Dave Ramsey’s 8% Rule Is Controversial, But Not Entirely Wrong

Dave Ramsey has never been shy about offering up radical advice. Looking to buy a home? Ramsey might tell you to pay for one in cash and avoid getting a mortgage.

And don’t even get Ramsey started about credit cards. If you bring up the topic, he’ll probably tell you they’re evil and encourage you to cut them all up immediately.

But there’s a reason Ramsey tends to dish out this sort of advice. He really wants consumers to thrive and prosper.

Meanwhile, Ramsey’s advice doesn’t only apply to working Americans. The financial guru has been known to dish out advice on retirement, too.

One specific piece of retirement advice Ramsey is known for is his famous 8% rule. It clearly goes against the very popular 4% rule, and many experts feel it’s controversial. But with the right strategy, Ramsey’s approach to managing retirement plan withdrawals could pay off big time.

The 8% rule versus the 4% rule

The 4% rule, which financial experts have long sworn by, has you withdrawing 4% of your portfolio balance your first year of retirement and adjusting subsequent withdrawals for inflation. Ramsey’s 8% rule is similar — only he has you taking much larger withdrawals.

Many financial planners would argue that an 8% withdrawal rate is too high and puts savers at risk of depleting their nest eggs prematurely. But Ramsey feels strongly that with the right portfolio composition, an 8% withdrawal rate is sustainable in the long run.

One key difference between the two rules, though, is that the 4% rule is based on a portfolio that’s split fairly evenly between stocks and bonds. Ramsey’s 8% rule hinges on having a portfolio that’s heavily loaded with stocks.

That approach, says Ramsey, could be conducive to an 8% withdrawal rate over time because your portfolio may be generating returns year over year that are equal to 8% or higher.

The problem with Ramsey’s approach

Ramsey’s 8% rule has validity, but it’s risky. For one thing, stock market returns are not always consistent from one year to the next. If there’s a period when the market only delivers 6% or 7% returns, an 8% withdrawal rate could mean dipping into principal to an unhealthy extent.

Also, the stock market tends to tank every so often. Withdrawing 8% of your portfolio during a downturn could mean locking in permanent losses.

Therefore, if you’re going to follow Ramsey’s advice, set up some protections and prepare to be flexible.

First, make sure to have at least two years’ worth of cash on hand in case you need to ride out a stock market crash. Secondly, plan to scale back withdrawals if the market is sluggish.

Also make sure to maintain a diverse mix of growth and dividend stocks in your portfolio. The growth portion is what might allow for an 8% withdrawal rate in retirement, but the dividend portion can give you some stability and income to offset your risk.

Should you follow Ramsey’s advice?

There’s a reason Ramsey’s 8% rule is so controversial — it’s too aggressive for a lot of people. But that doesn’t mean it’s wrong for you. Think about your risk tolerance, portfolio makeup, and other income sources when deciding what withdrawal rate to use for your portfolio.

And while you’re at it, you may want to consult a financial advisor. That way, you’ll have an expert who can tell you whether Ramsey’s guidance is suitable based on your specific situation.