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The Smart Take:
Recently, famous radio show host and personal finance guru Dave Ramsey made headlines by saying he’s perfectly comfortable with an 8% withdrawal rate in retirement. Critics were quick to respond, calling his advice scary, dangerous, and just plain wrong. So, who’s right?
On this episode, hear Tyler Emrick, CFA®, CFP®, break down Ramsey’s comments and how you should be thinking about income and spending in retirement.
Here’s some of what we discuss in this episode:
- How Dave Ramsey explains his position on the 8% withdrawal rate.
- Why the math might seem simple but is actually wrong.
- What you need to know about Geometric and Arithmetic returns.
- You can’t ignore the sequence of return risk with a 100% stock portfolio.
- Is the 4% rule too depressing?
Here are the past episodes mentioned in this show:
Ep 101: Interview with Retirement Researcher Dr. David Blanchett (Part 1)
Ep 102: Interview with Retirement Researcher Dr. David Blanchett (Part 2)
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The Hosts:
Kevin Kroskey, CFP®, MBA – About – Contact
Tyler Emrick, CFA®, CFP® – About – Contact
Episode Transcript:
Tyler Emrick:
Recently, famous Radio Show Host and Personal Finance Guru, Dave Ramsey, made headlines by saying he’s perfectly comfortable with an 8% withdrawal rate in retirement. Critics were quick to respond, calling his advice: scary, dangerous, and flat out wrong. So who’s right? Find out today on Retire Smarter.
Walter Storholt:
Hey, another edition of Retire Smarter is here. I’m Walter Storholt, alongside Tyler Emrick, Certified Financial Planner, also a Chartered Financial Analyst, Wealth Advisor with the True Wealth Design team. Here for another great episode. Very intrigued by both your headline, Tyler, and your teaser. Always enjoy talking about Dave Ramsey’s advice and guidance, because he is so popular out there. And, sometimes people really disagree with what he has to say. Sometimes, people are obviously really, really big proponents of everything he has to say and take it as gospel. So, it makes it fun to talk about, that is for sure, which I think is one of his main missions is to be an entertainer.
Tyler Emrick:
Fair enough.
Walter Storholt:
We do get to tap into that a little bit on today’s episode. But before we dive into all of that, we just had Thanksgiving. You are recording from home today, because of a little bit of snowfall. So, things have been busy at the Emrick household, it sounds like.
Tyler Emrick:
That’s right, yes. Thanksgiving was wonderful. Belly is still full.
Walter Storholt:
Nice.
Tyler Emrick:
I think we got almost three days of leftovers, which was great. On Thanksgivinged out though, so we’ll see. Maybe when Christmas rolls around, we’ll be back on some of the mashed potatoes, cheesy potatoes, ham, turkey, all that other good stuff.
Walter Storholt:
After we record today, I’m polishing off the rest of the sweet potato casserole, and then I think we’ll be almost done with all our leftovers.
Tyler Emrick:
Nice. That’s pretty good. That’s pretty good, considering we’re almost a week out from Thanksgiving.
Walter Storholt:
Yeah, we’ve still got some turkey, that’s going to get frozen and that’s going to get thrown in the freezer for maybe a turkey soup or something later on.
Tyler Emrick:
Yeah. No, that’s good. And then, of course, being in northeast Ohio, we got hit with a little bit of snow here to welcome us into the end of November, early December. Not too much, just a little bit of dusting, but just enough to keep me in the household and playing dad for today.
Walter Storholt:
Nice. Well, we are glad that you are still able to join us for the show today and get some great information out there for folks. And let’s dive into that content today, because, I don’t know, Tyler, we’re here at episode 136, and I don’t know if in those previous 135 episodes we’ve ever… Certainly, we haven’t had an episode that centered around a piece of Dave Ramsey advice or comment. Maybe, Kevin at some point mentioned him in passing and in a response, but I really can’t remember a time where we’ve brought him up in 135 episodes. So, well done. I feel like that’s an accomplishment.
