Is it Irresponsible for Dave Ramsey to Assume a 12% Rate of Return in His Examples?

October 8, 2009

My church participated in Dave Ramsey’s “The Total Money Makeover Live!” event a couple of weeks ago. I did not attend the event but did pick up a copy of the workbook that went along with the event.

I have never counted myself among the Dave Ramsey fans. Sure, his advice is better than racking up lots of debt and not saving for the future. But, he also generalizes and has a one-size-fits-all approach to the advice he offers his listeners.

What bugs me most is the math behind his assumptions.

For example…

On page 3 of the above-mentioned workbook, is this:

The American Dream

Imagine if…
A 30-year old couple made $48,000 a year and saved 15% ($7,200 per year or $600 per month) in a 401(k) at 12% growth.

At 70 years old, they will have…
$7,058,863.50 in the 401(k)”

How did Dave arrive at that number? Here’s the math:

FV = $600 × (1 + .01)480

FV = $7,058,863.51

That’s a lot of money!

But, how would this look in the real world? I summarized Dave’s information into the following graphic and used 2009″s numbers from the IRS to calculate income taxes.

Dave's Math

For my example, I assumed that this couple does not have children. If that were the case, it would probably be possible for them to sock away $7,200 per year. Their budget would be tight unless they economized.

Then comes my next question:


Seriously, WHO assumes a 12% rate of return for 40 years? Later on in the book, Dave stresses diversification. There’s not a properly diversified portfolio on earth that is going to average a 12% rate of return on a consistent basis. The ONLY way you’re going to get that kind of return is to invest ALL YOUR MONEY in small cap stocks, which are highly volatile.

I think the word “imagine” was the proper word to use for his scenario because the only way he’s going to get those numbers is with IMAGINATION!

To bring us back to REALITY, I reran Dave’s numbers using a much more conservative .77% monthly rate of return, which happens to be the geometric average return for the S&P going back to 1926. Take a wild guess at what the 401(k)’s expected value becomes with that number?


And that number’s even somewhat inflated because it assumes 100% of the money is invested in the S&P for all 40 years.


Neither of those numbers include inflation, which would eat up at least half of those accounts.

So why does Dave use such a high number for an assumed rate of return? I would have to say it’s to give people hope (a false sense of hope, but hope nonetheless). When people look at those numbers, they go, “WOW! I can do that? I had no idea!” I will admit, that those numbers are eye-popping.




69 responses to Is it Irresponsible for Dave Ramsey to Assume a 12% Rate of Return in His Examples?

  1. Yup BG #49, our NWM agent just told us to expect the dividends on our whole life policies to be around 5-6% in the coming year. So yes, expectations have been lowered from the original “illustrations.”

    However, it still beats losing $ like last year! And will be tax-free when our numbers’ are up!

    @#50 JJ–yes, I will NEVER, EVER be a cash person, either. If prices were to be lowered 3% for paying cash, then yes, but I covet my Upromise $ for college and my Discover rebates (which aren’t as generous as years’ past, but still good, esp w/the quarterly 5% Cash-back promotions.)

    Tax-free $ is good. Wonder when Congress/IRS will finally get around to whacking us on our freebies w/taxes :)

  2. @JJ “Anyone who has bought real estate in the past 5 years knows that it’s not always a good investment. ”

    Word. I don’t normally listen to Ramsey so whatever I know about him is what I read on these blogs. So naturally I didn’t know about his real estate advice.
    IMHO, and also based on my limited but moderately successful experience with real estate is that there are times to buy it and there are times not to. The prices don’t always go up – I was surprised why people in 2000s forgot about what happened with real estate in the 90s. When I bought my current place in late 90s, the family who sold me the place had to add their own money to pay off their mortgage – they were upside down and that with reasonable mortgages of the 80s. As in 2006, the bubble was totally obvious.

