RIP the 4% Rule?

I was at an industry event last week where an expert dismantled the 4% rule.  Supposedly.

There are a lot of dissenters when it comes to this rule, a rule which has been held steady as the benchmark for post-retirement, inflation-adjusted, sustainable withdrawal levels which many claim the retiree can put aside any fear of running out of money.

If you’ve been retired for a while,or have been in the financial advice business for more than two decades you probably have experienced periods of time where 4% seemed ridiculously low while at other times 4% annual withdrawals seemed unrealistically optimistic.

For many in the financial advice-giving business the perspective of the advice giver is firmly rooted in one of two things: what their employer has told them will work or what their personal experience (including education) has been.

So at this industry event the speaker scoffed at 4% (he was a younger guy in his thirties) while citing research by a known, published authority.

For the retiree however, the idea of + or – 4% inflation-adjusted annual withdrawals has to be considered individually with regard to the retiree’s propensity for risk, hands-on management and true need.

The speaker at the event made a meaningful error in his presentation in that he referred to the withdrawal rate while excluding some of the other available assets in the example he was using.

That is, the 4% withdrawal rate has to be considered with regard to all of the clients assets, whether or not they are currently being withdrawn from.

He cited the use of a lifetime income annuity.  Which is fine.  The distribution from many lifetime income annuities (the fixed variety) has, in my multi-decade professional life) generally been about 6 – 6 1/2% per year.  That of course includes principal and interest which is important to understand, but the speaker ballyhooed the withdrawal rate of the annuity while excluding the sample client’s other assets.

The withdrawal rate overall, including liquid but as yet untouched resources, would bring the cash flow rate to much less than the 6- 6 1/2% quoted, nearer to the maligned but generally accepted 4%.

In reality, more than 4%,inflation adjusted, is achievable.  Very achievable.  One of the issues with these blanket recommendations is that results vary greatly and are very specific to a multitude of variables, not least of which is sequence of returns.

Average rates of return on investments have little value when withdrawing money from savings over many years.  I won’t bore you with charts but understand that you can achieve a target average return and still fail.  The retiree that earns more than his target in the earlier years of retirement can have the same average return as a retiree that earned less than  his withdrawal rate at the beginning of retirement but the early-year victories will enable the retiree with early success to sustain his withdrawals for longer than the retiree who struggles to match his withdrawal rate early on.

This all makes sense, and if you are a pro then this should be all to familiar for you, but for investors, our clients, this is not obvious even after explaining it to them.

But it is important.  And unpredictable.  That’s why many pro’s, myself included, believe that a retiree should have her essential expenses (food, housing, medical etc) covered by lifetime sources of income (pension, social security, annuities) and everything else covered by non-guaranteed withdrawals from savings.  This way, sequence of returns be damned, if your investments fail to keep up with your withdrawal rate you won’t be without income and you will always be able to at least keep yourself fed, clothed, housed and healthy.



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