Does The 4% Withdrawal Rule Really Work?

Does The 4% Withdrawal Rule Really Work?

What if I told you one of the most common guidelines people use to plan for retirement is wrong? Further, what if I told you that making the mistake of following it can greatly impact the quality of life you live in retirement and the longevity of your savings?

Well, here goes.

More than 40 years ago, financial adviser William Bengen developed what is known as the “4% withdrawal rule.” This rule of thumb states you can withdraw 4% of your portfolio in the first year of retirement, adjust the amount withdrawn each year for inflation and safely avoid running out of money over three decades. (After further study, he later modified it to the “4.5% rule,” but still rounded it down.)

A great deal of thought and stress is put into planning and executing an appropriate withdrawal strategy. It’s arguably the most important factor for financial success in retirement. Taking out too much from your savings will lead to a shortage in your later years and potentially put your retirement at risk. On the other hand, spending too little could mean a lower standard of living than you want, or not fulfilling some of your retirement dreams.

Of course, by definition, rules of thumb are never meant to apply in all situations. However, it can be argued the hard, inflexible 4% rule shouldn’t be given much consideration to begin with.

The issue with inflation
The biggest flaw is in its annual inflation adjustment. Outside of health care, most retirees won’t see their expenses dramatically rise. In fact, overall expenses typically decline in retirement. According to the latest data from the Bureau of Labor Statistics, people ages 55 to 64 spend on average $60,076 per year, while people ages 65 and over spend $45,221, which is $14,855 less each year.

That’s why, in all my years as a financial adviser, I’ve seen very few, if any, clients give themselves a pay increase every single year.

The impact of market volatility
Furthermore, it’s important to be mindful of market conditions. For instance, it’s generally not a good idea to increase your withdrawal amount during a market downturn. Instead, you may want to consider a small, temporary cut. Especially, during a deep recession along the lines of 2008. In a best-case-scenario, this simply means making a few sacrifices, such as substituting a trip closer to home for a big vacation overseas. Other times, you may have a big, one-time expense to plan for. This is what I call a dynamic, or flexible, withdrawal rate.

The lack of flexibility
The reality is the 4% rule isn’t dynamic, so it doesn’t accurately reflect real-life spending habits. As in your working years, your income needs throughout retirement will also change. Early in retirement, you’re more likely to be active with travel, new hobbies, working on your home and other activities. So you may want or need more money. Over time, you’ll probably cut back on these big-ticket items for smaller, less expensive ones. Though by then medical expenses may begin to creep up. But, in a period where you have high medical costs, you will likely have reduced expenses in other areas.

One possibility: Dig deeper to start with
If you don’t anticipate your expenses, as with the average retiree, to rise as swiftly as inflation does, you may want to plan on withdrawing more than 4% in the early years of retirement. If you run a Monte Carlo simulation — a tool for assessing the probability of a portfolio’s survival — in your retirement plan, adjust the rate of inflation down and you’ll find that a withdrawal rate of 5% – 5.5% still leads to a high level of success. But Monte Carlos don’t accurately reflect real life. They don’t show the human element of making a smart adjustment to your withdrawals when markets drop.

Is an extra 1% really a big difference? Absolutely. For example, if you calculate that you need $54,000 in income from your personal savings in retirement, at a 4.5% withdrawal you would need to save $1.2 million to retire. But at a starting dynamic withdrawal rate of 5.4%, you would only need $1 million. For someone saving $1,000 per month during their later working years and earning 6%, you’d be able to retire a little more than two years earlier. Or, you could take the stance that you’d work and save the same length of time but have an extra $1,000 per month in cash flow.

If you’re a Nervous Nellie
However, with longer life expectancies and historically low bond yields, some may consider even 4% excessive. If you’re nervous about the risk of outliving your savings, you’re not alone. In a survey by financial firm Allianz, 61% of Baby Boomers said they are more afraid of running out of money before they died than death itself.

Fortunately, there are steps you can take to calm your nerves without making extreme lifestyle changes. One option is to simply build a larger nest egg, which may mean extending your retirement date or saving more during your working years. Or, you may be more comfortable starting with a lower withdrawal rate, provided all your expenses are covered. Then, you can gradually increase your rate as you become more confident in the survivability of your portfolio. With either option, the worst that can happen is you end up leaving a bigger financial legacy.

The bottom line
In any case, it’s safe to assume that you’re not going to put your spending on auto-pilot in retirement. With a little flexibility and planning, you can broaden your income options in your favor.


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Unlock the Mystery of Financial Success

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Most people waste a lot of time and energy seeking the one investment to solve all their financial worries. They want to unlock some secret that only rich people know about, thinking if they just knew that one magical place to put their money, it would make them wealthy, too.