Tyler Emrick:
Look at us finding new ways to explore the world of finance. But he really outdid himself this time. You mentioned entertainer as you were setting up the show a bit, and he really made some headlines with this one. And he was really diving into and talking about retirees and what we call safe withdrawal rates. So, what he was getting at is that he recommended, first, retirees invest 100% of their assets and stocks from which… Well, that comment in itself, I think toes the line a little bit.
Walter Storholt:
You could do a whole episode on that specific thing, yeah.
Tyler Emrick:
Yes. But then he goes on to say from which they could withdraw 8% per year from the portfolio’s starting value, with each year’s expenditures adjusted for inflation. So if I break that down a little bit and put some numbers behind it, essentially what he’s saying is, let’s say you’re heading into retirement and you’ve got half a million dollars in your portfolio. What Dave’s saying is, is you take that half a million dollars, 8% of it, roughly $40,000, and that is the number that you can safely withdraw throughout retirement and not run out. Not only can you withdraw that number, but each year that number can be increased by whatever inflation happens to be for that prior year. So if inflation was 3% in the scenario that we’re walking through, that would increase the $40,000 distribution up to $41,200. So it really doesn’t have anything to do with how your portfolio grows over the course of your retirement. He’s just saying, “Hey, in year one, take your balance. This would be a nice easy rule that you can follow; 8% you could pull out per year increasing with inflation.” Which I don’t know if you’ve had any exposure to safe withdrawal rates, Walter, but that is about double what most of the research tells us, or what most people tend to lean on as that safe withdrawal rate.
Walter Storholt:
I’ve always heard that 4% rule has been talked about. And some people say it’s too conservative, some people say it’s too aggressive, but we’re really blowing that out of the water in an 8% conversation.
Tyler Emrick:
We are. And Dave actually spoke to that. He was like, “Hey… He’s just not a fan of that safe withdrawal rate research. He actually blasted the researchers for being what he calls “Super nerds,” that live in their mother’s basement with calculators. One of those super nerds we actually had on the podcast. I don’t know if you remember, I think it was back in the earlier episodes, Kevin interviewed him over two, David Blanchett?
Walter Storholt:
Oh, yes. I remember the David… It was a great interview, yeah. Mm-hmm.
Tyler Emrick:
Okay. It was. Yeah, absolutely. A lot of great work by David. But, essentially, he’s picking their research apart a bit. And really, really expanding on it, saying, “Nope, that 3%, 4%, 5% withdrawal rate’s not even close. You should be closer to an 8%.”
So I guess the question becomes is, is; how did he even get there? And he actually was nice enough to break it down for us. So I’ll give you the math a little bit. So, by his analysis he’s saying, “Hey, if you’re all invested in stocks, you’re making roughly 12% per year in good mutual funds.,” because the S&P 500 averages close to that per year. He says, “If you back out inflation over the last 80 years,” he says, “4% is a good assumption there. You simply take 12, subtract 4, and you’re leaving with 8.” Because that 4% accounts for those inflation increases, and then the 8% withdrawal rate is what you’re left. He’s perfectly comfortable withdrawing 8% per year. And conservatively, he said, “Maybe seven,” but said, “No way is it closer to that 3%, 4%, 5% range that a lot of those researchers seem to fall back on.”
So, it seems pretty reasonable, 12% return per year. The math breaks down pretty basic, or at least in his mind. Now, unfortunately, in my opinion and what we’ll dive into a little bit, I think he’s a little wrong on his math. And there are two areas that we will dive into a bit today. And it seems like he’s not grasping the difference between what we call geometric returns, which is what you earn on an investment, and arithmetic returns, which is a simple average. And he doesn’t really appreciate how an all-stock portfolio increases sequence of return risk. So, headline those two a bit. Again, the difference between geometric returns and… Oh, come on, that is early.
Speaker 3:
Egghead alert.
Walter Storholt:
Got to hit you with you the egghead alert.
Tyler Emrick:
Kevin will be proud. Isn’t that a little early? Just a little bit early?
Walter Storholt:
I don’t think so. When you drop geometric returns and arithmetic returns back-to-back, it seems like you’re asking for it. So, there you go. It’s been a few episodes since you had one.
Tyler Emrick:
Well, beauty about it is, hey, we’ll dive into them in a little bit more detail throughout the podcast here. But, yes, those two things I feel like he’s missing a bit. The difference between those returns. And then not really appreciating how that 100% stock portfolio increase is what we call sequence of return risk.
