Many advisors still rely on the outmoded 4% Rule to help people plan for retirement income. In our opinion, the 4% Rule is responsible for destroying more people’s retirement than any other piece of financial advice.
The 4% Rule goes like this: stocks have averaged around 8.5 percent for the last 100 years. Bonds have averaged around 4.5 for the last 35 years. Let’s be really conservative, and draw 4% from your assets for as long as you live, and you should be fine.
This works beautifully in a bull market. When we move into a flat market cycle, not only does it not work, it could actually destroy your retirement.
Let’s look at an example. Hypothetically, you and your spouse wanted to retire with $100,000 a year income for as long as you live. The banker or broker using the 4% Rule advised that you needed $4 million to retire. The banker got that number by dividing the $100,000 figure that you said you needed as income by the risk free rate of 3%, to equal $3,300,000, meaning that you will need between $3 million and $4 million to retire. Let’s play make believe and say you worked hard and retired with that $4 million on January 1, 2000 — the beginning of our latest flat market cycle.
We’ll use S&P returns to show how you did with your 4 million bucks.
In the first three years of retirement, you lose half your stock money like most people did. However, you lose more than half since you are drawing 4% per year for three years. You’re down about 62 percent going into 2003, but there’s good news; from 2003 to 2007, the market’s double. However, you don’t get this double because you’re drawing 4% a year out of ’03, ’04, ’05, ’06, and ’07.
Then, you take the devastating stock market hit of 2008 — around 37 percent loss, plus your annual income withdrawal of 4%. You’re down over 40 percent in a year. Now, you no longer have the assets to stay retired. Sadly, the 4% Rule and asset allocation investing with buy-and-hold strategies for your risk money has taken you out.
Game over.
We all watched this happen to millions of people. The gray-haired people came back to retail, fast food, Wal-Mart, and banks. They had to sell their home and move in with their kids. They had to have a plan B. It was tragic and, in our opinion, unnecessary.
William Bengen, who invented the 4% Rule, publicly retracted it in 2009 saying that it does not work in a flat market and with record low interest rates. He called it dangerous and said that he, personally, would not use it. Yet, the bankers and brokers still use the discredited strategy today as their strategy to distribute income in your retirement years.
