Nashville radio empresario Dave Ramsey has helped millions of people navigate their way out of debt and set a more sustainable financial course. Much of his advice on personal budgeting is sensible and a clear benefit to many of his listeners. His investment advice, on the other hand, is often misguided and potentially hazardous.
Ramsey blew up the internet last month by suggesting that his listeners, regardless of age or other considerations, should invest 100% of their assets in stock mutual funds and begin withdrawing 8% every year adjusted for inflation once they retire. The 8% withdrawal is about double what most responsible advisors and financial planners take as a theoretical starting point before considering the myriad factors unique to each individual situation. Financial professionals pushed back, eliciting a testy retort from the talk show host.
The idea of a “safe” withdrawal rate in retirement traces back to a 1994 paper by financial planner by Bill Bengen in the Journal of Financial Planning examining expected returns from diversified portfolios consisting of 50% stocks and 50% bonds. Bengen and later authors concluded that a hypothetical retiree could begin withdrawing about 4% of their portfolio each year adjusted for inflation over 30 years with a low probability of depleting their assets. Bengen also found that a higher allocation to stocks slightly increased the odds of going broke within the 30-year window. Subsequent research produced similar results, suggesting a theoretically safe withdrawal rate between 3% and 5% depending on market valuation over the period as well as investment fees and taxes.
The popular radio host caused an uproar by assuring his listeners they could safely begin retirement with an 8% inflation-adjusted annual withdrawal rate. His rationale is based on a disregard for portfolio risk and overly aggressive asset allocation advice.
Ramsey tells his audience to eschew protective assets like bonds and cash, advocating for a 100% stock portfolio on the simplistic (and false) assumption that stock funds consistently return 12% per year. His recommended allocation is high octane, with the potential for greater returns but above average risk: 25% each into growth and income, growth, aggressive growth, and international stocks. Katy bar the door.
Where to begin? As most investors are painfully aware, the stock market does not go straight up but ping pongs; otherwise, stocks would produce bond-like returns. Betting the ranch entirely on risky assets increases the odds of losing the ranch. A hypothetical investor retiring in 1993 with $1 million in the S&P 500 could comfortably have withdrawn 8% adjusted for inflation every year and left money for the kids in 2023. Had our hypothetical friend pursuing the same strategy called it quits in 2000, he went broke in 2008. Works great, unless it doesn’t, or you die early.
A Morningstar analysis of hypothetical investors retiring in each year between 1965 and 2007 found that the all-stock approach ran out of money within 15 years nearly 1/3 of the time. Furthermore, over the 68 rolling 30-year periods since 1926, the all-stock mix survived only 55% of the time without running dry. The Morningstar analysis merely confirms the rich literature on the subject. Risk management is at least as important as investment selection, a critical precept ignored by simplistic airwave aphorisms.
Mr. Ramsey also promotes actively managed mutual funds with sales commissions upward of 5%. With the proliferation of ultra low-cost index ETFs and the virtual elimination of commissions, it is relatively easy to construct diversified portfolios for a fraction of the cost of loaded funds. And recall that it is virtually impossible for actively managed funds to consistently outperform passive indexes after fees and expenses. According to Standard and Poor’s, fewer than 3% of all US domestic equity funds outperformed their benchmarks over 20 years after adjusting for risk. No wonder US ownership of passive index funds overtook active funds in the US last year.
The 8% withdrawal recommendation drew a barrage of responses from financial professionals who do this for a living, are credentialed in investments and financial planning, are duly registered with regulatory agencies, and routinely provide responsible counsel to individual clients. The securities laws in the US, designed to provide some protection to investors from incompetent or dishonest purveyors, provide an exception for media commentators and publications, so long as they are not offering specific advice to any individual. Loosely translated, it’s ok for radio personalities to dispense investment advice assuming no one follows it. Professionals who offer thoughtful investment counsel to real clients are held to a much higher standard and bear responsibility for their recommendations.
The backlash from financial experts (“super nerds” he called them) drew a prickly response from Mr. Ramsey, who assailed “stupid people who put out low withdrawal rates” as “morons in their mother’s basement with a calculator”. Still, when parsing reams of data informing critical decisions that will determine the security of one’s retirement, a super nerd with a BA II Plus can prove quite handy. Besides, Mom has a billiard table in her basement.
Of course, no responsible professional would recommend a “safe” withdrawal rate to an actual client without understanding the individual circumstances and constraints in play. The idea of a 4% rate is merely a heuristic, a rule of thumb to be taken as a starting point from which to construct a rigorous individualized investment plan.
Many listeners mired in credit card debt have Dave Ramsey to thank for helping them escape the cycle and regain control over their balance sheets. When it comes to the prospect of funding retirement, a super nerd with a financial calculator is probably a better bet.