Letter to Our Clients - November 2015
Dear Clients and Friends,
Here is our version of a popular TV game show, where the “answer” is really “the question.”
Answer: The most quoted formula for determining how much an individual can withdraw each year in retirement from their investment accounts to have their money last their lifetime.
Question: What is the 4% rule?
Well, let’s ignore the game rules and move forward with question and answer.
Question: What is the source of this 4% rule?
Answer: In the 1990’s an investment professional named Bill Bengen was doing research on past investment returns, focusing primarily on stocks and bonds. He wanted to determine whether it was possible to identify a “safe withdrawal rate” for people in retirement, so that they could use their savings and investments in retirement and not worry about running out of money in their lifetimes. In 1994, he published his conclusions in one of the most influential articles ever written regarding financial planning. He determined that there was a basic 4% safe withdrawal rate, and that came to be known as “The 4% Rule.”
Question: What are the basics of the 4% Rule?
Here are the basic assumptions. You start with a “pot” of money. You invest 50% in the stock market and 50% in intermediate bonds. You withdraw from your account 4% in the first year, and increase that amount by a 3% inflation rate each year. You make no major withdrawals from this pot other than the 4% plus inflation. After 25 or 30 years (depending upon market conditions), you will be out of money, but that is OK, because you will be dead.
Question: What is the problem?
Answer: The article was published when the stock market was consistently generating double-digit returns, long-term interest rates were 2 to 3 times higher than they are now, and rates for money-market and bank savings accounts were 3% percentage points or higher than they are now. Inflation was still running about 4% or more a year. Projected lifespans were shorter then than now.
Currently the stock market remains near record highs, which many think will lead to mid-single digit stock market returns for several years (at best), or until there is another strong bear market. Interest rates are at record lows for long and short-term bonds, and for cash. Inflation officially is running at less than 2%. Lifespans are significantly higher now than in 1994. This calls into question whether a 4% plus inflation withdrawal rate (plus an inflation factor) will allow the average person’s retirement assets to last their lifetime.
Question: This is scary! What is one to do?
Answer: There is no easy answer. There is no “safe withdrawal rate.” Each person’s situation will be different, meaning that every person’s financial plan for retirement income needs to be uniquely built for them, and, most importantly, must be reviewed every year.
Question: Help! (We know, that is not really a question.)
Answer: Call us!
Thanks again for the opportunity to work with you. Please contact us any time we can be of assistance.
Best Wishes and Happy Holidays!
Robert K. Haley, JD, CFP®, AIF®
Theodore R. Haley, CFP®, AIF®