When You Assume...
Over the years, so-called personal finance experts have provided valuable information—but also a smattering of misinformation—but I can think of none quite as egregious as some remarks recently made by Dave Ramsey.
By now I’m sure you’ve heard—or heard about—his “counsel” with regard to acceptable retirement withdrawal rates—and his disparagement of the “supernerds” who would dare to disagree with him. As for that counsel, at a high level, Ramsey maintains that an 8% withdrawal rate is not only doable, but sustainable. All you have to do is be invested 100% in equities—oh, and assume a 12% return.[i]
That said, even though it was predicated on a number of assumptions that might not be true in the real world—a 30-year withdrawal period, a 50/50 portfolio mix of stocks and bonds, assumptions about inflation—oh, and a schedule of withdrawals unaltered by life’s changing circumstances—well, with the return of inflation as a reality (rather than a theoretical construct), it now seems that there’s an annual scramble to reassess that “safe” withdrawal rate. Indeed, a couple of years back a Morningstar paper challenged its conclusions in view of “current conditions”—opining that “using forward-looking estimates for investment performance and inflation,” the Morningstar authors said that the standard rule of thumb should be lowered to 3.3% from 4%.
That said, this is something of a moving target, and a few weeks ago Morningstar moved the target back to 4% (after having opined that a starting safe withdrawal rate for a 30-year horizon with a 90% probability of success was 3.3% in 2021 and 3.8% in 2022). Enter Dave Ramsey and HIS assumptions that allegedly support a much higher rate (though I don’t recall him offering a probability figure of savings lasting as long as your life[iv]).
Now, in fairness, even the Morningstar folks allow for some variance in “safe” withdrawal rates—explaining that the increase from 2022 in this “highest safest starting withdrawal percentage” for a 30-year horizon with a 90% probability of success “owes largely to higher fixed-income yields, along with a lower long-term inflation estimate.” Moreover, they assert that it’s predicated on assumed portfolios that hold “between 20% and 40% in equities and the remainder in bonds and cash”—which is, in itself, a fairly sizeable range.
There’s been plenty of evidence—both empirical and anecdotal—that retirement “spends” aren’t nice, even streams. Life’s circumstances change, of course—and our health care, and health care costs, are notoriously variable. There’s a sense that the pace of spending earlier in retirement is more like that anticipated in most retirement education brochures—traveling and such—but that pace slows down as we do.
At its core, once you stipulate certain assumptions about the length of retirement, portfolio mix/returns, and inflation, a guideline like the 4% “rule” is really just a mathematical exercise. A 4% “rule” may be simplistic, but it’s also simple—and when it comes to getting your arms around complex financial concepts and distant future events, there’s something to be said for that.
But—and as Dave Ramsey’s response should remind us—when you “assume” … (or when others assume on your behalf) make sure you understand the assumptions required to make it “work”—and perhaps more importantly, the likelihood/probability that those assumptions will be a reality.
- Nevin E. Adams, JD
[i] One of the more humorous—and insightful—rebuttals on all this came from SRP’s Jeanne Sutton: https://www.linkedin.com/feed/update/urn:li:activity:7130951358609838080/
[ii] https://www.forbes.com/advisor/retirement/four-percent-rule-retirement/
[iii] See www.portfolioconstruction.com.au/obj/articles_perspectives/retailinvestor.org_pdf_Bengen1.pdf
[iv] That said, Morningstar’s John Rekenthaler has—and you can read that analysis here
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