Reality and the Four Percent Rule

Some time ago a major financial services company ran an ad campaign based on “the number.” What is the magic number relative to a safe retirement, “safe” meaning not running out of money before you die? How much do you need to accumulate in dollars, and how much can you take out each year to be relatively certain that your bank balance will not go to zero before your heart rate does?

 You may have heard of the “4 percent rule” promulgated by financial planner William Bengen in a study published in the Journal of Financial Planning in October 1994.  Bengen studied 65 years of stock and bond data from 1926 to 1991, 38 thirty-year rolling periods, to determine a withdrawal rate that  as a percentage of one’s portfolio balance that adjusted for inflation each year could sustain 30 years of withdrawals without depleting the asset base. Out of that came the popular theory that a 4% withdrawal rate is reasonably safe.

Known as the 4% Rule, Mr. Bengen feels that it is still valid. It is useful as a guideline, but there are caveats. Recent studies, particularly a piece by Wade Pfau, PhD, in the May 2011 issue of the Journal entitled “Safe Savings Rates: A New Approach to Retirement Planning over the Life Cycle,” suggests another look.

Part of the challenge is the expected returns going forward for bonds and stocks. We are at the end of a 30-year bull market in bonds, with “safe money” yields at historical lows. On March 29, the benchmark U.S. Treasury note offered a yield of 1.851%; a 5-year CD, 1.21%. Traditionally retirees have relied heavily on bonds and CDs for peace of mind. With trailing 12 months All Items CPI at 2% as of mid-March, safe money yields adjusted for inflation and taxation are decidedly negative.

The 4% Rule is not a “rule”—it is a theory, and even Mr. Bengen admits it did not work well during periods of high inflation, which given excessive money creation, may be in our future. The S&P 500 Index on March 28, 2013, finally surpassed the previous high of October 2007. Suffering from “recency bias,” traumatized by two major market routs, many investors still are nervous about major commitments to equities. Dr. Pfau theorizes that with lower expected returns in bonds and stocks, a reduced withdrawal rate is justified. 

The 4% Rule may become the 3% Rule. That means for every $30,000 per year that you want from your portfolio, $2500 per month, you have to have $1 million in capital. What does that do to your retirement assumptions?

There are no magic bullets. Longevity risk is real. Advisors are looking at strategies to deal with the erosion of bond values in a rising interest rate scenario. You may have to rethink your asset mix, including how to handle volatile asset classes like stocks to minimize “reverse dollar-cost-averaging” as you withdraw money from your portfolio. A “bucket strategy” may be called for along with tactical asset allocation. Many popular money management theories are based on “accumulation,” not decumulation, the spending down of one’s asset base.

Retirement security is a multifaceted strategy that involves defining exactly what retirement is. Will you work past your full retirement age under Social Security? Have you studied strategies to maximize Social Security income? Do your have income sources beyond your portfolio or Social Security, such as a pension covering you or a spouse? Do you have obligations to aging parents or other loved ones that will drain some of your savings? Is your home paid for?

What is your health status? Will you insure long term care risks or self-insure? Medicare, which is not free or simple, does not cover many health-related costs, including long term care. Healthcare is wealthcare and medical and caregiving costs can be a major factor in running out of money.

A million dollars to generate $2500 a month? Being “a millionaire” ain’t what it used to be!

Lewis Walker is President of Walker Capital Management LLC. and Walker Capital Advisory Services, Inc., a Registered Investment Advisor (R.I.A.) Securities and certain advisory services offered through The Strategic Financial Alliance, Inc. (SFA).  Lewis Walker is a registered representative of SFA which is otherwise unaffiliated with the Walker Capital Companies. ▪  3930 East Jones Bridge Road ▪ Suite 150 ▪ Peachtree Corners, GA 30092 ▪ 770-441-2603 ▪ lewisw@theinvestmentcoach.com