Thursday, September 8, 2011

Why Dave Ramsey is an Epic Fail

            If you love Dave, great. He helps a lot of people. He is amazing at helping people get out of debt, but he is not an investment advisor. He is not a financial strategist. He is a salesman and an entertainer. I too love Dave for helping a lot of people, but it is important to know are realize that he is not a one size fits all answer. The Following is a very common scenario implementing Dave's strategy.
            If someone needed $50,000 a year in order to retire, and they think they can get a 10% return, then theoretically they will need to have $500,000 in order to retire. This is a modest living, but possible. If they retire in1998, and they didn’t make any withdrawals until the end of each year, then their account balance would look like this.

Return (%)
Return ($)

 $           -  
 $  500,000
 $  143,650
 $    50,000
 $  593,650
 $  125,320
 $    50,000
 $  668,970
 $   (60,943)
 $    50,000
 $  558,026
 $   (66,852)
 $    50,000
 $  441,175
 $   (98,250)
 $    50,000
 $  292,925
 $    84,128
 $    50,000
 $  327,053
 $    35,387
 $    50,000
 $  312,440
 $    14,966
 $    50,000
 $  277,406
 $    43,664
 $    50,000
 $  271,070
 $    14,800
 $    50,000
 $  235,871
 $   (87,791)
 $    50,000
 $    98,080
 $    26,589
 $    50,000
 $    74,669

            They did great when the market did great. Their account balance even grew when they were taking out their needed income. But as you notice their balance goes from $500,000 to $74,669 over the course of ten years. They are likely to run out of money in the next year or two. Most of us plan on being retired for longer than 10 years. If this person retired at age 65 they would run out of money by age 76 or 77. When someone runs out of retirement funds they often are not in the condition to work which leaves them two options; move in with family, or live in extreme poverty. Yes there is Social Security and Medicaid and Medicare for now, but that is never ideal nor desirable.
            You may ask, “What happened? Why didn’t it work?” The simple answer in this case is timing. The market doesn’t just go one way. It goes up, down, and sideways. This person only makes money on up years, and they still have to withdrawal money when they haven’t made any. This person just didn’t time his retirement right. It’s not an easy thing to do.
            The root of the problem is the assumptions of needs based planning that the market will always go up on an average 10%. That assumption allows people to plan on living off their interest rate, or their returns each year. However, as we talked about averages last post, it doesn't work. When their return is not enough, they will likely not be able to reduce their expenses sufficiently. The result is a withdrawal of the basis, or the amount from which they earn returns used to pay living expenses. This means that the amount of returns they will receive from year to year will be less. Essentially their retirement income will be less. Unless they decrease their expenses to match their decreased income the result will be fatal.


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