Could Retirement Planning Really be This Simple?
Hardly a week goes by that we don’t encounter another article examining the 4% rule, a guideline for sustainable spending during retirement. Joining the parade, last Saturday’s New York Times ran an article titled “New Math for Retirees and the 4% Rule.” A sidebar warned that a 2.85% withdrawal rate might actually be a “safer bet” for those entering retirement today.
What exactly is the 4% rule? The idea is that if retirees withdraw 4% of their portfolio in their first year of retirement, and adjust that initial amount for inflation in subsequent years, they should have little risk of depleting their portfolio over thirty years. Rules of thumb can be useful. For example: “Always take the employer match on your 401(k).” However, be it 4% or 2.85%, we view the concept as an oversimplification. It implies that you can set it and forget it.
The world has changed since the 4% rule was introduced by financial planner Bill Bengen in 1994. Bond yields are lower, but so is inflation. We’re living longer. Fixed pensions have largely disappeared. Generally speaking, stock returns now have a larger impact on overall success rates and that understandably makes people nervous given the roller coaster ride of the past decade.
Today’s planning techniques more explicitly consider these developments as well as return uncertainty and the risk of an unfavorable sequence of returns. If an extended market downturn occurs early in retirement, and spending is not adjusted commensurately, you will most likely not fully participate in the eventual recovery, impairing the long-term return potential of your portfolio.
In our view, a successful retirement plan is individualized and revisited periodically to make necessary adjustments. We start with questions rather than calculations: “What does retirement mean to you? How might you respond to a market decline – could you live on a bit less?” A good plan reflects the retiree’s unique mix of assets and income sources, as well as attitudes toward life expectancy and the probability of significant one-time expenses or windfalls. It will illuminate the tradeoffs of decisions such as traveling more, buying a second home or increasing gifts and donations. A good plan demonstrates the potential impacts of the choices that lie ahead – it does not prescribe a one size fits all solution.
Starting the process can be daunting – many people don’t know where to begin. We help with specifics like estimating future living expenses and more generally by prioritizing the next steps that will move plans forward. We are available when important financial decisions arise that would benefit from our experience and impartiality. We take care to shape each plan in the context of the individual’s unique history and outlook and recognize that a plan is of little value if its merits and limitations are not fully understood.
While the Times article mentions possible shortcomings of the 4% rule, it is more focused on refining it than replacing it. The simplicity and precision of the set-it-and-forget-it approach may be appealing, but it’s not a substitute for financial planning and experienced counsel.