Those would be chilling words to hear from the pilot as we sit on the tarmac readying for push-back from the gate. Hearing that, I don’t know about you, but I’d want to get off that plane! How does this relate to retirement planning? Read the following to find out.
For all the good that Dave Ramsey has done, there are many who will likely suffer if they follow his investment advice. He’s built a hugely successful and thriving business by helping thousands, probably tens of thousands of Americans to get out of debt. By writing bestseller books on the subject and hosting a daily nationally syndicated talk show, he’s become the go-to guy to figure out how to get out of debt. On his radio show, followers of his multi-step plan are encouraged to call in and relate how far they were into debt and how they worked their way out of it. I have enjoyed listening to his show from time-to-time and hearing how people worked their way out of what they thought was a hopeless situation.
I’ve read one of Ramsey’s books and I agree with the techniques he advocates for saying goodbye to debt, and committing to living a debt-free life. I think his advice within the realm of debt is spot-on. However, his advice regarding investing and retirement income planning fails to meet pragmatic standards when considering the long-term stock market cycles and the details of the market since 2000.
Ramsey’s approach to investing is to buy-and-hold, and quotes a long-term rate of return for a good mutual fund at an average of 12%. While he may be able to show that as a true statement, there are important factors one must additionally consider. For example, most often when you hear claims that the market has averaged a high percentage return such as he cites, the length of the term most often considered is on the order of 60 years. How many of us will invest for 60 years? If we instead examine stock market returns over a more reasonable return period – such as 20-year periods – and if we go back about 100 years, we’ll see that the market produces a negative inflation-adjusted return in over one-half of the 20-year periods! So if one is simply buying-and-holding, luck will likely determine a positive or negative return. As Dirty Harry asked, “Are you feeling lucky?”
Next, an examination of the market from 2000 to 2013 shows that between 2000 and 2002, the market declined approximately 50%, To add insult to injury, the market declined again in the same decade. From 2007-2009, the market declined approximately 57% and during this decline, it wasn’t only the stock market that declined – bonds and commodities also declined. Except for annuities and cash, there was nowhere to hide. Imagine seeing your portfolio skyrocketing in the late 90’s when the market was on a steep incline and deciding to retire at the beginning of 2000, and then having a portfolio worth 50% less just two years into retirement. This scenario caused many retirees and investors to lose sleep at night. Buying-and-holding may be OK in the right market environment and for someone who has decades to recover from a loss of that magnitude. But for one who is near retirement or already retired, it is unacceptable because recovering from that kind loss while you are taking distributions from the portfolio makes it highly unlikely that the portfolio will ever recover.
The prior point on investment methodology is a significant problem, but may be less significant when you consider Ramsey’s position on what percentage one can take as income from an investment portfolio. In a February 5, 2013 newsletter, Ramsey stated that one can take 8% income from a portfolio in retirement. That percentage is two times the percentage that is routinely quoted in academic research and financial publications for the investment advisor community. Two times.
An alternative methodology for evaluating how much one can safely take from a retirement portfolio has been introduced by an engineer – turned financial advisor. It is a logical and engineered approach to planning – in that a retirement income stream is calculated by considering the last 113 years of stock market, bond market, and inflation history in the United States. It is likened to constructing a building to withstand the worst windstorm that could come along, as opposed to planning for the average windspeed that has occurred. By considering having retired in any year since 1900, and including actual stock, bond, and inflation history, one can see the worst that has occurred in the last 113 years, and can plan to position the portfolio and income to be above the worst 10% that has ever occurred. This method produces a 90% chance that income will last a lifetime based on a method knows as aftcasting. That doesn’t eliminate the possibility of running of running out of money, but it helps to construct acceptable odds.
Sorry for the lengthy explanation, but you should also know that many in the investment advisory community have begun to question the viability of the commonly recommended safe withdrawal rate of 4%. That’s right – many in the investment advisory community feel that a withdrawal of 4% may be unsustainable – and Dave Ramsey says that one can withdraw at 8%!
According to the software and analysis I described above, withdrawing from a portfolio at the rate of 8% annually, adjusting annually for inflation, and buying-and-holding a portfolio of 60% stocks and 40% bonds, there is a 38% chance of depleting the portfolio of all assets in just 14 short years. It gets worse. That 8% annual withdrawal rate would produce a 66% chance of depleting the portfolio, 19 years into retirement. So if your advisor told you that you have a 66% chance of having any money left in your portfolio after 14 years, would you start spending that 8%, or would you find another advisor. I suspect you’d get off that ride just like you’d get off of a plane having a 66% chance of reaching its destination.
Sadly, there are so many who will likely heed Ramsey’s advice and take 8% from their portfolio. He helped them get out of debt, so they’ll likely trust his guidance in this area also. Unfortunately, he’s not also quoting the likelihood of lifetime income at that rate of withdrawal.