If you are planning for retirement or simply trying to build savings, you're probably familiar with Dave Ramsey. The famous money guru is known for stirring debate with some of his suggestions.
Ramsey argues for withdrawing 8% from your retirement account each year to meet your expenses during your golden years. Here are six reasons why you might want to rethink following Ramsey’s advice.
What is Dave Ramsey's 8% retirement rule?
Ramsey suggests that retirees invest all their assets in equities before annually withdrawing 8% of the portfolio’s starting value, with adjustments each year for inflation.
This is much higher than the 4% or even 3% that many other experts recommend as prudent.
Part of Ramsey’s strategy is based on the stock market's past performance, which historically has generated returns of around 10% annually. Ramsey believes an 8% annual withdrawal is sustainable if you can generate returns that match that average.
However, if you want to maximize your retirement savings, here are some reasons you might want to hesitate before following Ramsey’s advice.
Your nest egg is probably too small
It’s apparent that you are going to need a large nest egg to follow this 8% suggested plan. That simply isn’t a reality for a lot of retirees.
The median retirement savings for all Americans is just $87,000, according to the most recent numbers from the Federal Reserve. That won’t get you very far in retirement no matter what withdrawal rate you choose.
The stock market might not do as well as Ramsey thinks
The success of Ramsey’s 8% strategy relies heavily on the stock market achieving an average annual return of 10%. Historically, that is indeed about how well the stock market has performed.
But there is no guarantee of such success in the future.
In addition, stocks can perform poorly for long periods. If you are unlucky and end up withdrawing money as the market is falling, you could significantly erode your savings quickly. This is a phenomenon known as "sequence of return risk."
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You might have to take too much risk to meet your goal
Many experts argue that it is risky to keep 100% of your portfolio in equities during retirement.
Instead, they recommend diversifying your investments and keeping some money in safer instruments, such as bonds and even savings accounts.
If you have 100% of your money in stocks during retirement and the market crashes badly, you might not have enough time to wait for stocks to fully bounce back.
You might have to sell assets in a downturn to meet the 8% goal
It’s one thing to pull 8% from your account in a year when stocks are soaring, but it’s something else entirely to withdraw from accounts that are cratering in a bear market.
If your investments have declined significantly, selling them to bring in income makes some of your losses permanent. This can make your nest egg dwindle quickly.
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You might have to take Social Security early
If stock market returns lag what you expected and your savings start to dry up, you might be forced to file for Social Security earlier than you expected.
Filing for Social Security early means your monthly benefit will be permanently lower than if you had waited until later in life. Those who wait until age 70 to file get the biggest monthly checks.
You might run out of money
The bottom line is that withdrawing 8% of your portfolio year in and year out puts you at a serious risk of running out of money if the stock market does not perform as well as you had hoped.
If that happens, you might be forced to return to working again to generate income.
What other experts suggest instead
Ramsey’s advice goes against the more popular 4% rule.
This rule states that you can significantly lower the risk of running out of money by safely withdrawing an amount equal to 4% of your savings during the year you retire and then adjusting for inflation each year over a period of about 30 years.
Some experts even suggest a 3% rule just to be extra safe. If you want to eliminate some money stress, withdrawing 4% or 3% gives you a bigger margin of safety than withdrawing 8%.
Bottom line
As you prepare for retirement, consider whether you should follow Ramsey’s advice to use the 8% rule.
If you have a large nest egg and the stock market performs well, things might work out fine. But you are taking on an extra level of risk by withdrawing so much from your accounts each year.
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