Is Dave Ramsey’s Optimistic Investing Advice Irresponsible, or Motivating?

Dave Ramsey is a well-known author and media personality famous for his focus on saving and getting your financial house in order. His books have hit The New York Times’ bestseller list and 137,000 people follow his radio show’s Twitter feed.

Praise seems to be universal when it comes to his advice on how to pay down debt and save. But his ideas about investing are far less popular with some, who argue they are irresponsibly optimistic. Why does he set hopes so high? 

Dave Ramsey’s Extremely Optimistic Investing Projections

Ramsey’s projections on investing are quite optimistic.  He says investors can expect a lofty 12% annualized return on their investments. He also says they can plan to withdraw 8% of their savings each year in retirement. That’s twice the 4% benchmark that’s most commonly sited as the historically sustainable withdrawal rate.

Armed with such a rosy view, Ramsey has given the following remarkable example in his courses:
A 30-year-old couple making $48,000 and saving 15% per year, while  earning 12% a year on their portfolio would have more than $7 million saved by the age of 70.

$7 million!

It seems too-good-to-be-true on its very surface and that made me wonder why someone who seems to be such a successful motivator (who’s proven good at getting Americans — historically among worst savers on the planet — to stop borrowing and actually save) would chose to use such a far-out number.

There is a logic behind this super-sized projection according to behavioral finance expert and Santa Clara University Professor Meir Statman. “Making the reward for waiting larger helps us muster the self control necessary for delayed gratification,” Statman explains. “This is the purpose of the emphasis on the power of compounding.”

Behavioral Finance: Investing For Retirement and Lottery Tickets

In his book “What Investors Really Want,” Statman uses the example of Lottery bonds, popular in the United Kingdom and other countries. The British bonds promise a return of principle and, instead of interest,  a shot at lottery wins as great at 1 million British pounds. One-quarter of British households hold some form of lottery bond, which come in denominations as low as a single British pound. According to Statman they are especially popular with people who find it hard to save.  “The vision of a big prize facilitates savings,” he explains.

In the 2007 paper “Optimism and economic choice,” Duke academics Manju Puri and David T. Robinson also found that optimists are better savers. According to their research, a “one-standard deviation shift in optimism increases the probability of savings by about 2%.”

The study looked at optimists’ work choices, tendency to remarry as well as their portfolio and investing moves. The authors determine that most of the evidence points to a  conclusion that “optimism drives economic choices.”

There is a downside to being excessively upbeat, Statman warns: “A promise of an overly optimistic prize can lead to unwise choices, whether that’s a promise of a $100 million prize for a $1 lottery ticket, or a promise of a 12% annual return which leads investors to portfolios that are too heavily skewed toward equities. Some lottery players win, and the market might reward us with long term returns of more than 12% per year. But this does not make such bets wise.”

Issues with Ramsey’s Advice: Stock Investing Only, Highly Optimistic Projections

Three of the most commonly voiced concerns about Ramsey’s investing advice are:

1. Ramsey advises putting all your investments into equity mutual funds, no bonds, REITs or other investments and keeping that same allocation up until retirement. This goes against most conventional wisdom, including the rule of thumb espoused by Vanguard’s John Bogle and others that you own your age in bonds — so a 40-year-old would have a portfolio 40% bonds, 60% equities. A 70-year-old would hold 70% bonds, 30% equity. This strategy also contradicts the basic premise of one of the fastest-growing categories of mutual funds, Target Date Funds.  Target Dates are designed to have a “glide path” that gets more conservative (i.e., has less in equities) as you get toward your “target” retirement date. On Oblivious Investor, Mike Piper warns this level of equities “… would expose most retired (or soon-to-be-retired) investors to a meaningful risk of running out of money as a result of a poorly timed bear market.”

2. Ramsey asserts that investors can expect a 12% annual return from their investments. This idea raised enough eyebrows that a few weeks ago, Ramsey’s own blog posted an entry called “The 12% Reality.” It explains that the root of that 12% is the S&P 500’s average annual return from 1926 — the year of the S&P’s inception — through 2010: 11.84%. That seems to ignore both the cost of investing and inflation. But it also doesn’t address the huge gyrations that the index has gone through. In the decade of the 1950s, your return would have been even better than that 16.7% — bBut in the 1970s it was – 1.4%.

3. The idea that an investor can rely on pulling 8% a year out of their retirement seems chancy. That’s twice the speed of the most common 4% rule of thumb — and even that is something conservative types like Jim Otar, think is far too much. Otar’s argument is that a low withdrawal rate is your best defense against the market gyrations addressed above.

Optimism may be motivating, but has Dave Ramsey taken the power of positive thinking too far?

6 thoughts on “Is Dave Ramsey’s Optimistic Investing Advice Irresponsible, or Motivating?

  1. Tim Fortier

    Not only is disseminating such misinformation irresponsible, it shows Mr. Ramsey’s naive understanding of the market and how the stated 11.84% was obtained. Perhaps Mr. Ramsey should read the work Ed Easterling of Crestmont Research, who is perhaps one of the finest market researchers. He has published two books, “Unexpected Returns – Understanding Secular Stock Market Cycles” and most recently, ” Probable Outcomes – Secular Stock Market Insights”. I would like to quote a section from his recent book:

    “First, secular stock market cycles deliver returns in chunks, not streams. Second, most investors live long enough to have the relevant investment period extend across both secular bulls and secular bears. Third, investors do not get to pick which type of cycle comes first. Fourth, investors need to be aware that they will likely encounter both types of cycles. Those who experience secular bears during accumulation are generally better prepared than investors who are spoiled by a secular bull. A secular bull market is a pleasant surprise to retirees who endured a secular bear on the way to retirement. For retirees who grew to expect a secular bull during accumulation, the unexpected secular bear can be considerably disruptive.”

    My point is simply that if investors blindly follow the advice of Mr. Ramsey, then they are subjecting themselves to wherever they fit within the distribution of returns provided by the markets. Maybe it will be enough to fulfill their personal needs requirements and maybe it wont. The average annual return for the S&P 500 for the past decade is around 0%. And, as Mr. Easterling also points out, that current market valuations do not portend that the next several years will be much better.

    The idea that an investor should take 8% from their portfolio to support their lifestyle is reckless advice at best. Mr. Easterly has also conducted extensive research on this topic. Their have been 81 30-year periods (the life expectancy of a retiree) since 1900. Mr. Easterly divided those 81 periods into quintiles ranked by the starting P/E level of the market. The average of all periods resulted in a successful outcome only 75% of the time using a 5% withdrawal rate. but it gets worse. Based upon the current market valuation, we in the top quintile with a starting P/E in the 18.7 + range. The success rate of someone withdrawing 5% a year for 30 years falls to 41%. And oh by the way, that assumes not taxes, commissions or other factors which would inevitably reduce the net returns. And Mr. Ramsey is going to tells us we can safely withdraw 8%? Mr. Ramsey, you should be ashamed.

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