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Recently, financial expert Dave Ramsey made headlines with his advice on how to safely withdraw funds from your investment accounts during retirement. While Ramsey is well-known for his financial wisdom, this time, his advice may do more harm than good. In this episode of Financial Advisors Say the Darndest Things, I, A.B. Ridgeway, delve into why Ramsey’s 8% withdrawal rate could be a recipe for disaster when planning your retirement.
The Problem with Ramsey’s Math
Dave Ramsey suggested that an 8% withdrawal rate from your retirement accounts is “safe,” assuming you’re earning 12% from your investments. On the surface, this seems simple enough. As Ramsey put it, “If you’re making 12% in good mutual funds, and the S&P 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 eight.”
But is it really that straightforward? The answer is no, and the consequences of this oversimplified math could be dire. Ramsey’s logic is based on the assumption that you can subtract the average inflation rate directly from your investment returns to get a “safe” withdrawal rate. Unfortunately, this isn’t how the math works when it comes to managing your retirement funds over the long term.
The Correct Way to Calculate a Safe Withdrawal Rate
To calculate a true inflation-adjusted return, you can’t just subtract the inflation rate from your returns. The correct formula is a bit more complex:
(1 + Return) / (1 + Inflation Rate) - 1
Let’s break it down. If you had a 12% return and a 4% inflation rate, the correct math would be:
(1.12 / 1.04) - 1 = 0.07692 or 7.692%
That’s your real, inflation-adjusted return. It’s not 8% as Ramsey suggested, but 7.692%. At first glance, this might seem like a minor difference, but when it comes to retirement savings, small percentages add up over time, especially when you're dealing with large sums of money.
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The Impact of a 0.308% Difference
You might be thinking, “What’s the big deal about a 0.308% difference?” The problem is, when you're dealing with millions of dollars over several decades, even small discrepancies can result in significant financial consequences.
For example, if you retire with $1 million and you’re withdrawing based on an 8% return instead of the correct inflation-adjusted 7.692%, you could end up with a shortfall of over $250,000 by the end of your retirement. To be exact, your ending balance could be $258,766.45 less than you planned.
Think about that: $258,766.45 less in your retirement account because of a simple math mistake. That’s a quarter of a million dollars you could have used to buy property, contribute to a charity, or leave as a legacy for your children. Would you walk past a quarter of a million dollars if it were sitting on a table? Of course not. But that’s essentially what you’re doing if you follow Ramsey’s advice without understanding the math behind it.
The Risk of Following Entertainers for Financial Advice
As I discussed in the podcast, television personalities like Dave Ramsey are often seen as financial gurus, but it’s important to remember that they are primarily entertainers, not financial professionals. They may be surrounded by financial advisors, but that doesn’t mean their advice is always spot on.
Ramsey’s approach is often a one-size-fits-all solution, which doesn’t account for individual circumstances like portfolio allocation, risk tolerance, and sequence of returns—all critical factors in determining a safe withdrawal rate. If you follow his 8% withdrawal strategy without considering these variables, you’re essentially gambling with your retirement savings.
In fact, if you stick to an 8% withdrawal rate every year, regardless of market returns or the sequence of returns, you would have an estimated 68% failure rate. That means there’s a high chance you could run out of money during retirement, despite all your hard work and diligent savings.
Inflation: The Silent Wealth Killer
One of the most important factors Ramsey overlooked is inflation. Inflation erodes the purchasing power of your money over time, meaning that $1 million today won’t buy you the same amount of goods and services in 20 or 30 years. This is why adjusting your returns for inflation is crucial when calculating how much you can safely withdraw from your retirement accounts.
Even though Ramsey did mention inflation, he got the inflation adjustment calculation wrong, which could lead to disastrous results. As I explained in the podcast, “You can’t make good financial decisions if you’re working with bad numbers.” And when it comes to your retirement, those numbers need to be as accurate as possible.
The Real Cost of Bad Advice
Let’s revisit the math. If you were to take the 0.308% difference between Ramsey’s suggested withdrawal rate and the correct inflation-adjusted rate and apply it to $1 million, over 20 years with no withdrawals, you’d see a shortfall of nearly $260,000. That’s a significant amount of money to lose just because of a minor math error.
And it doesn’t stop there. If you’re withdrawing funds based on incorrect assumptions, the impact compounds over time, leading to an even larger gap between what you think you have and what you actually have. This is why it’s so important to understand the numbers behind your financial decisions, or at the very least, to work with a qualified financial advisor who can do the math for you.
The Importance of Financial Literacy
At the end of the day, achieving financial freedom is impossible without financial literacy. You can’t rely solely on television personalities or quick-fix solutions. You need to understand the basics of how your money works, how inflation affects your savings, and how to calculate a safe withdrawal rate that will allow your money to last throughout your retirement.
