The New York Times is criticizing (or echoing criticisms) of some of Dave Ramsey’s retirement advice. Namely, that the math he’s using on S&P 500 returns is overly optimistic–a 12% annual return, when a more realistic return when all factors are considered is more like 7 percent.
Generally speaking, his advice of using index funds rather than actively managed funds is probably a good thing. I lost the first couple of years of my retirement savings to an overly aggressive money managers bad moves, so I’m a believer in that. Settling for average returns puts you in the 90th percentile, so why get greedy?
I bristle a little bit at the advice to put everything in the S&P 500 though. I say this because one year the Wilshire 4500 (basically the 4500 other public companies that aren’t big enough to be in the S&P 500) outperformed the S&P 500. You’ll do better by putting some of your money into a fund that tracks either the Wilshire 4500 or Wilshire 5000. Most fund companies won’t give you either/or, so pick whichever you can get. I prefer the 4500, since I’m already investing in the other 500 companies through an S&P 500 fund.
Beyond that, you should add some sort of bond fund to the mix. When stocks are down, bonds tend to be up, and vice-versa. I’ve read the advice over and over that whatever age you are is what percentage of your investments should be in bonds. That seems overly conservative to me. I have more like half my age in there.
I also take 10-15 percent of my holdings, each, and put them in some sort of managed “growth” fund and some sort of international fund. My goal with that is to not completely miss out on growth. I may be too aggressive with that, but I’m still relatively young.
And then there’s the secret weapon: Automatic rebalancing. Every retirement company I’ve ever dealt with offers this service. You tell it what you want to hold on a percentage basis, and every so often (perhaps as little as once a year, or perhaps once per quarter) it buys and sells holdings to keep your money distributed. This keeps your portfolio from getting too conservative or too aggressive, and it takes the emotion out of the market by forcing you to buy low and sell high. When the market is infatuated with large companies, I need to be buying small companies and bonds while their prices are depressed. Then when the market turns its attention to small companies, I can be buying large companies and bonds, partly with the proceeds from buying the small companies at bargain prices in previous years. And when the market turns to bonds, I’m doing the same thing with small companies and large companies.
Rebalancing helps you to continue to make money even in the years when the S&P 500 is down.
But the most important thing is to visit a financial calculator and run the numbers for yourself, plugging in what you have right now and what you’re doing, and playing with the numbers to see what you need to do in order to get a better result.
And the thing about numbers is that you can play with all of them. Maybe what Dave Ramsey says about retirement is overly optimistic. But you know what? Once you’re not paying a mortgage, you can pretty much afford to contribute the legal maximum to a 401(k) plan. And if you’re contributing the legal maximum, the numbers still work on a 7% return. At age 50, you can ramp up your contributions by another $5,000 per year. If worse comes to worse, you can even work another year or two.
To me, the most important thing about his message is to get your finances under control. Have a plan for actually getting that mortgage paid off, rather than constantly refinancing and/or “upgrading.” Get your spending under control, and quit worrying about who has a nicer car or bigger TV or better landscaping than you. Come age 65, who had the nicer car at age 45 won’t matter anymore, but which person gets to retire at 65 and which one has to keep working until 70 or 75 will. And the price difference between a Honda and a BMW will make a lot of 401(k) contributions.
You have minimal control over the actual return on investment. So concentrate on the numbers you can control: Annual contribution, years until retirement, and years to pay out. Do that and you can still win. Especially if, come retirement time, you aren’t still paying for houses and cars.