For a number of years Dave Ramsey's 12 percent assumed rate of return has been a mainstay of the radio hosts's case for the average American to invest in the stock market. He believe that this strategy yields the best path to prosperity.
Many have taken Dave's suggestion at face value while others–like us–raise an eyebrow at this seemingly outlandish suggestion.
You can get a 12 percent rate of return by investing in the stock market? Hmmm….I guess but it sort of depends on what stocks you are investing in exactly.
Taking Dave Ramsey's 12 Percent to Task
If you're wondering why we've decided to take Dave to task, yet again, we'll point you toward an article over at the Motley Fool written by Brian Stoffel titled, Retirement Planning: The Dangers of False Optimism. We recently discovered the piece as Mr. Stoffel had linked one of our articles that we wrote regarding compound annual growth rate.
Stoffel's post was written back in 2013 but the information will be forever relevant or “evergreen” as it is known amongst content producers.
I won't go into any great detail here as it is not my intention to steal any of Mr. Stoffel's thunder but I will implore you to read his piece as it shines some light on the subject.
The article clearly ruffled Dave's feathers as Stoffel earned himself an invitation to be heard on the Dave Ramsey Radio show. Here is a link to that clip.
What's the Big Deal?
Well, in the end, Dave declared that Brian was “splitting hairs” and that he can do whatever he wants because it's his radio show. Which brings to mind a quote from Senator Daniel Patrick Moynihan:
Everyone is entitled to his own opinions but not his own facts
The actual compound annual growth rate (CAGR) of the S&P 500 since 1926 is actually 9.87% not 12%. And I understand that Dave says that was just for illustrative purposes but why not illustrate it correctly?
That 2.13% difference per year would mean difference of $1,657,096 for a $20,500 annual investment over 30 years. That doesn't really seem like I'm splitting hairs, does it?
Let's not forget the real dander of illustrating the S&P 500 from 1926–it didn't exist in 1926. That's right, the S&P in its current form was established in 1957 and there are less than 87 companies in the index that were present in 1957. So, I say “investing” in the S&P 500 is a bit tricky.
But You Can Take 8% at Retirement
That's right, evidently you can safely assume an 8% withdrawal rate from your accounts when you retire because you're earning 12% per year on average. If you take out 8% that still leaves you a 4% positive spread.
What a swell idea.
Only, you don't have a 4% positive spread because you don't have a 12% return, you have a 9,87% return, don't you?
Let's run another experiment. If we look at CAGR from inception of the S&P 500 to the economic boom of the 1990's (1957 to 1990) the CAGR of the market is 6.5%. And if we look at 1957 to 1980 it's only 3.72%.
Stoffel points out that if you took Dave's advice, you would have a 43% rate of failure at making it through your retirement with any money. So, since 1926 if you picked a date and lived to your life expectancy at that given time period, almost half the time you would have run out of money using Dave Ramsey's calculations.
I don't know about you but I'd like the probability of success to be a bit higher than 50/50.
Remember you only get once chance to get this right. You can make the math work (i.e. I think I”m going to get X return) but if it doesn't quite get to that assumed rate, it won't play out as you assumed and you don't get a do-over.