What’s Wrong With the 4 Percent Strategy?

Ray’s Take: When you finally reach your retirement date, one of your first questions will be: How much of my savings can I spend?

The seat-of-the-pants guideline for retirement withdrawals has been 4 percent for many years. That’s all well and good when 10-year treasuries were yielding 6 percent. Now they are under 2.5 percent so that approach and the rule are less clear. Retirement readiness is too complex to be bound by a simple rule of thumb. Further, that rule doesn’t necessarily take into account investment expenses.

Americans are living longer after retirement, which means savings have to last longer. Pensions are increasingly rare. Like the sequence of investment returns, retirement spending follows an irregular pattern. Retirees are commonly spending more money during the earlier years of retirement. This is intuitive as you suddenly have the time to do more things and feel like doing them. As the years pass these types of expenses tail off as you age and tend to lose interest in traveling or just become less energetic. Later in your retirement years the cost of medical care might increase.

You should strive to strike a balance between spending too much money early on and being broke later. Staying flexible and reviewing your plan annually can go a long way toward maintaining the retirement lifestyle you worked for. Better portfolio performance years should be followed by nicer trips while bear markets call for more austerity.

You need to take into account your health, your family’s history of longevity, variable rates of return, your risk tolerance and your goals, including the financial legacy you may want to leave.

The truth is that using the right withdrawal rate year after year is a lot more complicated than applying a simple rule of thumb. Everyone’s situation is different. Sustainable withdrawal rates are very closely related to the risk and returns provided by the underlying investment portfolio. 

Work with a financial adviser who is familiar with using all the tools available for building a retirement-income plan. You’ll thank yourself when you’re older, and you’ll be able to enjoy retirement with more peace of mind.

Dana’s Take: Sometimes the best advice is the simplest. After all, if it wasn’t short and sweet, “stop, drop and roll” probably wouldn’t do much for someone on fire. In the same way, financial rules of thumb are useful to many of us when making big decisions.

Simplicity is good. It helps us to keep things in order in our lives because we use these axioms to make decisions that take us along the road towards our goals, both financial and personal. Rules like don’t spend more than one-third of your income on your mortgage or more than two months’ salary on an engagement ring. These rules give us a starting point from which we can make decisions based on our own circumstances.  

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