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Over the half decade I’ve written this column and attempted to practice what it preaches, a central pillar has been the so-called 4% Rule. As originally postulated by Certified Financial Planner and author William Bengen, that’s the rule of thumb that retirees can safely withdraw 4% of the value of their portfolio each year without fear of running out of money in retirement. (That’s the gist, although you have to make adjustments for inflation.)
Problem is, with “lower for longer” interest rates and the spectre of negative interest rates, is it still realistic for retirees to count on this guideline? Personally, I find it useful, even though I mentally take it down to 3% to adjust for my own pessimism about rates and optimism that I will live a long, healthy life. I polled several sources to see if they still believe in the 4% Rule, or whether a 3% or even 2% rule might be more appropriate now.
“I think the 4% Rule is a reasonable rule of thumb,” says financial planner Aaron Hector, vice-president of Calgary-based Doherty & Bryant Financial Consultants. “If someone needed a starting point to determine how much they can take out of their portfolio, it is a reasonable place to start. Is it perfect for all people? No!”
However, fee-only planner Robb Engen, the blogger behind Boomer & Echo, is “not a fan of the 4% Rule.” Moreover, he says, Canadians are forced to withdraw increasingly higher amounts each year once we convert our RRSPs into RRIFs, so the 4% Rule is “not particularly useful, either.” RRIF withdrawal requirements, which begin at 5.28% of the value of your RRIF at age 71, rising steadily until it hits 20% at age 95, make the rule more or less moot. However, Hector counters that “as RRIF withdrawals progressively increase and become much higher than 4%, the excess withdrawn can be reinvested into TFSA or non-registered accounts.” As such, he says the 4% Rule should be viewed as a “spend” rule, not necessarily as a strict withdrawal rule.
Still, Engen thinks the rule doesn’t hold up because current bond yields are so low, and the rule fails to account for rising expenses and investment fees. “We’re also living longer, and there’s a movement to want to retire earlier. So shouldn’t that mean a safe withdrawal rate of much less than 4%?”
Spending varies over a typical retirement. It may make sense to withdraw more than 4% early on if you’re postponing CPP and OAS to 70. Once those kick in, you may decide to withdraw (or “spend,” in Hector’s view) less than 4%.
It’s best to be flexible. That may be intuitively obvious, but if your portfolio is way down, you should withdraw less than 4% a year. If and when it recovers, you can make up for it by taking out more than 4%. “This might still average 4% over the long term but you are going to give your portfolio a much higher likelihood of being sustainable.”
Still, some experts are still enthusiastic about the rule. On his site earlier this year, Robb Engen cited U.S. financial planning expert Michael Kitces, who believes there’s a highly probable chance retirees using the 4% Rule over 30 years will end up with even more money than they started with, and a very low chance they’ll spend their entire nest egg.
The problem lies in the data and testing for the absolute worst case scenarios, which, in Bengen’s research, included the Great Depression. Engen says: “Bengen looked at rolling 30-year periods to test the safe withdrawal rate, and found the worst case scenario was retiring right before the Great Depression in 1929.”
Even with that terrible timing, retirees could safely withdraw 4.15% of their portfolios. Kitces broadened the data set and found two more “worst case scenarios” that included 1907 and 1966. Even so, the average safe withdrawal rate throughout every available period was 6% to 6.5%. “Even more remarkable,” Engen says, “when starting with a $1-million portfolio and using the 4% Rule, retirees finished with the original million 96% of the time.”
Other advisors think retirees need to get more comfortable with risk and tilt their portfolios a little more in favor of equities. With near zero returns on bonds, more capital is required to deliver comparable incomes, says Adrian Mastracci, fiduciary portfolio manager with Vancouver-based Lycos Asset Management Inc. Spending too quickly can put retirement in jeopardy, so he views 4% as “likely the safe upper limit for many of today’s portfolios.” Like me, he sees 3% as offering more flexibility for an uncertain future.
While some advisors suggest retirees have roughly a 50/50 mix of stocks and bonds, or even err on the side of a cautious 40% stocks to 60% fixed income, at today’s puny interest rates, Mastracci suggests going the opposite direction and “moving the venerable balanced asset mix toward the 70% equity ballpark.… Becoming more conservative during retirement is a mistake. Asset mix choices make the biggest impacts on investment outcomes. Low returns may linger near zero longer than investors realize.”
Once you’re dependent upon investment returns, even a 5% drawdown rate may not be sufficient—particularly in your 90s, when families incur high health costs or need funding for a retirement home suitable for at least one spouse. “In many cases, beneficiaries have to accept inheriting smaller estates.”
Wealth Advisor Matthew Ardrey, vice president with Toronto-based TriDelta Financial, sees three alternatives to accepting low fixed-income returns. While fixed income has had a good year so far in 2020, new bond issuances will be at increasingly lower rates of interest. Retirees need to consider alternatives to sacrificing lifestyle by reducing withdrawals.
One asset he suggests is High Yield Bonds. Because these are corporate issues and entail higher risk, they fluctuate like equities. Alternatively, dividend-paying blue-chip stocks can provide yields of 5% or more. “If the retiree can ignore the fluctuations and just reap the dividends, this can provide some much needed yield.”
Further afield are Alternative Income Investments, which invest in private debt, real estate and infrastructure, and are not highly correlated to stocks. These yield 7% to 9% net of investment costs, but are less liquid, with redemption periods from 30 to 180 days. Income is paid monthly or quarterly.
In short, Ardrey concludes, retirees do not need to get more conservative about the 4% Rule, but they do need to recognize the investing landscape has changed for the foreseeable future. And investors must change with it.
MoneySense Investing Editor at Large Jonathan Chevreau is also founder of the Financial Independence Hub, author of Findependence Day and co-author of Victory Lap Retirement. He can be reached at [email protected]