I hate to break it to you, but that’s not how it works. The truth is that there is no perfect investment that will, without question, make you rich without time or effort.

But you could say there is a secret that the wealthy know that you don’t. You might not believe me, because it’s so incredibly simple. It’s not easy, however, or for the faint of heart.

The One-Word Secret to Wealth

Ready to know what the best-kept secret to financial success is?

It’s consistency.

See, I told you it was simple. But again, it’s not easy. You need to consistently make the right moves with your money day after day, week after week, year after year.

The good news is that anyone can do it, because this is more about what you do with the money you make, rather than the amount of money you earn. It just takes a ton of commitment, discipline, motivation and determination to take the right steps at every turn.

Financial success comes from consistently making smart decisions with your money, and then following through on those choices with your actions.

Consistency on the road to financial success looks like:

Saving and investing large percentages of your income (20% is a good target to reach for; 30% should be your minimum if you’re looking to grow serious wealth).
Spending in a way that aligns with your values. In other words, you use money only to gain what’s truly important to you and don’t waste resources on status symbols or material goods that don’t make you happy.
Keeping expenses low, even as your income rises, to avoid lifestyle creep at every stage of your life.
Avoiding big financial mistakes, like buying too much house or taking on loads of credit card debt.
Choosing an investment strategy that aligns with your needs and goals — and then sticking to that strategy over time (which will also require that you manage yourself and your emotions, and avoid making irrational decisions when markets get volatile).
All of this can be easy to do once. The challenge comes in always making the smart, rational decision in the context of real life, where emotions and distractions abound.

Chasing financial success by looking for quick and easy solutions (rather than doing the hard work described in the list above) is kind of like committing to run a marathon — and then spending all your time leading up to the race searching for the best running shoes available.

If you don’t put in the work, run the miles, eat the right stuff and avoid injuring yourself in the months leading up to your marathon, the best shoes in the world can’t do you a bit of good.

The same is true of reaching the level of wealth you want. It’s not one big, exciting move that you make. It’s all about putting in the miles, day after day after day.

Of course, there are exceptions. We all know (or have heard of) that one person who came into a massive inheritance, or who lucked out by picking the right stock at the right time, or who had a business idea that was worth millions. But most people don’t hit upon the combination of factors — which includes a heaping amount of luck — to “strike it rich.” Most of us, myself included, have to get good at consistently taking the right actions over time.

The Challenge of Being Consistent

If you know consistency is the key to financial success, and you also know it’s really hard to stay consistent out there in the real world — where you need to deal with distractions, competing priorities, your emotions and more — how can you ever stay the course long enough to build wealth?

You can do it yourself. You can set up a structure or a routine for yourself that you commit to following. Then you can be disciplined enough to stick to it over the years.

It’s just like going to the gym. You probably know someone who is completely committed to a specific exercise regimen and never misses a day. That doesn’t mean they don’t deal with distractions and emotions like the rest of us do.

You probably know how tough it is to commit to consistently working out if you’ve ever tried to stick to a routine but started to struggle to even make it to the gym by day three. Even if you manage to get there, you have to then spend a lot of energy to think about what you’re going to do. You may feel uncertain about the best routine, or not confident that the exercises you’re doing are going to eventually get you to your fitness goals.

After you commit to just doing something, you then have to push yourself hard enough to get the benefit of the workout (which is also tough, because your brain would prefer you coast instead of pushing yourself to the max).

On top of all this, you then have to figure out what to do once you leave the gym. Do you drink a protein shake? Is that over the top? What do you eat day to day to support the work you put in?

Clearly, all this is a lot of work, a lot of thinking and a lot of decision-making. And if you want those six-pack abs, you need to make all the right decisions and actions not just once but over and over again.

This is why personal trainers exist. They take the guesswork out of the process and give you a clear, straightforward structure to follow to get you from where you are to where you want to be. Not only do they coach you on what to do and how to do it, but they can push you to do more (and better) than you might be able to achieve if you were working out on your own.

How to Create Consistency in Your Financial Decisions

The financial planning you need to do to succeed works in the same way. Yes, you can do it yourself — just like you can go to the gym yourself — but it gets much easier when someone is there to help you. Financial planners can give you the structure, process and guidance you need to grow your net worth and build wealth.

An adviser who provides comprehensive financial planning will also provide accountability, teach you proper technique and give advice tailored to your situation — just like your personal trainer does at the gym.

It gets easier to be consistent with your financial decisions (and the actions required to back them up) if you get the accountability you need to stay on track for as long as it takes to meet your most important goals.

Just like training for a marathon, financial planning is a process. It’s not sexy or flashy or about the one magical thing that will allow you to breeze your way to your goals.⠀

Financial planning is about adjusting habits, making smart decisions and training consistently over a period of time. When you follow a structured process that keeps you “in your lane,” you see results.


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