Why Dave Ramsey’s 12% return isn’t a reality
If you’re a Ramseyhead, you can take what Dave Ramsey says as gospel and not question the financial guru’s opinions. I’ll be the first to admit that I’m not a fan of Dave’s work. Getting out of debt, for the most part, is common sense: Spend less than he earns and pay what he owes. Common sense, unfortunately, is not so common today.
Many claims that Dave does a lot of good by motivating people to get out of debt. I guess I’ll give it to him.
With so many Americans in debt, their target is “Joe Debt Sixpack”.
The sad reality is that most Americans cannot balance a checkbook. They lack the financial education to make money work for them and are led to believe that consumerism (buying expensive toys) is what makes you rich.
In David’s church, his approach to all financial advice is through an emotional appeal. For example, their Debt Snowball isn’t the most efficient way to get out of debt, but it will make you feel good.
For Dave, all debt is the work of the devil and, of course, he recommends paying off his house early. Never mind, in many cases, it’s a bad idea financially, especially in today’s interest rate environment.
On the other hand, Dave acts like a stern father and, for the most part, speaks preachy to his listeners. As if he’s implying that his listeners are intellectually challenged. Maybe they are, but it seems very off-putting, especially when the advice is so basic.
If you read any other personal finance blog, you will see that Dave’s programs and books are trusted by many almost to the point where he has a “cult” following. I guess if you’re under a mountain of debt, he’ll at least help you out a bit. On the other hand, most personal finance blogs are about getting out of debt and not investing.
While Dave’s approach to getting out of consumer debt is the right move, the question is what to do after you’re debt-free. Investing is the only path to financial freedom, and this is where Dave shows his inexperience.
Most of their investment advice is either right or completely wrong and can lead to huge false assumptions in financial planning.
Take, for example, the 12% return story that Dave has clung to, even with many financial professionals who disagree with this claim.
In his latest spiel, Ramsey is still giving the same lecture on how to get a 12% return on the stock market. For more information, you can visit Dave’s website or watch the heated video below.
“You can talk about the real rate of return, [yield] after inflation. You can discuss all these damn mathematical theories, some of you financial nerds just sit and analyze your numbers and do nothing to help people. And what do we do? We get people to invest.”
You forget to add: that you do this by giving a bogus rate of return that no one else in the investment community can replicate. Dave then proceeds to make it heavy.
“Are they going to be 12? NO! They can be 14. Are they going to be 14? NO! They can be 18.”
It states that its returns are not compounded (CAGR), but average annual returns. Most people and I assume that especially Dave’s audience, have no idea of the difference. Investors grow their money on a compound basis and not by average annual return. Therefore, the CAGR is what matters when doing financial planning.
Dave’s spiel, like most of his, seems childish at best. I have never seen a tirade with more ad-hominem attacks and straw men.
Still, let’s keep the argument about the 12% average annual return. What is this 70-year-old mutual fund that Dave is talking about? The only one I know of is Vanguard’s Wellington Fund, which has averaged 8.33% since its inception. That’s a total of 367 basis points (or 3.67%) lower than the yield it suggests.
Still, CFA Wade Pfau has argued that the eight percent return is a myth if you include all the factors every investor has to deal with.
In reality, you should expect a compound inflation-adjusted return of 2%.
This is much lower than the mythical 12% return suggested by Dave Ramsey.
As I said before, Ramsey is right: the average American doesn’t save enough for retirement. So I’ll give him some credit for that. The average savings rate is around 4% and has been declining since the 1970s. Most financial experts say we should be saving at least 15% of our annual salary for retirement. I recommend saving 20% for retirement.
One of the hidden problems when investing in the expense of funds. As it happens, Dave doesn’t talk about this point. I’m not sure if this is out of ignorance or to better sell his story and the investments he recommends. Ironically, Dave’s ELPs put investors into high-fee mutual funds, putting a real damper on compounding returns. Which, by some estimates, can eat up to 30% of his investments over the entire retirement savings period.
Ramey’s numbers are not only wrong about the return on investments but also about the liquidation of his investments when he retires. Dave suggests that he should be able to spend 8% of his portfolio per year in retirement. According to recent studies, even the original 4% gold standard might be too high.
Combining both of Dave’s inaccuracies is very dangerous. If he uses them to estimate the amount needed to retire, his retirement will be underfunded. I didn’t even go into his 100% recommended stock allocation and the risks associated with it.
Listen to Dave’s investment advice at your own risk. Do you want to learn how to enter the stock market? Click here.