A lot of those super nerds he referenced had a lot to say about his 8% withdrawal rate. And they back-tested and did some data on it and said, “Hey, if you were to follow this 8% withdrawal rule while holding a four-stock portfolio in the early 2000s, you would’ve run out of money in as little as almost 13, 14 years.” So I’ll break down the math behind that a little bit as we always seem to do here in the podcast and get the details. But let’s peel back the onion a bit and dive into each of those issues, I guess if you want to call them that, that we have with what Dave’s trying to say here.
So geometric returns and arithmetic returns. So, essentially what we’re getting at here is just because you average 12% return per year, doesn’t mean that a retiree’s portfolio is going to grow by 12% return per year. So simply saying, “Hey, the S&P 500 is going to average that, or at least it has historically averaged that if I have a hundred percent in stocks. Boom, there you go.” In practical application, there are other things to consider, and this geometric return we feel is a better representation of that. So let me give you a little bit of breakdown on the numbers. So let’s say you have a million-dollar portfolio, you retire, and in year one your investments fall by 20%. So, at the end of year one of retirement, you’re down to $800,000.
Walter Storholt:
Which is very realistic. Look at 2020.
Tyler Emrick:
We just went through that.
Walter Storholt:
Look at this past year.
Tyler Emrick:
Well, 2022, yeah. You’re exactly right. So, $1 million portfolio at the end of year one drops to 800, and then let’s say the next year you have a good year and you earn 25%, so you’re back up to a million. So 25% at 800k. So over the course of two years, your portfolio really has not changed at all. You started with a million and you still have a million dollars left. But if we take an average over those two years, negative 20% and positive 25%, that means your average annual return, or arrhythmic return, is 2.5%. Although your geometric return is zero, your dollars haven’t changed; 1 million at the beginning, 1 million at the end, that… I can barely say it too. I’ve said it too many times, haven’t I?
Walter Storholt:
No worries, no worries.
Tyler Emrick:
Through the pod. But is it 2.5% return per year? Because again, negative 20 in year one, positive 25% in year two.
Walter Storholt:
I feel like this is, we’re sports analysts and we’re massaging the stats to fit our narrative.
Tyler Emrick:
That’s a good point on that. I didn’t think of it that way.
Walter Storholt:
Just putting it into perspective. “Oh, 2.5%.” “No, it’s actually zero.” “Well, it depends on how you look at it.”
Tyler Emrick:
Well, and it could be very odd, especially heading into a year. You talk about those retirees that possibly retired in early 2020 or in 2008 when we had a major market crisis and your account values dropped by a significant dollar amount, that can be detrimental to your overall retirement plan, and it hurts a lot more if one of those scenarios happen early in retirement, which is a wonderful segue to that issue number two that we had, is that having a hundred percent stock portfolio increases that sequence of return risk, because the more volatile your portfolio is, the more risk you have of retiring into one of those bad markets and it hurting your jumpstart to retirement, and can really put you in a tough situation if you have these hard and fast rules saying, “Hey, I’m going to withdraw 8% every single year and not adjust with my portfolio changing.”
So, if we break down the math on that a little bit, how impactful that sequence of return risk can be, we just go back to that prior comment when I said, “Hey, a lot of these super nerds that do a lot with this safe withdrawal rate, when they look back through the data and say, ‘Well, what if we create a portfolio that Dave Ramsey said would get us this roughly 12 to 14% return per year. And let’s say that that was a retiree that had that type of portfolio and they retired right at the end of 2000.'” So 2001 was their first year of retirement, and essentially the numbers, the way they broke down, I think it’s important for us to maybe dive into that just a smidge, so the listeners can hear and see how those balances change.
So if you were that individual, first year of retirement, January 2001, a million dollars saved for retirement, you pull out $80,000 per year, that’s the 8%. So in 2001, your investments would’ve slipped by about 7.5%, and then of course you would’ve withdrawn your 80,000. Year two, portfolio would’ve fallen again, almost 18% it would’ve fallen. And again, you would’ve withdrawn out $80,000 plus, whatever inflation was that particular year. So just two years into retirement, your balance is now just over $600,000 down from a million, because you’ve pulled out the money that you’re living off of and your portfolio has lost 7.5% in year one and almost 18% in year two.
