For those who do not know Dave Ramsey, he is a man who touts himself as a financial guru. He may not know finances, but his hard approach to getting out of debt is probably the only advice people who do not know how to control their money can use. Otherwise, most of his advice is outdated or just wrong.
The other day, a thirty-year-old caller called into the Dave Ramsey show to figure out some things about a reasonable withdrawal rate. He had watched a George Kamel ( works for Dave Ramsey) video about living off of your portfolio with a 3-5% safe withdrawal rate.
At that point, Dave Ramsey got flustered like an old grumpy man yelling at the kids to get off his lawn. He first wanted to get George Kamel's video off the internet because, in his view, 8% should be the withdrawal for people. His math says 12% annual return with 4% inflation, which means you can withdraw 8% annually.
Dave Ramsey is not a math guy; he assumes that a 12% average return means your portfolio should get 12% yearly. Well, that is not how the market works, as there are times when the market goes up and down.
For the uneducated observer, this math works out. If your investments make 12% yearly, you can take out 8%. What if the investments go down 18% in one year? In 2022, the stock market went down 18%. If you retire at age 70 and hope to only live until age 80, then maybe withdraw 8%, but what if you live to age 100? Then, you will most likely run out of money.
Let's look at some history instead of some averages. In 2000, the market was down around 9.7%, then in 2001, the market was down 11.75%, and lastly, the market went down 21% in 2002. That's three years in a row the market was in negative territory.
The market bounced back a bit, but in 2005 and 2007, the market only made around 5% return. We cannot forget the crash of 1987 or even the Great Financial Crisis, where we saw a dip of 35% in the market. Crashes in the market happen, and you cannot depend on a 12% return yearly. There will be years when the market is up and when the market is down or flat.
The 4% Rule and the Trinity Study
In 1998, the Trinity Study was published, showing that if you want your investments to last for 30 years, the safest withdrawal rate would be 3-4% of your portfolio. The study looked at historical returns of ups and downs in the market. It figured out that throughout history, in the last 100 years, you will be safe to withdraw 4%. That gives investors a 7% return with inflation, allowing you to withdraw 4% and have 3% to grow.
Between 1926 and 2018, the market averaged a return of 10-11%. Adjusted for inflation (historically 3%), you will have a return of 7%. This is an average inflation. There are times when inflation has been high. In 2022, inflation was up to 8.8%.
If you want to test your portfolio over 30 years, you can use the calculator on FICalc. Using the 4% rule, 96.7% of the time, your portfolio will last 30 years. If you take an 8% withdrawal rate, your portfolio should survive 39% of the time. The calculations show the years you could retire and stay or fail, but looking at this data, would you rather have a 39% chance or a 96% chance?
Should You Listen to Dave Ramsey?
Dave Ramsey is a salesman trying to sell people things. He comes out as confident, shrewd, and a bit of an angry man, and that works with getting people out of debt, but his financial advice has left many in the position of having to go back to work since their nest egg got depleted. In the video, his daughter Rachel even had a look of not wanting to cross this enraged man.
There are better people to listen to if you seek solid financial advice. Rick Ferri is a CFA who has done a ton to help people with their finances. He is one of the hosts of the Bogleheads on Investing Podcast and uses simple ways to encourage his clients to do better in their retirement.
Do your own research, and do not let someone like a bully salesman like Dave Ramsey sell you something on stocks always get 12%, and you should be able to withdraw 8%. His math is wrong!
I’m Steve. I’m an English Teacher, traveler, and an avid outdoorsman. If you’d like to comment, ask a question, or simply say hi, leave me a message here, on Twitter (@thefrugalexpat1). Many of my posts have been written to help those in their journey to financial independence. I am on my journey, and as I learn more I hope to share more. And as always, thanks for reading The Frugal Expat.