Is the “4% Rule” Still Relevant When It Comes to Retirement Income Strategy?
Ann D. Blakey, CFP®, MBA
Retirement is supposed to be your chance to rest and relax after working hard for years. Unfortunately, the peaceful retirement that many people dream of has become a lot more uncertain. Between the ongoing war in Ukraine, lingering concerns over the pandemic, historic inflation, and market volatility, it can be difficult to determine exactly what your retirement nest egg will look like in 20 or 30 years. One of the biggest concerns we hear from our clients is not knowing how much they can safely withdraw from their retirement assets without running out of money.
Traditionally, the “4% Rule” has been used as a gold-standard guideline. But recent events have called into question how sustainable it really is. Here is everything you need to know about the 4% rule and whether it’s still relevant for your retirement income strategy.
The “4% Rule” is a theory about how much money you can safely withdraw from your retirement accounts each year without running out of money. It became widely publicized after Bill Bengen’s research in 1994, which showed that withdrawing up to 4% of retirement assets annually could sustain the typical 30-year retirement.
A quick Google search of the “4% Rule” will turn up article after article debating whether or not it is broken and outdated. Recent research conducted by Morningstar suggests that 4% withdrawals will often be too high. Three analysts found that the historical variables that made Bill Bengen’s conclusion possible no longer apply in our current economic environment. These factors include:
Low bond yields
Yields on long-term bonds are historically low – under 3%, as compared to the 14% high in 1982. Coupled with rising inflation and the expectation that interest rates will also rise, many experts question how today’s bonds can sustain the traditional 4% retirement withdrawal rate.
High stock valuations
Stock valuations have also been historically high. From the 1870s to the 1980s, the U.S. stock market traded at very predictable values. Since 1990, however, stock valuations have skyrocketed. This has made it difficult to predict future returns (and safe withdrawal rates), since experts are unsure where the market as a whole is headed.
With inflation at record highs, the Fed has made a decision to increase interest rates. This affects the 4% Rule in two ways. First, inflation causes prices to increase, which erodes retirees’ purchasing power. A retirement nest egg that was worth $1,000,000 in 2010 is only worth $768,531 today. Secondly, increasing interest rates causes bond yields to drop even more, which puts a retiree’s investment portfolio even further behind.
Since past performance can’t be used to predict future returns, it’s important not to rely too heavily on research that is solely based on historical market performance. Instead, we think it’s better to reduce your exposure by using appropriate risk-reduction strategies in your portfolio.
If this article has you worried so far, don’t panic yet! The 4% Rule is just a guideline and it shouldn’t be the be-all, end-all strategy used in your retirement plan.
It’s important to keep in mind the context in which the 4% Rule was created. It was designed nearly 30 years ago by a single advisor! Its simplicity was what made it catch on so quickly. But that doesn’t mean it should be set in stone for all eternity. Just as our economic environment has changed dramatically over the last 30 years, it makes sense that the guidelines around safe withdrawal rates should change too.
At Washington Wealth Advisors, we focus on creating income in retirement so that you can avoid drawing down your assets for as long as possible. Our retirement strategies utilize income first, then capital gains, and the principal is used as a last resort. We will design a retirement withdrawal strategy based on your unique needs, so you can retire with confidence.
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Washington Wealth Advisors is a fee-only registered investment advisory firm serving busy families, executives, women building wealth, and small business owners. We provide Wealth Advisory Services—financial planning coupled with asset management—guided by a personalized investment strategy based on each client’s unique goals. Our fiduciary approach, independent advice, and proactive investment management help to support our clients’ overall financial peace of mind.
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