Is the 4% Retirement Spending Rule Obsolete?

Andrew Busa, MSPFP, CFP^®, MPAS^®, CCFC

Director of Financial Planning

This week’s reader question is about retirement spending:

Is the classic 4% rule still valid and how should I factor inflation into my retirement spending budget?

Maybe, and yes.

This ubiquitous retirement spending maxim, the “4% rule,” came into vogue in the 1990s. The financial planner who created it, William Bengen, examined historical returns from the stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. and bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. markets and applied them to a diversified portfolio to determine the percentage a retiree could prudently withdraw from their retirement accounts over time. In all of the market scenarios he studied, including the ugliest, withdrawing 4% annually from his hypothetical portfolio meant never running out of money over any 30-year time horizon.

More recently, the solidity of the 4% rule has been challenged, with pundits asking whether rising inflation combined with lower bond yieldsYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price. means a 4% withdrawal can still work for retirees today.

On the surface, the 4% rule is appealing in its simplicity—in combination with a good long-term investment plan, it could see you through retirement. But even Bengen admits that his rule is too general to be considered gospel. We agree. This rule of thumb—like many others—was never intended to be an absolute for every person’s financial plan.

Retirees have quite a few spending regimens and solutions to consider: Monte Carlo simulations use a predictive model to project the likelihood of achieving retirement goals at various withdrawal rates. The bucket method divides assets into three categories (cash, bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. and stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company.) and aligns your withdrawal rate with your retirement horizon and riskThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline. appetite. And so on.

Like all helpful guidelines in the financial planning playbook, retirement spending needs to be tailored and adjusted to each individual’s situation. The key is to stay invested in an appropriate mix of assets throughout one’s retirement.

The desire to switch to what is probably a too-conservative portfolio is understandable, since retirees are often more interested in a return of their money than a return on their money. However, the retirement timeline is lengthy. You may be retired for as long as you were employed! As a result, you need that money to be working for you, compounding and earning a solid rate of return over time to ensure you don’t run out of gas.

As far as inflation’s impact, we know it can be a challenge when it rises quickly, especially if it throws a fixed budget out of whack. We don’t think the current inflation rate is sustainable; regardless, this is a great time to review your plan to make sure you’re comfortable with what you can safely spend in retirement.

About Adviser Investments

Adviser is a full-service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trustsA legal document that functions as an instruction manual to how you want your money managed and spent in your later years as well as how your assets should be distributed after your death. Assets placed in a trust are generally safe from creditors and can be sold by the trustee in short order, avoiding the lengthy and costly probate process., institutions and foundations since 1994. Adviser Investments and its subsidiaries have over 5,000 clients across the country and over $8 billion in assets under management. Our portfolios encompass actively managed funds, ETFsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index., socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.