Dave Ramsey's 12% return is wrong

[Milly]

I am currently reading Dave Ramsey's "Total Money Makeover" and he claims the S&P 500 has had an average 12% rate of return in the last 80+ years. I'm going to call funny or lucky math on that one.

I assume he must have taken the current S&P value the day he wrote (copyright 2003) and used that number to back out the % return vs. the value 80 years ago. I used trend lines instead.

If you use Excel to graph the S&P 500 values from the beginning (1871) till now and make a exponential trend line, the % return is 4.45%. I figured that was a little harsh though since it started out much more stagnant than today. I tried again, from 1922 till 2002 (80 years like he claimed), it was only 6.19%. Using this method, if you use any year earlier than 1964, the return is less than the 8% most people assume they get.

If you use today's data, as opposed to 2002, it is worse. You get 8% return if you are looking back to any of the 1970's, but everything else before the 2008 crash is 7% or less.

Bottom line, you can't use historical data to justify a 12% return and maybe not even an 8% without carefully chosen numbers. Ramsey's book was just written after a few decades of great numbers.

Note: this doesn't mean his principles are bad, just inflated. I am loving the book!

[Jluke]

Here is my experience with S&P 500 (SPY):

$1000 purchased October 2004
$1000 purchased June 2007

current market value is $4580 when factoring in dividends and growth.


12% sounds good when you are trying to sell books and your product.

[sblatner]

I love his principals except his claim of 12%. I think he is setting people up for disappointment. Better to say 8% and have them make more!

I also have a problem with his endorsed local providers. He endorses people on his website but then has no control over them and some are crooks.

[Petunia 100]

Yep, the 12% return quoted is wildly optimistic. He quotes simple arithmetic average, not Compound Average Growth Rate (CAGR). The problem with that is investors don't actually earn the simple arithmetic average, they earn CAGR.

Total Stock Market (not S & P 500) does get close to 12% simple arithmetic average in many different time periods, and as you say it depends on which time period you choose to measure. Of course, historical returns of an index ignores both expenses and inflation, which are very real.

There are a lot of problems with Dave Ramsey's investing advice, which in my opinion is deliberate in order to earn revenue for Dave Ramsey. But that's another story.

[disneysteve]

This has been discussed many times. Dave Ramsey's plan for getting out of debt and learning to live on a budget is solid and has helped many people. His investing advice leaves a lot to be desired. Don't look to him for investing advice.

[Captain Save]

I think it's a pretty well known fact that Dave Ramsey pulls numbers out of thin air... and is too stubborn to admit that he's wrong.

[Guppy Tender]

Not Really important

I agree that Dave Ramsey's investing number of 12% interest is a little bogus.

The thing is if you actually listen to the Dave Ramsey Show you will discover this actually does come from him looking at his own portfolio of investments.

Now as he says "The important part is not how much you get in interest, the important part is to just save" Even if you do not make a huge amount of interest each year you will come out ahead of the person that invests nothing.

Compound interest will work in your favor, you must invest though to take advantage of it. The majority of us here know this.

[TexasHusker]

I agree that Dave Ramsey's investing number of 12% interest is a little bogus.

The thing is if you actually listen to the Dave Ramsey Show you will discover this actually does come from him looking at his own portfolio of investments.

Now as he says "The important part is not how much you get in interest, the important part is to just save" Even if you do not make a huge amount of interest each year you will come out ahead of the person that invests nothing.

Compound interest will work in your favor, you must invest though to take advantage of it. The majority of us here know this.

With CDs paying 1 percent or less these days, I don't think compound interest is going to get you anywhere. It doesn't even keep up with inflation. If there are interest-paying instruments out there that will work in my favor, I would appreciate your sharing them.

[disneysteve]

Now as he says "The important part is not how much you get in interest, the important part is to just save" Even if you do not make a huge amount of interest each year you will come out ahead of the person that invests nothing.

Compound interest will work in your favor, you must invest though to take advantage of it. The majority of us here know this.

With CDs paying 1 percent or less these days, I don't think compound interest is going to get you anywhere. It doesn't even keep up with inflation. If there are interest-paying instruments out there that will work in my favor, I would appreciate your sharing them.

TH, I don't think Dave Ramsey has ever suggested that "how much you get in interest" doesn't matter. But when addressing push back on his 12% advice, what I believe he has said is that if someone invests and only gets an 8% return, that's not such a bad thing. They are still going to be far better off than the person who didn't invest.

I agree that using 12% to do projections is unrealistic (not impossible but unlikely) but if it encourages people to invest who otherwise might not have, that's a good thing.

[corn18]

TH, I don't think Dave Ramsey has ever suggested that "how much you get in interest" doesn't matter. But when addressing push back on his 12% advice, what I believe he has said is that if someone invests and only gets an 8% return, that's not such a bad thing. They are still going to be far better off than the person who didn't invest.

I agree that using 12% to do projections is unrealistic (not impossible but unlikely) but if it encourages people to invest who otherwise might not have, that's a good thing.

While I agree that if it gets them investing, that is a good thing, I hope they don't use that to decide when they have enough to retire. I think I am being aggressive when I forecast 4% real returns when deciding when I can retire. If I set that to 12%, I could retire next year. And then I would go broke.

[disneysteve]

While I agree that if it gets them investing, that is a good thing, I hope they don't use that to decide when they have enough to retire. I think I am being aggressive when I forecast 4% real returns when deciding when I can retire. If I set that to 12%, I could retire next year. And then I would go broke.

The other problem is that he tells people they can take out a much higher % in retirement than the usual 4% rule. I don't remember exactly but I know it's high.

I agree that people shouldn't use 12% to decide how much they need to save or when they can retire. I think he uses it more as, "look what you could get if you start investing". I think we all agree that it's not realistic but I can understand why it can be motivational.

[TexasHusker]

TH, I don't think Dave Ramsey has ever suggested that "how much you get in interest" doesn't matter. But when addressing push back on his 12% advice, what I believe he has said is that if someone invests and only gets an 8% return, that's not such a bad thing. They are still going to be far better off than the person who didn't invest.

I agree that using 12% to do projections is unrealistic (not impossible but unlikely) but if it encourages people to invest who otherwise might not have, that's a good thing.

What instruments are paying 8% interest? Heck I'll take half of that amount.

[disneysteve]

What instruments are paying 8% interest? Heck I'll take half of that amount.

Not 8% interest but 8% annual return has certainly been reasonable over the last decade.

I just took a look at a few Vanguard funds and the 10-year average returns - which still includes the 2008 recession. The S&P 500 fund has a 7.5% return. The Small Cap Index has an 8.2% return. And the Health Care fund, which I have a substantial investment in, has an 11.06% return.

[TexasHusker]

Not 8% interest but 8% annual return has certainly been reasonable over the last decade.

I just took a look at a few Vanguard funds and the 10-year average returns - which still includes the 2008 recession. The S&P 500 fund has a 7.5% return. The Small Cap Index has an 8.2% return. And the Health Care fund, which I have a substantial investment in, has an 11.06% return.

OK...I was thinking the earlier poster was referring to interest. That's a very different animal than total return.

[disneysteve]

OK...I was thinking the earlier poster was referring to interest. That's a very different animal than total return.

Oh. No, Dave Ramsey talks about the return from an investment portfolio of mutual funds. And he essentially only recommends growth funds (another issue with his advice). So if you are 100% in growth stock mutual funds, earning 8% probably isn't unreasonable over the long haul. 12%, however, is pushing it.