Q. Is it still safe to use 4% withdrawal rate to take money out of my retirement portfolio?
A. We will share a few reasons for people who think why the 4% rate is outdated, you can determine if they make sense or not by yourself.
What is 4% rule?
This rule states that a 65-year-old could withdraw 4% of their assets from their portfolio during the first year of retirement, grow those assets by the inflation rate in subsequent years, and have minimal probability of running out of money over the next 30 years. The 4% rule may seem safe at a glance, but the complexities of retirement challenge the validity of this strategy.
Why 4% is outdated?
When the 4% rule was first introduced in the early 90s, the probability of running out of money was calculated using historical returns. When updated with new capital markets data, using a moderate risk portfolio, the 4% rule today is actually closer to 3.5% for current retirees and a 3.5% withdrawal rate yields only an 85% probability of success. In other words, this withdrawal rate would fail 15 times out of 100.
In addition, the 4% rule fails to address the following uncertainties imbedded in every retirement plan:
A. We will share a few reasons for people who think why the 4% rate is outdated, you can determine if they make sense or not by yourself.
What is 4% rule?
This rule states that a 65-year-old could withdraw 4% of their assets from their portfolio during the first year of retirement, grow those assets by the inflation rate in subsequent years, and have minimal probability of running out of money over the next 30 years. The 4% rule may seem safe at a glance, but the complexities of retirement challenge the validity of this strategy.
Why 4% is outdated?
When the 4% rule was first introduced in the early 90s, the probability of running out of money was calculated using historical returns. When updated with new capital markets data, using a moderate risk portfolio, the 4% rule today is actually closer to 3.5% for current retirees and a 3.5% withdrawal rate yields only an 85% probability of success. In other words, this withdrawal rate would fail 15 times out of 100.
In addition, the 4% rule fails to address the following uncertainties imbedded in every retirement plan:
- Life expectancy: The 4% rule was developed based off of a 30-year period when in fact many retirees can expect a longer retirement—especially those who retire before age 65. Life expectancy is impossible to predict, but it's important to be realistic when planning. An underestimated retirement duration increases longevity risk.
- Portfolio returns: The 4% rule is indifferent to the year-overyear change in portfolio value. If a retiree plans to start retirement spending USD 40,000 from a USD 1mn portfolio, and then the portfolio declines by 40%, they will be left with a portfolio value of USD 600,000. The retiree's USD 40,000 annual spend is now 6.67% of the portfolio. Consecutive annual declines in portfolio value, combined with increasing annual spending rates, result in a situation where the retiree's withdrawal rate is no longer viable .
- Expenditures: The 4% rule yields a constant (inflation-adjusted) spending rate; however, most retirees prefer tospend larger amounts earlier in retirement and less later on. Additionally, most investors' retirement expenses aren't the same every month. Large and lumpy expenses, such as healthcare and long-term care costs, can derail an otherwise sound plan —especially one that's funded by an unwavering income.
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