Now, hey, just inevitably, as the stock market tends to do, has a bounce-back year. So in year three, you have a 31% return, which brings your average up pretty good. And then over the next four years, you’re averaging around 12% return per year and boom, 2008 hits and your portfolio falls by almost 38%. So, from day one of retirement, January 2001, now you’re sitting at the end of 2008, you’ve withdrawn your 8% return per year, your portfolio is down to almost a little over $300,000 left, because you’ve experienced these big downturns in the market and you’ve maintained that big withdrawal rate that keeps pulling down those assets over time.
Your average return over those first nine years isn’t terrible. It’s a little over 5%. Again, you’re down to just a few hundred thousand dollars and your withdrawal has increased to almost a hundred thousand dollars per year, because remember we’re increasing that each year with inflation. So we extrapolate that out over the remaining few years, and you’re running out of money in 2013 or 2014, just what? 14 years into retirement. And if you take the average return over those entire time periods, it’s just under 10% return per year. So not too far off that 12% that Dave Ramsey says that we could average, but you’re completely out of money at that time. So those impacts of those returns or a negative year in the market can really hurt retirees as they’re pulling a big chunk of money out.
Walter Storholt:
No kidding. That’s amazing to see that illustration and just how fast you run out. And now granted, that’s two big hits back to back: the ’01 drop and then again having the drop in ’08. But there’s nothing to say that we wouldn’t be in that pattern right now with a drop from the pandemic or post, and then next year something happens and you’re creating a similar scenario could happen at any point in time when we retire. We don’t know.
Tyler Emrick:
Right. Well, and two, I think a lot of people don’t quite understand or understand the volatility that’s in the market. And one of the key things here that Dave Ramsey’s saying is, “Hey, you leave your money 100% in stocks,” and very rarely, every retiree is different, but there’s a reason why most retirees go into retirement with a diversified portfolio and target a lower amount in stocks than say their entire portfolio. Not every retiree, but this impact and the volatility and having to live off of it can really be a double whammy if it hits you not only early in retirement but over the course of say a 10-year time period because there are 10 year time periods where the stock market does not return that average of 12% return per year.
Walter Storholt:
It’s also interesting, I think if you look at this story that you drew out for us here, Tyler, in real life, it probably doesn’t play out, even though those are the real numbers over those years. A real person who would be in this scenario is probably changing their game plan halfway through this scenario, not continuing to withdraw at that percentage rate, but that’s just as big of a story. So maybe they’re not running out of money in 2013 and ’14, but now maybe they’re trying to live off of half of what they’d intended to live off of to help stretch that money out. And now that’s creating a whole nother host of problems as people try to change the game plan years into retirement.
Tyler Emrick:
Correct, or really going into retirement and not understanding that that could be a major risk and understanding that; hey, if you take on this much stock exposure, you take on this high of a withdrawal rate, there could be consequences down the road depending on what happens in the market. And talking through that and understanding that and what that might look like, I think is extremely valuable. So wonderful point there, Walt. You’re correct.
Walter Storholt:
Somebody living off of $80,000 all of a sudden being asked to live off of 30 or 40 then changes their lifestyle.
Tyler Emrick:
That’s right. Well, and I think as Dave Ramsey was exploring this idea and making this almost outlandish comment, I think he’s almost over correcting, because the old rule in a lot of that data that we look at that says, “Hey, what is the safe withdrawal rate?”, does tend to settle into that 3 to 4% withdrawal per year range. And Dave says, “Well, hey, if you’re telling retirees they can only pull out 3 to 4% return per year and they look at having say a million dollars and they can only get say $40,000 a year from it, a lot of individuals might go and say, ‘Wow, I need a lot more saved for retirement. I can’t live off of $40,000 a year. I need to have $2 million.'” And what that does is that-
Walter Storholt:
It’s almost depressing knowing that you’ve saved a million and now you’re only living off of 30 to 40. Like; what was the point of working so hard and saving so much? And that almost seems unrealistic probably, that people who have earned that much and save that much are going to then have the lifestyle that meets that.
