There has been much discussion lately on the reliability of
the suggested 4% withdrawal rate. It has long been
held that withdrawing 4% from your retirement assets per year was a “safe”
withdrawal rate. “Safe” means if the
retiree starts taking 4% out of their portfolio when they retire and increase
that amount by inflation each year then that income will last them the rest of
their life. 4% became a rule-of-thumb
even though it actually has strong academic backing. Recently, however, online articles and general advisor talk have
suggested that given the current low rate environment or due to big market
collapses like 2008 and 2009 a 4% withdrawal rate is no longer feasible.
A recent WSJ article suggested we “Say Goodbye to the 4% Rule.” They even gave an example suggesting had you retired on January 1, 2000 and used the 4% rule your portfolio value would have fallen a third by 2010. (We call foul on this figure as our data shows a well diversified 60/40 portfolio would leave you with a third MORE in nominal value by 2010). The CFA Institute even conducted a poll of professional investors and found that 57% thought the 4% rule was no longer sustainable in the current low rate environment. (Click Here)
A recent WSJ article suggested we “Say Goodbye to the 4% Rule.” They even gave an example suggesting had you retired on January 1, 2000 and used the 4% rule your portfolio value would have fallen a third by 2010. (We call foul on this figure as our data shows a well diversified 60/40 portfolio would leave you with a third MORE in nominal value by 2010). The CFA Institute even conducted a poll of professional investors and found that 57% thought the 4% rule was no longer sustainable in the current low rate environment. (Click Here)
The debate may have merit, but the most troubling thing I see with this new trend in
thinking is that advisors and “professional investors” actually have no idea where
the 4% rule actually came from. The 4% rule is already based on worst case scenarios, NOT average
market returns. So if
your investment professional suggests that in this new low rate environment a
4% rule no longer applies then I would be very wary of their advice because
they lack the very basic understanding of where the 4% rule came from. Michael Kitces, a popular financial writer
and head of research at Pinnacle Advisory Group, has written some very good articles
on the subject and a video presentation of his research can be found here. I will not regurgitate everything he already
explained very clearly, so I highly encourage you to check the links out. He found that in the last 140 years there were
only four 30-year time periods where the safe withdrawal rate was between 4 and
4.5% (all other periods where higher with an average safe withdrawal rate of
6.5%).
Kitces also addresses the issue of actual spending needs
changing in retirement. This I believe
should be the biggest take away from the 4% rule debate. The real focus should be on
working with your advisor to find a dollar value in real terms that will
provide a comfortable retirement. Safe withdrawal rates should merely act as the
guardrails to guide expectations. The question should not be “How much can I
safely withdraw?” but instead “How much do I need to live comfortably in
retirement and is that amount sustainable given my portfolio value?” Once this question is addressed the client
and advisor can work through many variables together (one of them being a what a “safe”
withdrawal rate is) to give the client the best chance of attaining his or her
retirement goals.
Creating a plan based on desired retirement income and not a
withdrawal rate also encourages clients to “take the pedal off the wheel” if
they are several years out from retirement and they are substantially ahead of
their plan. Planning based on a safe
withdrawal rate can often have the unintended consequence of a client reaching
for return late in life to “lock in” the safe withdrawal rate of a larger portfolio. This can potentially end very badly for them.
In Summary:
1) A 4% safe withdrawal rate is based on worst case
scenarios NOT average returns. The safe
withdrawal rate was actually significantly higher in most 30 year time periods.
2) Safe withdrawal rates should really be the “guardrails”
of your investment plan. It is much more important to determine a real income value that will give you a
comfortable retirement and then working within your personal circumstances to
maximize the probability of reaching that goal.
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