Retirement planning: The truth about the 4% withdrawal rule

The truth about the 4% rule

It might be more wishful thinking than a rule


Jonathan Chevreau provided a good overview of the 4% retirement rule, while pointing out some of its problems, in a recent MoneySense article.

Put simply, the 4% rule describes the maximum initial annual withdrawal rate (subsequently adjusted for inflation) that “ensures” investors won’t run out of money over a 30-year retirement.

I’ve put quotes around “ensures” because there is nothing magical about 4%. The percentage was determined by looking at the historical record in the U.S. based on a portfolio that was equally invested in intermediate U.S. Treasuries and U.S. common stocks.

As Mr. Chevreau points out, the rule has been modified over years as new data rolled in. In addition, it has to be tweaked for those who retire early and for investors who use different asset mixes.

Unfortunately, the 4% rule might be more wishful thinking than a rule because it fails when applied in many countries, according to Wade Pfau. He wrote that, “With a 50/50 asset allocation, the 4% rule did not survive in any country, though it came very close in the U.S. (3.94%) and Canada (3.96%). Even allowing for a 10% failure rate, 4% made the cut only in Canada, the U.S., New Zealand, and Denmark.”

He goes on to say, “In eleven of twenty countries, the SAFEMAX fell below 3%. […] Shockingly, the 4% rule would have failed more than half of the time for countries including Spain, Germany, France, Italy, and Austria. Italians attempting to use the 4% rule in their domestic financial markets would have actually faced failure in 76% of the historical periods.”

Compounding matters there is no saying that world markets will perform similarly in the future. It might turn out that the twentieth century was an unusually good one for investors and that following periods might not be so generous.

As a result, those who follow the 4% rule – or even a more conservative 3% rule – might be gambling with retirement ruin. At a minimum they should be prepared to tighten their belts should the markets turn against them.

Safer Canadian Dogs

Investors following the Dogs of the Dow strategy want to buy the 10 highest yielding stocks in the Dow Jones Industrial Average (DJIA), hold them for a year, and then move into the new list of top yielders.

The Dogs of the TSX works the same way but swaps the DJIA for the S&P/TSX 60, which contains 60 of the largest stocks in Canada.

My safer variant of the Dogs of the TSX tracks the 10 stocks in the index with the highest dividend yields provided they also pass a series of safety tests, such as having positive earnings. The idea is to weed out companies that might cut their dividends in the near term. Just be warned, it’s a task that’s easier said than done.

Here’s the updated Safer Dogs of the TSX, representing the top yielders as of January 16. The list is a good starting point for those who want to put some money to work this week. Just keep in mind, the idea is to hold the stocks for at least a year after purchase – barring some calamity.

Name Price P/B P/E Earnings Yield Dividend Yield
Emera (EMA) $45.65 1.69 18.38 5.44% 4.58%
CIBC (CM) $110.66 1.96 10.32 9.69% 4.48%
Power (POW) $30.20 1.11 15.05 6.65% 4.44%
TELUS (T) $44.01 3.14 18.57 5.39% 4.36%
Shaw (SJR.B) $27.91 2.51 12.4 8.06% 4.25%
National Bank (NA) $55.23 1.94 16.69 5.99% 4.06%
Fortis (FTS) $41.36 1.47 22 4.55% 3.87%
Bank of Nova Scotia (BNS) $77.37 1.77 13.32 7.51% 3.83%
Bank of Montreal (BMO) $98.23 1.65 14.13 7.08% 3.58%
Royal Bank (RY) $94.27 2.18 13.86 7.21% 3.52%

Source: Bloomberg, January 16, 2017


Price: Closing price per share

P/B: Price to Book Value Ratio

P/E: Price to Earnings Ratio

Earnings Yield: Earnings divided by Price, expressed as a percentage

Dividend Yield: Expected-Annual-Dividend divided by Price, expressed as a percentage

As always, do your due diligence before buying any stock, including those featured here. Make sure its situation hasn’t changed in some important way, read the latest press releases and regulatory filings and take special care with stocks that trade infrequently. Remember, stocks can be risky. So, be careful out there. (Norm may own shares of some, or all, of the stocks mentioned here.)

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