Jul 1, 2020
This week I’m talking about the 4% rule.
The 4% Rule is a short-hand rule of thumb that helps you calculate how much of your portfolio you can safely withdraw in retirement without running out of money. To use the 4% rule, you take your portfolio value at retirement and multiply it by 4% and you have a safe withdrawal rate for year one. Increase that for inflation each year and you have a simple rule of thumb for calculating a safe withdrawal rate in retirement where you’re unlikely to outlive your portfolio.
Today, I’m talking about the primary problem with the 4% rule.
There are actually a few glaring problems with the 4% rule - primarily, it makes several assumptions about your mix of stocks and bonds and bond returns that may be wildly different than how you’re actually invested in retirement.
But that’s not the real serious problem with the 4% rule. If you’re unlucky enough to retire around the same time as a major recession where your portfolio might drop 20%-30% during the first few years of retirement, it could be game over for you.
If your retirement gets off to a bad start in terms of your timing and your portfolio returns in the early years are dismal, you increase the likelihood that you’ll run out of money using the 4% rule.
The risk that you’ll retire at the onset of a major recession and stock market downturn is actually one of the major risks to you outliving your money in retirement.
This actually has a name - it’s called the sequence of returns risk - so if you want to learn more, you can google sequence of returns risk and you’ll better understand why bad returns in the early years of retirement are bad news for you.
Unfortunately, it also debunks the usefulness of the 4% rule in retirement. So be sure to have a backup plan and be willing to lower or suspend your withdrawals in the early years of retirement if you happen to retire during a recession.
That’s it for today. Thanks for listening. My name is Ashley Micciche and this is the One Minute Retirement Tip.
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