- A 50/50 balanced portfolio of stocks and bonds.
- With annual withdrawals of 4% of the account balance.
- Adjusted for the annual inflation rate.
And, you won’t outlive your nest-egg for up to 30 years. Of course, less than 30 years’ of withdrawals mean you can safely withdraw more than 4% annually, and more than 30 years’ means you withdraw less.
You’ve Heard It; But Can You Trust It?
- In one type of analytical support for the rule, the conclusion is based on every possible consecutive 30-year period for which reliable historical returns are available – using large-cap stocks and long-term government bonds.
- Another approach is to use computer simulations based on historical returns and standard deviations, using various withdrawal rates and asset allocations.
Note the commonality: based on HISTORICAL PERFORMANCE.
We read the SEC mandated warning: “past performance does not necessarily predict future results” so routinely that it often fails to register with our brain. Yet we rely on that premise when we blindly implement the 4% rule during retirement.
Advantages of the 4% Rule
- Simple to understand.
- Easy to implement.
- Disciplined approach.
Disadvantages of the 4% Rule
- Ignores current economic conditions.
- Relies on historical performance that does not take into account investment management expenses.
- While withdrawing too much risks running out of money, withdrawing too little means short-changing yourself.
Does the 4% Rule Still Make Sense?
The economic downturn and the relentless stock market volatility should have all of us wondering whether the 4% withdrawal rule still makes sense. Is there any reason to believe that the economy will recover soon or that returns will stabilize in the near-term? Now, may be a time to err on the side of caution – and consider a withdrawal less than 4%. Negative returns early in a withdrawal program can create a very bad situation from which recovery could be difficult.
- With today’s low-interest environment it may be impossible to generate sufficient income (of say 4%) from just the fixed-income portion of a balanced portfolio; and withdrawing too much will start eating into the growth portion of a total portfolio too soon – reducing your accumulated assets to a level that will be unable to continue generating life-time income.
- Obviously, those with other income streams – such as an employer defined-benefit pension or an annuity payout – have the flexibility of delaying withdrawals from accumulated assets when market conditions are less than optimal. Have a plan.
- A portfolio tilted toward fixed-income vs. equity investments will be less susceptible to daily fluctuations in the market. Relying primarily on interest and dividends for living expenses during retirement means you don’t need to check today’s market performance indicators with fear and trepidation. Cash-generating assets will reduce a retiree’s exposure to market flux.
However, if you don’t retain enough accumulated assets with the potential for growth, you will run out of assets too soon. Your engine won’t have enough horse power. The trade-off is and will always be: that increasing your stock allocation reduces the fact of failure (actually running out of money) but increases the magnitude of failure (the number of retirement years without retirement income from your accumulated assets). Your personal risk tolerance profile will decide which you would rather avoid: the risk of running out of money or the risk of not spending as much as you could have.
Using the 4% rule, if a portfolio under-performs you are spending more than you should. If a portfolio performs better than expectations, you are not spending as much as you could. So, forget just “set and forget”. You are likely better off periodically fine-tuning your withdrawal rate based on your time horizon and current market conditions.
Do consider the 4% safe withdrawal rule, but only as a starting point.