This Dave Ramsey Retirement Advice Is Wrong and Dangerous

Popular personal finance expert Dave Ramsey recently gave some retirement advice that made many financial planners shudder. It has to do with Ramsey's definition of a safe withdrawal rate from retirement savings, and to put it mildly, he is suggesting an unsustainable withdrawal rate that could leave retirees broke at a time of their life when they really don't need to be running out of money.

What most financial planners recommend

The most commonly used retirement savings withdrawal guideline is known as the "4% rule" of retirement. Some planners advise a more conservative rate of 3%, but the 4% rule is one that has been around for decades.

The basic idea is that you'll withdraw 4% of your retirement savings during your first year of retirement and give yourself cost of living adjustments to keep up with inflation in subsequent years. If you do this and maintain a 60% stock and 40% bond asset allocation, this gives you a very high chance that your nest egg will last for at least 30 years.

Of course, this isn't a set-in-stone rule. The 4% rule admittedly has its shortcomings and makes a lot of assumptions itself. Plus, personal situations should be taken into consideration -- for example, if you wait until age 75 to retire, you can probably safely withdraw a bit more than someone who retires at 60 and needs their money to last for 30 or more years.

However, the point is that Ramsey's 8% withdrawal suggestion is wrong and dangerous, and as we'll see in the next section, it could leave retirees financially vulnerable later in life.

Dave Ramsey's retirement savings withdrawal advice

On a recent show, Ramsey called a 3% withdrawal rate "ridiculous," advising listeners to take 8% of their money each year. And here's his logic:

"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 has averaged four percent, if you make 12 (%) and you need to leave 4 (%) in there for inflation raises, that leaves you 8 (%). So I'm perfectly comfortable drawing 8 (%). But if you want to be a little bit conservative, 7 (%), but sure not 5 (%) or 3 (%)."

In addition to calling for an 8% withdrawal rate, Ramsey also suggested that retirees keep 100% of their money in stock-based mutual funds.

Why Ramsey's advice is wrong and dangerous

To be fair, Ramsey's numbers are generally correct when it comes to the S&P 500's average returns and the long-term average inflation rate.

However, the biggest fatal flaw in Ramsey's reasoning is that the stock market doesn't deliver the same returns every year.

Consider this simplified example. Let's say that you retire with $1 million in mutual funds. As Ramsey suggests, you withdraw $80,000 throughout your first year of retirement. And we'll assume the market generates a 12% return, as Ramsey suggests it will, which replenishes your money and a little more. We'll say inflation is running at 4%, so this means your second-year withdrawal rate should be $83,200.

However, what happens if the stock market drops by say, 30%, during the second year you retire? It's happened before. Now, your roughly $1 million nest egg declines to $700,000. And you're set to pull out $83,200. In this case, you'd be on track to end the year with just over $600,000 in retirement savings. Now your $83,200 withdrawal represents about 14% of your portfolio, and even Ramsey would likely agree that this level of withdrawal would be unsustainable at this point.

In fact, Morningstar recently completed an analysis of Ramsey's 8% annual withdrawal rate over rolling 30-year periods. A 100% equity mutual fund portfolio would have survived for 30 or more years just 55% of the time. It would have lasted less than 20 years in 32% of cases, and the retiree would have been broke within 10 years in 6% of those 30-year periods. In short, an 8% withdrawal rate gives you a not-so-good chance that your money will last the rest of your life.

Credit where it's due

To be clear, I'm not attempting to discredit Dave Ramsey. His advice has helped millions of people get out of debt and achieve levels of financial peace of mind that they previously only dreamed of. And having listened to his show occasionally, I can definitively say that he does an excellent job of helping people make sense out of seemingly complex financial situations, such as inheritance or divorce.

However, when it comes to a safe retirement withdrawal rate for a brokerage account, he is sadly mistaken. It's one thing to be broke when you're in your 40s or 50s. It's quite another to run out of money when you're in your 80s and are physically unable to go back to work. A realistic retirement savings withdrawal rate like the 4% rule that is most commonly used by financial planners will provide an excellent combination of current income and the likelihood that your money will last as long as you do.