In Question: The Validity of the 4% Rule

You may feel like the current economy is trashing everything you've learned about how you should handle your retirement money or at the very least calling your earlier assumptions into question.  One such assumption, the 4% rule, is coming under more scrutiny by retirement planners.  This week even the Wall Street Journal had an article alluding to that fact. I had an opportunity to discuss this volatile retirement issue in an interview on Fox 9 News last Friday and again on KSTP on Sunday morning.  Here are a few things to keep in mind as you navigate your retirement planning and evaluate whether the 4% rule is appropriate for you.

What is the 4% Rule?

Simply put, the 4% rule suggests that if retirees withdraw 4% of their nest egg every year, their savings should easily last 30 years. In 1994, a well known financial planner developed the 4% rule which has become widely adopted by financial experts and Wall Street firms.  Following this rule of thumb, retirees determine a certain percentage or amount of money that could take from their portfolios every year which would allow their savings to last them their lifetime.  (This rule assumes that the portfolio was held in a tax-deferred account and was split between large and small company stocks and U.S. Treasury bonds.)

Is the Rule flawed?

While the rule has worked during much of the 1990’s, as stocks have become more volatile, many observers are wondering if the rule still holds. Longevity is the greatest risk that investors face in retirement. Since people are now living longer, they risk outliving their money in savings.  In addition, these long-living retirees are likely to face challenges like:  high inflation rates, stock market downturns and health care bills due to deterioration of health.  A major mutual fund company (T. Rowe Price) published a study analyzing a family who retired in the year 2000.  The study indicated that the 4% rule only has a 29% probability of success. Furthermore, the more volatile or aggressive you are with your financial portfolio, the greater your risk.  According to the Wall Street Journal article on the subject of the 4% rule this last week, “The next five years could be crucial, particularly for individuals who retired in 2000 and have experienced two major stock-market downturns since then.”

What should the rule be?

When the rule was set in stone, interest rates were much higher and the markets were doing much better.  Some say a more realistic number now is 2.5% or even as low as 1.8%.  Secured Retirement Advisors is encouraging caution because the financial problems we face today could get worse.  Here are some reasons why:

1. Demise of pensions
2. Demographics (10,000 boomers are retiring daily for next 15 years)
3. Longer Expected Life Expectancies.  Because everyone’s retirement plan is unique, you should work with a professional that focuses on a plan that starts with income generation and protection, not on returns and upside potential.

Be careful not to overload your portfolio with too much of one type of product - investments or insurance products. An independent financial advisor can advise you on both types of products.  Remember, it’s best to start with a well thought out retirement plan first, and then consider products for your portfolio.

I hope this helped clarify the issues surrounding the 4% rule featured so much in the media of late.  As promised, next week I will be completing the top ten list started last week so be sure to tune in for that.  Secured Retirement Advisors is ready to offer a personalized and comprehensive financial plan for families in or nearing retirement so they can live their retirement years with security - without worrying about their money.  Feel free to call us with your retirement planning questions at 952-460-3260 or visit us for a complementary consultation.