There is a lot of merit in what most* of Dave Ramsey has to say.
After all, his Baby Steps and Financial Peace University program have helped thousands of families get out of debt and take control of their financial lives.
Yet, my one complaint as a Certified Financial Planner™ has always been how dangerous it is to provide general advice to such a wide audience.
Financial planning is personal and is anything but a one-size-fits-all approach.
What’s right for you, isn’t going to be right for your relatives, your neighbors, or coworkers.
Everybody has different investment goals, different timelines, and different circumstances.
Earlier this week, Dave may have perhaps made the biggest gaff when he incorrectly insisted on being able to safely take 8% out of your portfolio every year in retirement.
Here’s what he had to say:
“If you’re making 12% in good mutual funds and the S&P 500 is averaging 11.8%, and if inflation for the last 80 years is 4%, if you make 12% and you need to leave 4% in there for average inflation raises, that leaves you 8%.So, I’m perfectly comfortable drawing down 8%.But if you want to be a little bit conservative, 7%. But, sure, not 3%, 4% or 5% as the experts suggest That’s way too conservative.”
Unfortunately, not only is this mathematically wrong, it’s also incredibly dangerous.
You see, there’s a big difference between geometric returns (what you earn in an investment) and arithmetic returns (the simple average).
Just because an investment averages a return of 10-12%, does not mean you can consistently rely on that investment to provide consistent, predictable returns each and every year.
Take a look below at the different returns that the S&P 500 provides each year.
Why does this matter?
Four words … sequence of return risk.
Perhaps the biggest risk someone could encounter in retirement and one that Dave fails to mention, is sequence of return risk.
Sequence of return risk refers to the pattern of stock market returns AFTER you retire.
Retiring into a strong, bull market bodes a whole lot better for you and your retirement than retiring into a financial crisis or bear market.
Simply put, when you retire matters.
AND THIS IS WHY IT IS IMPORTANT 
WARNING: Failing to adjust your lifestyle or spending during the years when the market is down, is a surefire way to run out of money in retirement.
In fact, a retiree who listened to Ramsey and followed an 8% withdrawal rule while investing only in the 4 stock mutual funds that Dave recommended in the 2000s would have run out of money in as little as 13 years. – Phau and Blanchett
Don’t believe me?
Check out the math for yourself.
Even though both investors in the below example start retirement with the same amount of money, and take the same amount of withdrawals, they have very different results.
Why?
Because of how different the markets perform when their retirements begin.
If you want to learn more about how to calculate how much you can afford to spend in retirement and the various methods used to calculate those figures, CLICK HERE to read an entire blog post I wrote dedicated to this topic.
The Importance of Having an Appropriate Portfolio in Retirement
David Blanchett and Dr. Wade Phau, who are highly intelligent and esteemed experts in the field of retirement planning, wrote about the risks of withdrawing from your retirement portfolio when the stock market is down and had this to say:
“Volatility does two things to your safe withdrawal rate.
First, it means that retirement portfolios can fall in value.Second, when retirees withdraw a fixed amount from an investment portfolio that has fallen in value, it chips away at a nest egg that has already suffered a beating and that portfolio is now smaller.Less savings means less money that can rise in value when returns go back up.”
Remember: When you sell at a loss, two things occur…
- You permanently lock in a tangible loss
- You rob your investments of the future opportunity to recover, compound, and grow.
This is why broad and generic financial advice is so dangerous!
Investing 100% in stocks may be appropriate for somebody in their 20s or 30s but is more than likely way too aggressive for somebody approaching retirement or already in retirement.
If you’ve been following my weekly newsletters, then you know that I recently wrote on the importance of having a war chest full of short-term investments like bonds and cash.
If you missed it, you can read more by CLICKING HERE.
Remember, you build your retirement portfolio backward by first determining how much money you need on a monthly basis.
Here’s a little exerpt from last week’s newsletter that talks about how to build your retirement portfolio, while taking your spending needs into consideration.
Now that we know how much monthly income we’ll need to generate, the first step is to identify how much you want to allocate to your SAFETY bucket. I refer to this as your war chest.
This safety bucket is designed to withstand market volatility, bear markets, and give you peace of mind while you sleep at night.
Because of this, you won’t have to compromise your current standard of living in retirement because you have set aside 3-5 years (or even 7+ years if you’re more conservative) worth of cash, CDs, and bonds.
What this also means is that you are giving your stocks room to grow, recover, and compound.
As your long-term investments grow, this is the bucket that we use to replenish your safety bucket as you enjoy retirement and spend on the things, experiences, and memories that bring you fulfillment.
By properly building your portfolio to match your investment strategy, taking into account your individual spending needs and circumstances, and making periodic adjustments to your spending as market conditions shift, you are positioning yourself for a successful retirement.
Financial Planning is an ONGOING process and your portfolio and financial plan should adjust as your life and circumstances change.
If you have questions about these thoughts or anything else, please be encouraged to reach out anytime.