Tyler Emrick:
Well, and I think that’s where our biggest issue with these rules in general, whether it’s 8%, a lot of them go off of the old 4% rule, pulling out 4% return per year. I think Kevin even did a podcast just on the 4% rule. We might be stretching pretty far back on us there, Walt.
Walter Storholt:
Episode 95, it looks like. Yes, Retirement Rules Gone Awry, part of a great series. It’s still applicable today, I think.
Tyler Emrick:
Absolutely. Absolutely. But I think the approach or to think about retirement and what can you live off of and how much can you withdraw off of your assets per year, it takes a little bit more digging and using these rules can get you in trouble. It might be a fine starting point, but that’s all they are. And there are a few reasons for that, and I think there are a few tidbits here that I’ll share that I think are a little bit better of an approach, as opposed to just that hard and fast rule.
The beginning part, it really starts with understanding your spending and what that’s going to look like over the course of retirement. As financial advisors, we read a lot of academic journals and a lot of research trying to understand where are retirees spending their money and how does that change over the course of retirement? And I think the data’s pretty clear that you take an individual, say retires in their early 60s, and extrapolate that over the course of a 30-year retirement, generally what happens is, is each year of retirement, retiree spending decrease a bit, and that decrease actually is shown to happen all the way into, say, your mid-80s. And then it’s going to increase in your mid-80s and start to increase again.
As you’re visualizing it and you’re listening to me talk, they call it the retirement smile. And you can Google this, a lot of research is done on it, but you boil down your assets and go into retirement saying that, “Hey, every single year of retirement, I’m going to need 4% of my portfolio per year to live off of.” Well, that’s not really taking an accurate representation of how your spending’s going to change over the course of retirement. You might pay off your house, cars might get paid off. Maybe you’re purchasing less cars in your 80s, maybe you’re not traveling as much in your 70s and 80s. So, retirees might need a little bit more from those assets early in retirement, and that might dwindle off and change as they go over the course of retirement. So that retirement spending and understanding what you are going to need to retire is point and key number one.
And then the other approach and the other thing I think we need to be looking at is, well, what other assets do you have to live off of besides just maybe a 401(k) and an IRA? And the biggest one that comes to my mind is Social Security. You might have a pension plan, and a lot of times when you kick in, say Social Security for example, there’s a lot of strategy that comes into play there, especially for individuals that can retire, say, in their early 60s. You can wait and delay and take your Social Security all the way up into 70 and continue to get increases. And a lot of times for a family of two who both have Social Security benefits, it might make sense for at least one of those individuals, the higher earnings spouse, to delay benefits later.
So what that means is, is you might need a little bit more money to live off of from your assets early in retirement, and that withdrawal rate or percentage might be very high for say the first five or six years of retirement. And then when you kick in something like Social Security, you’re not going to need as much from your assets to live off of, because Social Security is going to replicate or going to replace that. So thinking through your situation and what triggers and sources of, let’s call it, income that you’re going to have into retirement and when those start is extremely helpful as you’re looking at the entire picture.
And then finally, when we look at a safe withdrawal rate and running out of money, or having it last you, excuse me, through a long and healthy retirement, there are some considerations there. And I think looking at it maybe from a statistical point of view is a little bit more valuable. And what do I mean by that? So, if you take Dave Ramsey’s strategy and say, “Hey, how many scenarios could we run that where that 8% withdrawal rate could become successful? Hey, it lasts you a 30-year retirement, you would pull out 8% return per year. How long or how many times do you actually come out and you’re okay?” And we call that, a fancy term for that, it’s called Monte Carlo Simulation. And the way you can think about that is really the way that I think about just the basic financial plan, it’s; hey, you have this group of assets, 401(k)s, IRAs, all the like that you’re going to use in retirement. We have a good idea, or hopefully you have a very good idea how your spending is going to look and how it’s going to change over the course of retirement. But what we do not know is how much money you’re going to earn in interest or on your investments as you have them.