As I said in the podcast, “I’m glad that you’re listening to this podcast because you’re taking the first steps toward financial freedom, but you can’t get to financial freedom without financial literacy.”
What Should You Do Instead?
If you’re nearing retirement or planning for it, here’s what you should do instead of following blanket advice:
Consult with a Financial Advisor: A financial advisor can help you calculate a safe withdrawal rate based on your unique situation, including your portfolio, risk tolerance, and expected lifespan.
Understand Your Numbers: Don’t just take someone’s word for it. Make sure you understand how your withdrawal rate is calculated and how inflation affects your retirement savings.
Plan for the Long Term: Remember that retirement planning is about making your money last. Focus on a sustainable withdrawal rate that will allow you to enjoy your retirement without running out of funds.
Stay Informed: Financial planning isn’t a one-time event. Stay informed about changes in the economy, inflation rates, and how they might impact your retirement strategy.
Adjust as Needed: Be prepared to adjust your withdrawal rate based on market conditions and your personal circumstances. Flexibility is key to a successful retirement plan.
The Bottom Line
Dave Ramsey’s 8% withdrawal advice may seem appealing, especially if you’re looking for a simple solution to retirement planning. However, as we’ve explored in this blog post and on the podcast, that advice could lead to a significant shortfall in your retirement savings due to incorrect assumptions about inflation and investment returns.
Don’t let one miscalculation derail your retirement. Take the time to understand your numbers, consult with a financial advisor, and make informed decisions about your future. After all, your retirement is too important to leave to chance.
In the end, remember this: Financial freedom isn’t just about saving money; it’s about making smart, informed decisions that will allow your money to work for you throughout your life.
Introduction:
In this episode of Financial Advisors Say the Darndest Things, host AB Ridgeway delves into the recent controversy surrounding Dave Ramsey's advice on safe withdrawal rates in retirement planning. He sheds light on the potential pitfalls of relying solely on surface-level financial advice and emphasizes the importance of understanding the intricacies of inflation-adjusted returns.
Key Topics:
Dave Ramsey's 8% Withdrawal Rate: AB Ridgeway examines Dave Ramsey's assertion of an 8% withdrawal rate as "safe" and highlights the flaws in the calculation methodology.
The Impact of Inflation: The episode explores the critical role of inflation in retirement planning and the necessity of accurately accounting for it in investment strategies.
Sequence of Returns: AB Ridgeway discusses the significance of the sequence of returns, portfolio allocation, risk tolerance, and volatility in determining a truly safe withdrawal rate.
Mathematical Precision: The importance of using precise mathematical formulas, such as the inflation adjustment rate calculation, to avoid potentially detrimental errors in retirement planning is emphasized.
Financial Literacy: The episode underscores the need for financial literacy and the potential consequences of relying solely on generalizations or incomplete information from mainstream financial figures.
Quotes:
"You cannot get to financial freedom without financial literacy."
"We can't make good financial decisions if we're using bad numbers."
"Even small discrepancies in calculations can have significant repercussions over the long term."
Episode Summary: AB Ridgeway urges listeners to critically evaluate financial advice, emphasizing the necessity of understanding the underlying principles behind retirement planning. By dissecting the flaws in Dave Ramsey's advice, he highlights the importance of precision and accuracy in financial calculations, particularly concerning inflation-adjusted returns. Ultimately, the episode serves as a call to action for individuals to seek comprehensive financial education and guidance to secure their financial future effectively.
Keywords You Should Know:
Safe withdrawal rates
Retirement planning
Dave Ramsey controversy
Inflation-adjusted returns
Financial literacy
Sequence of returns
Portfolio allocation
Risk tolerance
Volatility
Financial education
About Financial Advisors Say The Darndest Things Podcast:
As Christians, we were taught to be good stewards over our tithing and giving to the less fortunate. But when it came to our personal finances and investing we were left clueless on what the Bible says. What does the Bible say about managing debt, leaving a legacy, investing, and planning for your retirement? Mr. Christian Finance answers these and many other questions because we want to teach you how to become rich and righteous!
Meet A.B. Ridgeway:
A.B. Ridgeway, MBA (info@abrwealthmanagement.com) is the owner and Christian Financial Advisor with A.B. Ridgeway Wealth Management. With a decade in the finance industry, his goal is to give believers clarity around the most confusing topic in the Bible, money, and tithing. A.B. Ridgeway helps tithing Christians become cheerful givers but unlocking their money-making potential, so they can prosper and be the great stewards of the wealth God has entrusted them with.
*Disclaimer: This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services. Any information provided has been obtained from sources considered reliable, but we do not guarantee the accuracy or the completeness of any description of securities, markets or developments mentioned. This is strictly for information purposes. We recommend you speak with a professional financial advisor.
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