Is the 4% Retirement Spending Rule Obsolete?

Is the 4% Retirement Spending Rule Obsolete?

December 13, 2021

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 stock and bond 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 yields 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, bonds and stocks) and aligns your withdrawal rate with your retirement horizon and risk 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.

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