    As to Ramsey credit card advice – it is silly, but I kind of see his point: his target audience is composed of credit addicts. So I can see how someone who doesn’t understand the difference between credit and spending money should stay away from cards. One things that bugs me is that he seems to see everything in black/white – all credit is bad, stocks and real estate are good. I read on some blog – not sure if it is right – that he actually shouted at a young doctor for having a lot of student loans. It’s totally ridiculous since only very rich can become doctors without student loans. Credit can be a great tool and taking a loan instead of paying cash can be a good investment decision under the right circumstances: e.g. business loans or some student loans or even low fixed interest loan when one expects inflation or has access to better reasonably safe investments. E.g. only a few months ago, I bought some AA and AAA individual municipal bonds with tax free interest rate of 5% and 5.25%. Not only that I bought them at a discount. At the same time, the mortgage interest rate was around 4.5%. Now, if I were to “upgrade” to a more expensive property at the time or upgrade, you bet I would’ve taken mortgage instead of paying cash.

  3. JJ, I have to laugh at your post about using “free” money from credit card companies. I guess you’ve really pulled one over on them, you’re sticking it to them, they have nothing on you!

    Dave’s whole point on credit cards is not that some people are not “responsible” in paying them off, but it is a FACT that you spend MORE using credit cards than cash. Why do you think all the stupid fast food places take them now? For OUR CONVENIENCE? Nope! They find that someone who walks in with a $5 cash will only spend $5. Someone with a credit/debit card (debit cards apply as well that’s why Dave says USE CASH for most purchases) you will spend more, supersize, get the kid the extra thing they’re whining for, etc.

    Also, have you ever taken a wad of cash to Home Depot or Best Buy and gotten a deal? If not, then you have again fallen victim to the credit card over spending. I’ve negotiated with my mechanic for car repairs because I know he has to pay a fee to the credit card company to process the plastic. Cash saves him money, so he gave me a discount. I personally think the price of goods has gone up solely because of credit card fees the business owner has to pay. We all know businesses pass costs/taxes on to customers, they don’t pay it themselves. I know a restaraunt owner that was contemplating having a “cash price” due to credit card fees increasing he wanted to lower his costs by encouraging cash usage.

    Dave’s point (in my opinion) is that we’ve taken simple common sense and made sophisticated financial products that only make money for their creators. It’s not a “sin” to use credit cards, but if you think you’re beating them at their game, you’re mistaken. Like Dave says “if you play with snakes you’ll get bitten.”

  4. Stocks generally average +8 or 9%/yr but a diversified, less risky portfolio of stocks and bonds would do a little less than that. I also agree that there are many great funds out there that have historically outperformed their respective index on a risk-adjusted basis. And if you’re with a fee-based advisor, you can buy them with no-loads and simply pay the advisor .5-1.25%/year.

    If you want an example, compare NYVTX to the S&P 500 or PTTAX to the Barclay Aggregate Bond Index.

    The big picture is that he is helping a lot of people do the right thing with their finances. Stocks are still the best investment vehicle in the long-run, bar none.

  5. Stacey #51) I think my adviser was pumping the returns in the 2001 portfolio he put together for me. He was assuming a 10.6% return (before taxes), and 9% (after taxes), and also assuming we were in the 15% tax-bracket — but in actuality, we were near the middle of the 27.5% bracket in 2001. Maybe he was assuming we’d be in a 15% bracket during retirement, which I guess would make more sense.

    Is using a 10.6% ROR (before-taxes) irresponsible? What would be a responsible ROR assumption for an 80/20 mix, for example? Or better yet, what would be a better assumed ROR for an 80/20 mix _after_inflation_?