So what we do, from a financial planning standpoint, is we test that, so we go each year of retirement, so you need to get those expenses, and assume you get a different rate of return and extrapolate that out each year over a 30-year time horizon and say, “Hey, at the end, do you have money left? Okay, hey, that’s great. That’s a successful plan. Let’s go back and let’s assume that you retire into a poor market and you lose a lot early in retirement. Do you still run out of money?” So if you run a scenario like that, taking Dave Ramsey’s advice, slightly over half the time you actually run out of money or you have a successful… So it’s almost a coin flip as to if your money’s going to last you 30 years.
If you pull that time horizon down and say it’s only a 20-year time horizon, about two-thirds of those occasions, the strategy actually comes out successful. So you can use that information to help make better decisions now. And a lot of the families that I talk with wouldn’t want to leave their retirement and say, “Hey, there’s a coin flip that you’re going to run out of money in 30 years.”
Walter Storholt:
Yeah, that doesn’t sound very attractive.
Tyler Emrick:
No, not at all. We call those success rates. We talk about them almost on every meeting that we have to make sure that families are tracking in the right direction and make sure we can have that spending conversation should we need to. Understanding those numbers and looking at it from that frame of mind, I think adds more value than just saying, “Hey, I’m heading into retirement. Can I pull out 4% or 6% or 8% return per year?” Or not return, but, “withdrawal per year and live off of it, shut the doors, close it, and never look at it again?” To your point, things change and I think having a much more dynamic approach is more valuable and helpful.
Walter Storholt:
Yeah, that’s great, Tyler, great breakdown of all of this. I think it’s important to remember the context for everything like we were talking about with those stats there briefly, and it’s the context of Dave Ramsey. When you hear advice from him, keep in mind that often he’s speaking to a very large, very broad audience on the radio or on his YouTube channels or whatever the case may be from where he’s speaking about these things and he’s dealing with people getting out of debt, and he’s trying to get people to be more confident in managing money. He doesn’t want you to live your life in fear. And so, this information that he’s shared here, this sort of advice, tracks with that. He’s saying, “Quit being a scaredy cat about your money. The earth is crumbling and the world’s ending, and you need to go be a miser and live in a hole. Have some confidence, live your life to the fullest, get out there and do it.”
And so he’s following that mentality, to me, at least a little bit with this, but I think you’re right. It’s like an overcorrection. It’s like, all right, oversimplification, overcorrection. Hopefully people don’t take that as gospel on the surface and do a little bit more digging and a little bit more research and talk to somebody like you, Tyler, who can put their plan through these different stress tests, through these different simulations to really get an idea of the potential success of whatever strategy they follow.
It’s nice if this stuff could all be super simple and super easy, but if you want to maximize your opportunities and your chances, you’ve got to go below the hood. You got to go below the surface and look into these details, and I know that that’s what you guys do at True Wealth Design each and every day with your clients. And if you’re listening to today’s show and wanting to go into that deeper level of planning, that’s what Tyler, Kevin, and the great True Wealth Design team are doing all the time, and you can get a complimentary 15-minute call with an experienced advisor on the team to see if you’d be a good fit to work with one another. It’s very easy to set up that visit. Just go to truewealthdesign.com, click the “Are we right for you?” button and schedule your 15-minute call. Just like that. No obligation to do anything. It’s just a complimentary meeting to see if you’d be a good fit to work with one another and what could be done for your situation going forward. Just begin that conversation very easily. You can also call 855 TWD Plan. That’s 855 TWD plan, or again, truewealthdesign.com. We’ll put all that contact info in the description of today’s show.
Tyler, well done. Really appreciate your guidance on this today, and we look forward to catching up with you again in a few weeks.
Tyler Emrick:
Always. It was a pleasure.
Walter Storholt:
Congrats on your egghead alert today as well, by the way.
Tyler Emrick:
A good deal.
Walter Storholt:
Geometric and arithmetic returns. Wow, that was definitely a new term to share with us on the show, but made a ton of sense, and I definitely feel like I can Retire Smarter after today’s episode. We’ll talk to everybody again next time, come back and join us for another edition of Retire Smarter. Until then, take care.
Speaker 4:
Information provided is for informational purposes only and does not constitute investment, tax or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fee.
