I don't think my last post really did a good job of showing how dangerous financial planning could be when you pick the wrong projected investment return. In the previous example it was the argument whether to use 7% or 12%. It's only a 5% difference, what's the big freaking deal, right??
So let's say you're a typical Dave Ramseyite. You're 35 and just got out of debt. You bought a home putting down 20% and you live their with your wife and child. You've been through the baby steps and are now to the point to where you want/need to start saving for retirement. Since you got a late start you now need to save 15% of your income instead of 10%, like if you were 25 in order to retire at the typical age of 65.
You make the USA average of $55,000, so you need to save approximately $159 per week. What's going to be the difference between his and my projected future assets when you reach 65? Well, at my projection of 7% you will have approximately $780,000 by the time you retire at 65. Under his estimate of 12% return you'll have $1,990,994 for retirement at 65. See the difference!! More specifically we're off by a difference of $1,210,994! That's an ass load of money!
Now what's more dangerous, you under estimate and save too much or over estimate your return and save too little? The amount that you have to save and your projected return are inextricably linked. You can't perform the calculation without both.
On top of this, Mr. Ramsey is also an advocate of people estimating that they can pull out 8% of their assets while in retirement to live off of. This is incredibly dangerous!!! The stock market is notoriously volatile and the last thing you want to do is take out money from the market after it had a 50%+ drop. Here's why...
Let's say you're retired and have a million in liquid assets in the stock market that make the 12% that Ramsey projects. Then taking out 8% is fine, since you'll still be left over with 4% to save for the future and to keep up with inflation. You take out $80,000 and save $40,000. But what happens when the stock market drops 50%? You now have $500,000 and taking out 8% means that you now have $40,000 to live off of and you can save nothing for the future inflation. On top of this, when the stock market recovers, you now deprived it of $40,000 for future growth. Not to mention, when it falls that much and you take a withdrawal, it's like a 16% withdrawal, instead of an 8% withdrawal.
This is why I'm an advocate of living off of renewable income like dividends, interest, and rental income. These will fluctuate, but not nearly as much as the above scenario all the while keeping your assets intact and growing for the long haul. 8% is far too great of a withdrawal rate and the industry standard is 4%. I mostly agree with this, but think 3% is even better. 3% is eternally sustainable, in my free opinion...
So let's say you're a typical Dave Ramseyite. You're 35 and just got out of debt. You bought a home putting down 20% and you live their with your wife and child. You've been through the baby steps and are now to the point to where you want/need to start saving for retirement. Since you got a late start you now need to save 15% of your income instead of 10%, like if you were 25 in order to retire at the typical age of 65.
You make the USA average of $55,000, so you need to save approximately $159 per week. What's going to be the difference between his and my projected future assets when you reach 65? Well, at my projection of 7% you will have approximately $780,000 by the time you retire at 65. Under his estimate of 12% return you'll have $1,990,994 for retirement at 65. See the difference!! More specifically we're off by a difference of $1,210,994! That's an ass load of money!
Now what's more dangerous, you under estimate and save too much or over estimate your return and save too little? The amount that you have to save and your projected return are inextricably linked. You can't perform the calculation without both.
On top of this, Mr. Ramsey is also an advocate of people estimating that they can pull out 8% of their assets while in retirement to live off of. This is incredibly dangerous!!! The stock market is notoriously volatile and the last thing you want to do is take out money from the market after it had a 50%+ drop. Here's why...
Let's say you're retired and have a million in liquid assets in the stock market that make the 12% that Ramsey projects. Then taking out 8% is fine, since you'll still be left over with 4% to save for the future and to keep up with inflation. You take out $80,000 and save $40,000. But what happens when the stock market drops 50%? You now have $500,000 and taking out 8% means that you now have $40,000 to live off of and you can save nothing for the future inflation. On top of this, when the stock market recovers, you now deprived it of $40,000 for future growth. Not to mention, when it falls that much and you take a withdrawal, it's like a 16% withdrawal, instead of an 8% withdrawal.
This is why I'm an advocate of living off of renewable income like dividends, interest, and rental income. These will fluctuate, but not nearly as much as the above scenario all the while keeping your assets intact and growing for the long haul. 8% is far too great of a withdrawal rate and the industry standard is 4%. I mostly agree with this, but think 3% is even better. 3% is eternally sustainable, in my free opinion...
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