  6. @Doug W: “… it is a FACT that you spend MORE using credit cards than cash…”

    Since when is it a fact? Based on some not very scientific studies that look at a very small number of people and didn’t adjust for confounding evidence? Plus if you even accept the conclusion of the studies and ignore the flaws, you are forgetting that “on the average people spend more” is not the same as “everyone spends more”. Have you ever had statistics? I find it amazing that people who know zero statistics love to quote studies they haven’t themselves read and don’t understand. Here is an example for you: “on the average women gain weight after the menopause” is true. But “every woman gets fat after menopause” is wrong. Averages are extremely misleading. Take 10 people one of whom carries a huge credit card balance i.e. significantly overspends. If you divide then a total amount of money spent by 10 people, you’ll get “credit card users spend more on the average”.

    “Also, have you ever taken a wad of cash to Home Depot or Best Buy and gotten a deal? ”
    Actually, I always ask if I can get a better deal with cash. If I can, I’d use cash. If not, I’d use credit cards.

    BTW Doug W, I’ve used credit cards for over 25 years. Would you care to compare net worth? Mine is in seven digits…

  7. @kitty #56) “@Doug W: “… it is a FACT that you spend MORE using credit cards than cash…”

    Since when is it a fact?”

    It is a fact! Here is a simple thought-exercise: Person with cash can only spend the amount he has in his pocket — no debt (spends less). The average CC-toting American has an $8k balance on his cards. I see your argument about averages, but even if the “statistics” are not exactly perfect for you, you still can’t deny that the average non-CC person has exactly $0 in CC-debt, and the average CC person has “greater than zero” CC-debt.

    That right there should tell you that the people carrying credit cards spend more than people who do not.

  8. kitty) ah, one more: I would like to compare networths (if you don’t mind), though I think you have some age/time on me since you used CC cards for 25 years. What was your networth (inflation-adjusted) when you were 32?


  9. @BG: ” Person with cash can only spend the amount he has in his pocket — no debt (spends less). The average CC-toting American has an $8k balance on his cards…”

    I.e. some Americans have over 16K balance and some have $0 balance. We know most Americans carry balances, and consequently spend more than they would’ve otherwise. But what you cannot prove is that CC users who always pay their balances in full spend more than they would’ve otherwise. Your logic fails here: if those of us who always pay our balances in full are able to do so, then we only spend what we have, right?

    Being able to buy isn’t the same as buying. I can easily afford $300 pair of shoes I fancy and barely notice it, but I am not doing it because I think it’s silly to spend $300 on a pair of shoes. On the other hand I spent over $100 on an opera ticket in Bayreuth (Germany) many years ago when I earned a lot less than what I do now and had a lot less money and paid cash for it — it was from someone selling an extra ticket in front of a theater (at face value).

    “What was your networth (inflation-adjusted) when you were 32?”
    OK, I am 50 now. So it’d be 18 years ago. Tough to remember, honestly, probably in low six digits, but I could be off considerably. BTW – when I say net worth I include home equity and investible assets; no other items. I also don’t include the value of my pension.

    So at 32: I really don’t know. By that time I had been contributing to 401K for several years up to company match, I had also been buying ESPP on 10% of my salary. I kept most of 401K in stable value since I got scared by 87 crash. Missed out on some good stock market years. I had also been buying ESPP stock for 10% since 1984 and holding on to most of it — yes, it seems wrong now, but as I said above, we didn’t have internet and financial advice then. My employer seemed as stable as a rock in the 80s. But by early 90s i.e. by the time I was 32, my employer was as close to bankrupcy as it ever got – there was talk about break up, and the stock went down a lot, but it seemed silly to sell it when it was below break up value. It’s done OK since then, I cannot complain.
    I also had some cash/CD savings, but I really don’t remember how much. Around that time, I had paid a large chunk of my cash savings – over 25K – for a down payment on a 125K condo as I had just moved to a more expensive area. No other debt but mortgage at 32, and I have always made a point of buying property for less than I could afford so that I had money to enjoy life (within reason). At any rate, I was saving over 16% in combination of 401K and ESPP between ages of 25 and 32, and I had money left every month which I kept in cash and CDs. So I was probably saving over 20%, but I wasn’t really trying.

