cruze asked about why it was stupid.
“Because it’s too low. It’s too low, and it’s not realistic. You do not need to live on 4% of your money for your nest egg to survive. And what it sets up is, this guy, he doesn’t think that he has enough money. He’s on a plan to be very wealthy, and he’s worried about whether he is going to have enough money or not, because people, stupid people, put out low withdrawal rates… If you think that you can pull only 4% off investments making 12%, where is the other 4% going? You aren’t destroying the nest egg, you are growing the nest egg.”
Dave Ramsey went on to rant about how a 4% withdrawal rate is supposedly stealing people’s financial hopes and retirement dreams. You can see the entire clip on Twitter from the broadcast here.
The Breakdown
Dave Ramsey has been hustling three key points for over 20 years:
- Have 100% of your assets invested in stock funds, no matter your age
- Good mutual funds will give you an average return of 12% per year
- You can take out 8% of your portfolio and you will
In other words, say that you have a $1 million in your stock portfolio. On the first day of retirement, you can take out $80,000 for the first year and then adjust for inflation each year thereafter. According to Ramsey, the 12% average return ensures that you can withdraw 8% per year in perpetuity.
Why 8% Doesn’t Work as a Safe Withdrawal Rate
Remember how we mentioned sequence of returns risk earlier? The problem with using an average annual return of 12% is just that – it’s an average. In retirement, what matters aren’t average returns, but rather the order of your returns. To that end, you might even say that using average returns to predict future results can be misleading, especially with the unpredictable nature of financial markets.
Let’s expand on the order of returns. While you are working, you probably invested so that you could build up a retirement nest egg. If your investment assets fell in value, you had time for them to recover. After all, you were still working, you could contribute more to your retirement accounts, and your assets would rebound in value over time. In that case, order of returns didn’t matter as much.
However, once we reach retirement, things are different. During your post-career years, you will count on your assets to generate income for you. If your assets take a hit in the time just before or early into when you are retired, that window for recovery isn’t what it was during your working years. You don’t have as much time for your assets to bounce back.
It’s inevitable that you will have up years and down years. Another thing to consider is what those gains and losses might look like. In some years, you will have single-digit gains or losses. Years of double-digit gains will be great, but on the other hand, years of double-digit losses can really take a chunk out of your retirement assets.
Worse, what if you are withdrawing money during a down year? Those losses will compound. Your account balance is smaller from those initial losses, and the amount you take out reduces your balance further.
Even a 10% loss at the wrong time can do a lot to take someone’s lifestyle goals or retirement plan off the rails. If a 4% withdrawal rate gives you just enough financial guardrails to keep you on track, how could an 8% withdrawal rate come close to being sustainable? To ensure that you don’t outlive your income in retirement?
The short answer is that it doesn’t. The math doesn’t compute.
Longevity Risk and Healthcare Costs
Another thing that Ramsey’s 8% withdrawal rate overlooks is the risk of increased longevity. As people live longer, they face the challenge of having enough money for a longer retirement.
There are also healthcare costs and long-term care costs, which usually go up in the 70s and beyond. When these health costs are added to the menu of existing retirement expenses, they can quickly eat into someone’s retirement income. An 8% withdrawal rate may not well be sustainable at that point in time.
Consider Alternative Withdrawal Strategies
Many financial professionals look at 4% as a sustainable withdrawal rate, and it’s certainly more manageable than 8%. But even then, it’s not a foolproof method. If you have scrimped and saved during your working years for a secure retirement, are there other ways that might help ensure you have enough income?
One option to think about is creating an ‘income floor,’ or a certain amount of income that you can count on each year. You could opt for an annuity and turn on its guaranteed income stream so that you have a steady, baseline source of money. The annuity would provide income for as long as you lived, in times good and bad.
The rest of the money could be diversified into other assets, including ones with growth potential that can keep up with inflation. The stability and guarantees of the annuity could help ensure that you have a steady income stream in good and bad economic climates.
If a “safety-first” strategy with an annuity doesn’t appeal to you, you may also explore other withdrawal strategies. Those can include a bucket-driven approach, RMDs as a guide for withdrawals, a dynamic withdrawal approach, and other rules-based strategies that can offer flexibility.
Some Final Thoughts on Dave Ramsey and an 8% Withdrawal Rate
Dave Ramsey has a following of millions seeking financial freedom, but his financial advice isn’t always the best. Many retirement researchers and economists have done research and found that a conservative withdrawal rate, such as the 4% rule, is quite effective. It’s not foolproof, and for those who want more flexibility or more certainty, other withdrawal strategies can be explored.
Either way, Ramsey’s 8% withdrawal rate is unsustainable and impractical. It’s likely to lead someone to run out of money, as Ramsey’s assumption of 12% average returns doesn’t hold up to scrutiny.
If you are near retirement or planning for your retirement income, consider other approaches beyond the Ramsey school of thought. Blended strategies incorporating contractual guarantees, such as those from annuities, can provide retirees with a safety net in times of market and economic uncertainty. Other withdrawal strategies have also been tested by advisors and researchers and found to hold up well.
Talk to your financial professional about your financial goals in retirement and what options can help you reach them. They can help you find the right strategy for your situation. If you are looking for a financial professional, many experienced and independent financial professionals are available here at SafeMoney.com.
You can connect with someone directly by visiting our “Find a Financial Professional” section and seeing if they are a good fit for your goals. If you would like a personal referral, please feel free to call us at 877.476.9723.
