Hey folks. I was listening to Dave's podcast the other day, and he once again demonstrated why he should not
be giving inveseting advice. A Twitter follower wrote in, asking Dave how to calculate how much he could have at retirment if he saves regularly. Dave appears initially confused, unsure whether the writer is asking how much he could
have, or how much he should
have (that is, what number should he be aiming for to ensure a comfortable retirement). Dave decides to address both questions. The following quotes are transcribed directly from the podcast. I've cleaned up some of his "uhms" and "you knows."
I know it's long, I apologize for the length. If you're too impatient to read the whole transcript, I've bolded his particularly egregious comments.
"What's the formula you use to figure out how much money you could have at retirement? - or SHOULD have at retirement?"
Wait a minute, how much money you COULD have at retirement. Well COULD have at retirement is a formula that is in a financial calculator laying here. And so if you enter a payment amount that you're willing to put into an investment, a rate of return that you're expecting from that investment, and the amount of times you're going to enter that payment, meaning 12 times a year if it's a monthly contribution to a Roth, that kind of thing, then it spits out a number as to what you will have.
For instance, I'll just tell you one I've memorized, I don't have to put it in the calculator. If you save $100/month in a great growth stock mutual fund that averages 12% a year which I own several that have done that, SEVERAL that have done that, for those of you that are GOOBERS out there who can't figure out a way to find a mutual fund that averages that kind of a rate of return, go to one of our ELPs or simply go and buy Morningstar software. It's not really hard to find a fund that has averaged that over a long period of time. Anyway, making 12% on my money if I put $100/month away, and I do that from age 20 to age 60 for 40 working years, or 30 to 70, however you want to measure it, 40 years, I do that once a month, $100, becomes $1,176,000. Now that is a financial formula, there is a financial formula that you can actually do that longhand with a whole series of tables that we used to use back when the dinosaurs roamed the earth before we had a little financial calculator in our hand that would do it all for us, or in our computer program that would do it all for us.
I use a very very old-fashioned calculator, a Hewlett-Packard 12C 'cause that's what I was trained on. It's a different keystroke process and it changes it you know my mind works that way so the logic process on that I'm used to and so I've stayed with it and I can do it very very quickly with that do all kinds of things very very quickly with that particular calculator. But you'll use whatever you want to use.
Now that's how you find out what you COULD have at retirement. What SHOULD you have at retirement? I recommend that you try to have enough of a nest egg invested that throws off a rate of return that at 8% you can live on it. And so if you had $500k saved, a half a million saved, at 8%, that'd be $40,000/year. That'd be about a little less than an average household income. If you had $1 million invested and you lived off of 8% of it, you'd have about an $80,000/year income. Now, here's where I get that, and it's not a perfect formula, it's just kind of a rough and dirty thing to inspire you to save. If you want to get really really nerdy about it and really detailed about it and break it all down, you can. But I can just tell you that it's almost impossible to have life turn out like your plan is. So what you need to have are general concepts that help you calculate rough ideas, and then you move towards that, and as you move towards that you're wealth is going to increase and what's going to fool you is you're going to end up with more than you needed, just 'cause you were aiming at it, in most cases.
Now, so, so the way I get that 8% formula is this. If I have a million dollars invested at 12%, the inflation rate, meaning how much stuff goes up, a loaf of bread goes up, clothing goes up, in cost every year, has averaged about 4.2% for the last 72 years. The consumer price index is the measure of inflation. So if it costs me 4% more next year just to buy the same things, that I bought last year, then I need to have my investments steadily growing by 4% to break even with inflation. And so if I put a million dollars in an account, in 5 years, it will buy, about 25% less than it would buy now. It'd be more like I had $750,000. And so, you've got to have your, in other words a millionaire is not what it used to be. So you've gotta have your investment program including inflation.
Now, so if I'm making 12% on my money, but I need to leave 4% in there to break even with inflation, that means I can pull off 8%. And still break even. Now, some of my critics, if you read "I hate Dave Ramsey" and "Dave Ramsey sucks" on the Internet and that kind of stuff, and there's plenty of 'em out there that do nothing, but they criticise me, because they have nothing else to do 'cause they do nothing, but they claim you can't get those kind of rates of return and that's unrealistic. Well that's fine. If you want to do it at less than that, you can. Then you would say well I don't think I can get 12% so I can only get 10%. Well you still need to account for inflation, and so you need to be planning to live off of 6% If we're making 10 we're gonna leave 4 in for inflation, now we're gonna live off 6. And that's called a real rate of return, an after inflation adjusted rate of return.
And so, you know it doesn't matter to me. I know what I've gotten on my mutual funds, and I'm not a rocket scientest. I'm not an investment guru, I'm a guy with a finance degree with several other letters and licenses after my name that knows how to calculate this stuff. But you know there's people out there that are smarter than me on this stuff on investing. That's fine. But I'm still investing and still achieving an average over time with mutual funds with track records of over 12%. Now if you can't do that then you need to adjust your plan. And you know honestly, I've done better than that. But I mean, 12% is fairly conservative.
[In a mocking voice]"Well the economy just can't sustain.." oh you don't know what the crap you're talkin' about. Now we're getting into the philosophy of whether we're gonna think positively or whether we're gonna think negatively. Now we're getting into the philosophy of whether we think this country is crashing or whether it's going to get better. And now all you're doing is freakin' guessing. All I'm doing is looking at historical data that brought us to this point. Can we project that into the future? Reasonably? It's about the only thing reasonably we can project into the future, we can't project your negativity. It doesn't work. Or your freakin' guess. This is the Dave Ramsey show.
With respect to the first interpretation of the question (how much the writer COULD have),
It's interesting that Dave doesn't even seem to be aware that algebra can answer this question simply. He seems to think the only way to answer this question is by trusting a magical button on his calculator, or consulting some ancient tables of numbers (in which the calculations have already been performed for an arbitrary set of inputs).
Of course, there is a formula for calculating this value. It's admittedly a little complicated to try and dictate over an audio medium like a podcast, but he could have at least acknowledged that you can do the calculation without a magical calculator or ancient tables of numbers.
The formula is: B = A(1 + i)^n + (P/i)((1 + i)^n - 1)
where B is the ending balance, A is the starting amount (0 in Dave's example), i is the monthly
interest rate (a wildly optimistic 1% in Dave's example), and n is the number of investment periods - months in this case (480 in Dave's example; 40 years).
When he addresses the second interpretation of the question, Dave makes the same classic mistakes I've complained about in the past. Specifically:
- He doesn't seem to realize that 12% is an extremely optimistic anticipated rate of return.
- He implies that during retirement, you should remain completely invested in the stock market, whereas conventional wisdom advises adjusting your asset allocation to decrease your exposure to stocks as you approach and enter retirement.
- He completely ignores the impact of mutual fund fees. 12% isn't 12% after loads and fees are taken out. But then again, Dave said "12% is fairly conservative."
- He either doesn't know (or doesn't care) that virtually all experts acknowledge that a 4% withdrawal rate is considered "safe." He instead advocates a rate double that, then admits he's not an expert. Well why not at least tell us what the experts do say?
It really makes you wonder whether Dave ever actually looks at his own investments and calculates his actual rate of return. How can someone who presents himself as a money expert be so incredibly ignorant and wrong-headed when it comes to investments? He dismisses the research of industry experts like Warren Buffet, Peter Schiff, and anyone else who warns that we should not expect the same aggressive growth we've seen in the past as saying they "don't know what the crap they're talking about."