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.
On page 3 of the above-mentioned workbook, is this:
“The American Dream
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:
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.
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:
WHERE ARE THEY GOING TO GET A 12% RATE OF RETURN FOR 40 YEARS?
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.