Higher Income or Higher Risk?

Separately, conventional thinking suggests that the 4% rule, which isn’t without its detractors, is more reliable — based on academic research — to lead to greater portfolio success over a 30-year retirement period. On the plus side, you have the S&P 500, which has returned an average of 12% to 14% annually over the last 10 years, including reinvested dividends. This lends some merit to Ramsey’s argument, but it overlooks the possibility that the market could quickly turn and the country could enter a potential recession, which would immediately harm anyone trying to adhere to the 8% schedule.

Let’s not forget that inflation also plays a role here and cannot be ignored. This means that 8% leaves very little room for error as far as your investing strategy.

If I had the opportunity to sit down with any one of Ramsey’s followers and discuss this, the first thing I want to mention is that the 8% rule is too aggressive. I’ll say this with complete confidence, even as you can find plenty of supporting evidence that the market returns between 10% and 12% annually, especially based on S&P returns.

The issue is that this doesn’t account for inflation, which means that, based on current inflation rates, the real return is more likely to be between 7% and 9%. It’s for this reason that I would amplify the message that 8% leaves someone almost no room for error if they want to adhere to this strategy. I would also like to point out that once you factor in inflation, taxes, and fees, before you even consider market volatility, it becomes clear why you might earn closer to 6% on average in the end.

If someone asked me point-blank if the 8% rule can work, here’s how I would respond. Yes, in some cases, albeit rare ones, the 8% rule can work, and it’s even more true if you are talking to someone with a shorter spending horizon, likely someone who retired later in their 70s.

Alternatively, if you have someone who has Social Security and or a pension plus the money they are withdrawing from investments, the 8% rule can work with the additional income flow. However, I would urge caution here, especially if you hope to have a 25–30 year retirement window. There is no way around saying it, but the math isn’t guaranteed to work and likely won’t for just about everyone.

Alternatively, I might want someone to look at different strategies, such as adjusting their withdrawals up or down based on market performance, so they are living somewhere inside the 4% and 8% window. Another option I would strongly recommend for most people is to secure all your essentials with guaranteed income sources, such as a pension or annuity, and then utilize the market for extras like travel and entertainment.

At the end of the day, my big takeaway for everyone is that the 8% rule sounds excellent on paper, but in practice, it’s hard to guarantee success. The last thing anyone wants is to run out of money when they need it the most, so sticking to this rule for now might be the best option.

Of course, the absolute best move is to talk to a fiduciary financial advisor who can give you both qualified and expert advice on how to build a portfolio that works for your needs.

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