|The time is right to do away with 4-percent rule
In 1994, a financial advisor named Bill Bengen published research articulating the “4 percent rule,” which became a landmark of retirement planning. The 4 percent rule postulates that a retirement nest egg can last 30 years if a retiree withdraws 4 percent of it per year (incrementally adjusted for inflation), given a portfolio of 50 percent stocks and 50 percent bonds. Bengen studied numerous 30-year stock market time spans to arrive at his theory, which many retirement planners took as a guideline.
Lately, the 4 percent rule has taken quite a bit of flak. At age 20, it looks less and less valid. Why? Two factors leap to mind.
• The return of significant volatility: Bengen came up with the 4 percent rule during the 1982-2000 bull market, the greatest extended rally Wall Street has ever seen. Across that period, the S&P 500 rose 1153.94 percent (and 2041.47 percent with dividends reinvested). The S&P’s annual total return averaged 19.02 percent in that time frame. Back then, retirees and retirement planners harbored assumptions of double-digit annual returns, and withdrawing 4 percent a year from retirement savings seemed conservative.
The bear markets of the 2000s were a rude awakening. Someone who retired in 1979 with a 50/50 mix of stocks and bonds in their portfolio would have enjoyed an average annual total return of 13.75 percent for the next 20 years – but a portfolio equally divided between stocks and bonds would have returned less than 4 percent in recent years, even in this current bull market. That brings us to the second factor.
• Low yields from fixed-income investments: In 1990, the 10-year Treasury returned better than 8 percent. In 2012, it yielded around 2 percent. Many fixed-income investments have yielded less than that in recent years. If you are withdrawing 4 percent a year from your retirement savings and less than half your retirement portfolio is invested in equities, you are staring at a problem.
No retirement planner would urge retirees to put all their money in stocks – the volatility risk is just too great. Assigning half (or more) of a retirement portfolio to debt instruments, however, presents an undeniable opportunity cost. Consumer prices are rising only slightly, but interest rates remain in the vicinity of historic lows; retirees who want to keep ahead of inflation aren’t making much progress by investing substantially in bonds, and inflation may subtly erode their spending power.
• The 1990s are gone, along with the old retirement planning assumptions: Even Bengen is revisiting the 4 percent rule today. He retired in 2013 and conceded in Barron’s that “we could have low returns for a long time...we’re in uncharted territory. It's very hard to predict what will happen.” Recently, some respected voices in the financial services industry – including analysts at T. Rowe Price and American College professor Wade Pfau – have argued that retirees may be better off withdrawing roughly 3 percent of their savings each year.
The era of “set it and forget it” has passed. Determining a retirement withdrawal rate today means considering plenty of variables, including changing market conditions and emerging economic trends.
Ken Weise, an LPL Financial Advisor, provided this article. He can be reached at 707-584-6690. Securities offered through LPL Financial. Member FINRA/SIPC. The opinions of this material are for information purposes only.