    Keep in mind also, that during the 80s I thought my retirement was secure: my employer had no layoff policy and very generous retirement plan that also promised medical care. This all changed in the 90s – the plan changed, medical care promise went away, then benefits were frozen. But during the 80s, I did believe I had a secure job from which I would retire at 54.5 with a generous pension.

    Hence, I wasn’t making it my life’s purpose to save, or be frugal, even though a roommate I had for a few months after I started working told me “you are so cheap” (I really don’t understand why, I swear I wasn’t).

    I traveled all over Europe, I bought stuff I liked – within reason. But while I may have made a number of stupid investment decisions, but overspending with CC wasn’t among them. In fact, I have always been a whole lot more careful with cards than with cash.

  10. @kitty #59) Great story, thanks for sharing. I’m in the ballpark where you were at 32, I guess, but I’m not saving nearly the amount you were. I’ve had to spend boatloads on medical (15% of my net) these past two years — its sad to be in a position where I claim the medical deduction, even though I have insurance and work for a fortune 25 company.

    FYI: I think we work at the same place: HAL+1. The early 90s were dangerous times, but you got some nice stock splits since then if I guessing your employer right. Unfortunately I came in just afterwards (1999) so I only got a little of the tail-end.

    As for the CC discussion: I see your point. For people who pay the CC card off every month then they are equivalent to “cash”-people, but I think the majority of CC users do not pay the cards off in full every month — but the trend is looking better.

  11. @Doug, I think Kitty correctly analyzed the whole “average” cc balance argument–some carry 0, some carry high amounts, etc. Although I use mine for almost every purchase, they are paid in full each month. And unless everyone in the universe went back to paying cash, little ol’ me paying cash will not have a positive effect on my personal net worth b/c prices will not be lowered by merchants. “Oh here comes Stacey…I’m going to lower my prices 2% just for her!!”

    It would take a universal cash tsunami for decreased merchant prices to occur, and even then, I doubt it would. It’s like waiting for gas prices at the pump to fall after barrel prices drop.

    So, in a nutshell, if I continue to “earn” my Upromise rebates which are immediately channeled into my oldest son’s 529, earn 5% or so a year (we’re 100% equities in his plan), take my 3% IL income tax deduction on the contribution, then at the finish line I’d say I’ve definitely earned a monetary benefit that cash couldn’t give me (and that’s not even considering the interest I earned on the monthly amount of CC pmt that continues to earn 1.3% or so in my savings acct while I wait to pay the bill.)

  12. I think that if you don’t do anything you get nothing. Dave is making a point to folks that you have to DO something. Does the math have to be ablsolutly correct? No! From what I see posted here you must have a math major to keep up with everything. I myself am a humble bloke and need it right there where Dave has put it plane and simple. Diversify in Mutual Funds and most importantly tithe 10%…God Bless.

  13. Oh! I forgot…

    Be Debt freeeeee!!!!

    Are you?

    That is the key to Wealth.

    Dave says to do what rich people do. Rich people dont borrow and don’t do complex invesetments.

    KISS….Keep is simple sweetie!…;-)

  14. It’s funny you should mention the 12% because during the Financial Peace University class, they showed us a lesson on mutual funds. And he states in the video that critics state that this type of mutual fund that yields 12% doesn’t exist. He then makes fun of these people and says they do, but never offers any sources of where people can find these funds. Does anyone even know where you would go to invest in a mutual fund??? Because he never tells you this in the course.

  15. Ramsey loves that 12% return. I was reading today on his website that im an idiot for buying a small cash value life insurance plan along with my term, and that I should be investing the money from the cash value account into a 12% return mutual fund. Where is this fund? Because its not like im going to need life insurance when im 51 because i bought a 30 year term at 21. If I listen to Dave, I will never run into any unexpected financial hardships and will be debt free.

