Here are a few paragraphs from my newest book about the 4% retirement withdrawal “rule” and something called “Sequence of Returns Risk”. But before you read them, watch this 60 second video, OK?
“In 1994, financial planner, William Bengen developed the 4% rule. It quickly became the guiding “formula” used by both professional advisors and do-it-yourselfers for about 2 decades.
The 4% rule (or theory) says that at retirement, with a portfolio of 60% stocks and 40% bonds, one could withdraw 4% of the initial savings (and increase it by inflation every year) and the retiree would have a 90% chance of his income continuing for 30 years and that the savings would not be completely depleted until the end of those 30 years.
By the way, a 100% stock or a 100% bond portfolio has less than a 60% chance of lasting 30 years. Under most long-term market scenarios (back-testing), a 60%/40% seems to be best.
So for example, someone with $1 million at retirement could withdraw $40,000 the first year. If inflation was 3% that year, the second year they could withdraw $41,200. That growing income could conceivably last for 30 years until the savings and income stream would be all gone. Of course, it’s even possible that your account would be larger than one million in 30 years.
If you got on a plane and the pilot announced the good news “that there is only a 90% chance of landing safely at your destination”, would you get off that plane?
Given the two extreme bear markets in the 2000’s and the coming end to the 30 year long bull market in bonds, (assuming you believe that interest rates will eventually rise to more normal levels as investors will demand higher returns from riskier borrowers as government, corporate and all other types of debt continues to skyrocket) — Mr. Bengen has apparently all but repudiated his own theory.
In fact, it wasn’t too long ago when he told a financial magazine that he would probably not use the 4% rule for his own retirement now.
The reason this theory is not used very much lately (except by “planners” who have not been keeping up with academic advances in financial planning) is largely due to something called “sequence of return” risk. I’ll be writing a lot about this investment risk in the pages that follow.
Basically, sequence of return risk is that stock losses early in your retirement can have a very profound effect on whether you outlive your money or not. But for now, I’ll leave it at that. However, this will be a recurring theme throughout the book.
Morningstar has since (2013) come out with its 2.8% rule (replacing the much more aggressive 4%) saying that it is the withdrawal rate a 60%/40% (stock/bond) portfolio could reasonable rely on for a 30-year retirement. That means that a $1,000,000 retiree could withdraw $28,000 their first year in retirement and have that figure grow by inflation.
In an article in the Wall Street Journal in 2013 entitled “Say Goodbye to The 4% Rule”, they suggested a 2% initial withdrawal rate would safely bring someone through a 30-year retirement. Do you see a pattern here?”
The information gets much better from there, but that’s enough of a taste of it to give the video a little more meaning.
All the best… Mark
PS – you can get your own copy from Amazon by clicking here: www.MarksNewBook.com
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