Why Dave Ramsey's 12% Return Isn't Reality

If you are a Ramseyhead you might take what Dave Ramsey says as gospel, and fail to question the financial guru’s opinions. I’ll be the first one to admit, I’m not a fan of Dave’s work. Getting out of debt, for the most part, is common sense — spend less than you earn and pay down what you owe. Common sense, unfortunately, isn’t all too common today.

Many state Dave does a lot of good by getting individuals motivated to get out of debt. I guess I’ll grant him that.

With so many Americans in debt, his target is “joe debt sixpack”.

The sad fact-of-the-matter is most Americans cannot balance a checkbook. They lack financial education to make money work for them and are led to believe that consumerism (buying expensive toys) is what makes you rich.

In the church of David his approach for all financial advice is done via an emotional appeal. For example, his Debt Snowball isn’t the most efficient way to get out of debt, but it will make you feel good.

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To Dave all debt is the work of the devil, and of course, recommends paying off your house early. Nevermind in many cases that’s a bad idea financially speaking, especially in the current interest rate environment.

Then again Dave acts like a stern parent, and for the most part talks down in a preachy fashion to his listeners. As if he’s implying his listeners are intellectually challenged. Maybe they are, but seems very off-putting especially when the advice is so basic.

If you read any other personal finance blog, you’ll see many swear by Dave’s programs and his books almost to the point where he has a “cult-like” following. I guess if you are under a mountain of debt at least he’ll help you somewhat. Then again most personal finance blogs are about getting out of debt and not investing.

While Dave’s focus of getting out of consumer debt is the right step, the issue becomes what to do next after you are are debt free? Investing is the only path to financial freedom, and this is where Dave shows his inexperience.

Most of his investing advice is either just OK, or outright wrong, and can lead to some big false assumptions when financial planning.

Take for example the 12% return story Dave’s been sticking to, even with many financial professionals taking issue with this claim.

In his latest rant, Ramsey is still giving the same sermon about getting a 12% return in the stock market. For more information, you can check out Dave’s website or watch the heated video below.

“You can discuss real rate of return, post-inflation [return]. You can discuss all of these freakin mathematical theories some of you financial nerds just sit around and crunch your numbers and you do nothing to help people. And what do we do? We get people to actually invest.”

He forgets to add — he does this by giving out a false rate of return that no one else in the investment community can replicate. Dave then proceeds to lay it on really heavy.

“Are they going to get 12? NO! They might get 14. Are they going to get 14? NO! They might get 18.”

He does state his returns are not on a compounded basis (CAGR), but average annual return. Most individuals and I assume especially Dave’s audience, have no idea the difference. Investors grow their money on a compounded basis, and not by average annual return. Hence why CAGR is what matters when performing financial planning.

Dave’s rant, like most of his, seems childish at best. Never have I seen a rant with more ad-hominem and straw men attacks.

Even so, let’s keep the argument about the 12% average annual return. What is this 70-year-old mutual fund Dave speaks of? The only one I’m aware is Vanguard’s Wellington Fund which has averaged 8.33% since inception. That’s a whole 367 basis points (or 3.67%) lower than the return he suggests.

Even so, CFA Wade Pfau has discussed the eight percent return is a myth if you include all factors that every investor has to deal with.

In reality, you should expect a 2% compounded inflation-adjusted return.

This is far lower than the 12% mythical return Dave Ramsey suggests.

As I’ve stated before, Ramsey is correct the average American does not save enough for retirement. So I will give him some credit for that. The average rate of savings is around 4%, and has been decreasing since the 1970’s. Most financial experts state we should be saving at least 15% of our annual salary for retirement. I personally recommend saving 20% for retirement.

One of the hidden issues when investing is fund expenses. Dave just so happens to not discuss this point. Not sure if this is out of ignorance, or to better sell his story and the investments he recommends. Ironically Dave’s own ELPs put investors into high fee mutual funds — putting a real damper on compounding returns. Which some estimates claim can eat as much of 30% of your investments over the entire saving term for retirement.

Ramey’s numbers are not only incorrect about investment returns, but also winding down your investments when retired. Dave suggests you should be able to spend 8% of your portfolio a year in retirement. From recent studies, even the original 4% gold-standard might be too high.

Combining both inaccuracies from Dave is very dangerous. If you use them to estimate the amount needed to retire, you will severely underfund your retirement. I didn’t even get into his recommended 100% stock allocation and the risks associated with it.

Listen to Dave’s investing advice at your own peril. Want to learn how to get into the stock market? click here.