  16. I apologize in advance. The beauty of America is Ramsey gets to have his own show, whether he’s nuts or not. And we the people can listen or not. He’s sharing his opinions, and I actually enjoy getting a little excited about the possibility of greatness. If someone tells me there’s a way to get 12% rate of return, heck, I’m going to find a way. Do you really think Ramsey is going to tell the world what funds he’s investing in? He’s not going to do the work for us. There are a lot of things we can’t control, but the things we can we need to take advantage of, or adleast not think, well-Ramsey must be crazy because I’m an educated person and I haven’t found what he says to be true. Sometimes looking at opportunity like we did when we were kids goes a long way… and sometimes pulls you out of a funk, lets you take a deep breathe, and smile.

  17. Wondering why you’re not getting 12% on your investments? According to Dave Ramsey, it’s because you’re a moron. No, really!

    I know, I know, that was a surprise to me too. I mean, wasn’t consistent 12-13% returns a big red flag that Madoff had to be cooking the books? But at the 4 minute mark on the above clip, Dave helpfully explains things:

    “Let’s say you outperformed the stock market because you had the good sense to actually study mutual funds and select a good one and got 12% on your money. Let’s just pretend you are smart enough to do that. I can do that in 35 seconds on Morningstar. Some of you financial people are too STUPID to find a 12% mutual fund. I don’t know WHY you’re that dad-blame dumb, by the way, but some of you are. I can find one in 32 seconds on my Morningstar, but anyway, I just found one…”

    I keep remembering the “past performance” caveat in “A Random Walk Down Wall Street.” The book said that of *course* some funds are going to beat the market, with so many of them trying; you’re just never going to know which ones will do so in advance. It said that if you had a room full of people flipping coins, eventually someone is going to flip 100 heads in a row. This does not mean that person actually has head-flipping skills. ARWDWS broke down some statistical evidence that funds which have great 10 or 20 year winning streaks tended to perform really badly in following decades.

  18. @ Moron 😉 … smile I’m just kidding :-)

    Here is a list of US Stock Mutual Funds from Morningstar Financial with at least a 10 Year track record making annualized returns of 12% or greater. I don’t ever recall DR stating leave your money in the same fund for 40 years and play dead. But maybe it was on a show I didn’t hear :-)

    CGMRX CGM Realty 17.64
    SSGRX BlackRock Energy & Resources Inv A 17.17
    CGMFX CGM Focus 16.57
    PSPFX U.S. Global Investors Global Res 16.57
    LEXMX ING Global Natural Resources A 15.76
    PRGNX Prudential Jennison Natural Resources B 15.59
    RSNRX RS Global Natural Resources A 14.87
    GHAAX Van Eck Global Hard Assets A 13.96
    VGENX Vanguard Energy 13.51
    YAFFX Yacktman Focused 13.10
    RSPFX RS Partners A 13.00
    ICENX ICON Energy 12.90
    FAIRX Fairholme 12.74
    IGNAX Ivy Global Natural Resources A 12.49
    BURKX Burnham Financial Services A 12.48
    FSDPX Fidelity Select Materials 12.48
    YACKX Yacktman 12.43
    LMVYX Lord Abbett Micro Cap Value I 12.39
    HWSIX Hotchkis and Wiley Small Cap Value I 12.22

  19. Lots of sharp comments on this thread. Whomever made note of geometric mean hit the nail on the head.If a fund loses 50% this year, it has to do 100% next year just to get even. If the tacticle managed fund only loses 30%, it only has to do 42% to get even. So beating the S&P in a given year isnt really apples to apples.

    I do agree with Ramsey on watching fees. I have seen advisors sell funds with 1.5% internal fees then charge a 2% wrap fee. So that fund will have to beat the respective index by 3.5% just to be even.

    I’ll gladly pay .3 in extra fees for well managed tacticle fund that limits downside loss, is style pure and limits drift. A low fee portfolio that includes a mix of asset classes to include equities,small med and large cap, foreign and domestic, fixed income, hard assets, real estate, commodities and cash is, in my opinion the way to go.

    Of course, you could just figure out the exact date you will die, and save yourself a ton of planning!!