Does the 4% spending rule still make sense?

Does the 4% rule for retirement spending still hold true? Vanguard retirement expert Maria Bruno and Christine Benz of Morningstar talk about how retirees should go about creating a retirement spending plan. 

Other highlights from this webcast:

Notes:
All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.


TRANSCRIPT

Amy Chain: Let’s take a question that came from Hank in Naples, Florida. Hank, thank you for your question. Hank says, “What is the proper percent to be withdrawing each year from your retirement savings?” This is a big one that we get a lot too.

Christine Benz: This is a hot topic. And some of the most important research in financial planning has come down the pike in this area over the past few years. Investors are concerned that the old 4% guideline that they may have heard about is perhaps too lofty given that we’ve heard so many people saying, “Keep your expectations for market returns down.” So a group of financial planning researchers did a piece a couple of years ago where they suggested that perhaps 3% was a better withdrawal guideline given muted return expectations. It’s highly individual-dependent, and I think you want to keep a couple of key things in mind. One is the asset allocation of your portfolio. So certainly if you’re someone who has a more conservative portfolio, if you’re only comfy with a fairly heavy weighting in bonds and cash, then you should be a person who is taking a lower withdrawal rate. If you have a more aggressive asset allocation, you should be okay taking perhaps even a higher withdrawal rate than 4%. So keep in mind the asset allocation. Also keep in mind your time horizon. So older retirees some of them may say, “Well, I very much want to have money that I’m going to pass on to my children and grandchildren. It’s okay if I have to take less from my portfolio for me because that’s a priority for me.” For other older retirees who don’t have that bequest desire though, they may have good reason to take more, certainly, than 4% from the portfolio. They can comfortably take more than that if they’re in their 80s, for example. So it is highly individual-dependent. It’s also important to keep in mind that we’re talking about a couple of different things when we’re talking about withdrawal rates. So people might think, “Okay, 4%. You’re telling me that I should take 4% of my portfolio year in and year out.” And that’s really not what the 4% guideline says. The 4% guideline basically assumes that someone wants a fairly static standard of living in retirement. So you’re taking 4% of that initial balance and then giving yourself a little raise for inflation each year on that dollar amount. So that’s what underpins the 4% guideline. Other retirees might say, “Well, I’m okay taking that fixed percentage year in and year out.” Just know if that’s your strategy that that’s going to buffet around your quality of life quite a bit depending on how your portfolio performs.

Maria Bruno: And, I mean, we’re hitting the two big questions right out of the gate, I think, in terms of how do I draw down, both how much but also from where. Those are the two in my opinion and probably your experience as well. Those are typically the two biggest questions that we get from people in retirement. I think with both of them flexibility is key.

Christine Benz: Yes.

Maria Bruno: Because as Christine mentioned, it depends upon your goals and, you know, it’s not feasible to adhere to a very rigid spending pattern. You need to have some flexibility in terms of the markets and the impact to your portfolio. But then, also, expenses, unexpected expenses come up so there’s flexibility going to be there.

Christine Benz: What’s going on in your life. Yes.

Maria Bruno: Yes, exactly. We have done some new research at Vanguard that looks at dynamic spending, for instance, and the whole premise of that is—

Amy Chain: Explain what you mean by dynamic spending.

Maria Bruno: It’s exactly what we’re talking about in terms of setting a target, but having flexibility around that so to account for market volatility. So when the markets are up, you might be able to take a little bit more. Doesn’t necessarily mean you have to take all of that growth, but reinvest it in the portfolio which then gives you a buffer or a floor during the times when the markets may be a little bit more rocky. And I think many retirees actually do do that to the best that they can. So I think flexibility is key and we’ll probably use that word a lot tonight.

Christine Benz: Yes. Another thing to bear in mind, and we talked about how the retiree’s own expense pattern might vary over time, one of my colleagues has called it the retirement spending smile. So you’ve got the retiree who’s in his or her mid- or maybe even early 60s. Those are the go-go years of retirement typically. And maybe they extend well into the 80s. Every retiree is different, but typically those maybe that first decade is the high spending period of retirement. Then maybe it tapers off a little bit. The retiree is still active but maybe not doing as much intensive travel and not spending quite as much. And then, toward end of life, you may have accelerated healthcare expenditures which would cause the spending to increase again. And, of course, every retiree is different, but when we examine retiree spending patterns in aggregate, they oftentimes look like that.

Notes:
  • All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
  • This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.