THE 4% RULE PROBLEM 2018-10-03T13:41:33+00:00
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The Big Problem with The 4% Rule

The financial industry provides thousands of strategies for retirement investing, but typically only one recommended withdrawal strategy known as “The 4% Rule.” Still largely the standard for typical financial advisors, the problem with The 4% Rule is that it’s based on market conditions in the U.S. during a very specific time in history, specifically, the 1990’s. It also doesn’t take into account investment costs, taxes, timing or the fact that retirees don’t usually spend their money in the same linear fashion. It works like this: the retiree withdraws 4% of their account balance at the time of retirement and takes it in 12 monthly installments, repeating each year for 30 years. Assuming a steady, inflation-adjusted income from a U.S. equity-weighted, balanced portfolio of stocks and bonds, it also assumes that the remaining balance will continue to grow, providing enough income for this static withdrawal percentage each year for 30 years. Too many assumptions, not enough sense.

The Big Problem with The 4% Rule

The financial industry provides thousands of strategies for retirement investing, but typically only one recommended withdrawal strategy known as “The 4% Rule.” Still largely the standard for typical financial advisors, the problem with The 4% Rule is that it’s based on market conditions in the U.S. during a very specific time in history, specifically, the 1990’s. It also doesn’t take into account investment costs, taxes, timing or the fact that retirees don’t usually spend their money in the same linear fashion. It works like this: the retiree withdraws 4% of their account balance at the time of retirement and takes it in 12 monthly installments, repeating each year for 30 years. Assuming a steady, inflation-adjusted income from a U.S. equity-weighted, balanced portfolio of stocks and bonds, it also assumes that the remaining balance will continue to grow, providing enough income for this static withdrawal percentage each year for 30 years. Too many assumptions, not enough sense.

We created the new TRUTM Method by throwing out the old one.

In retirement planning the big challenge is in analyzing the valuation of the portfolios at the time of retirement, which will then serve as the baseline for setting a reliable income that will last a lifetime but not be too little or too much.

Our goal was to avoid a “Downside Failure,” where the selected withdrawal rate was too high, resulting in the premature depletion of the retirement portfolio; or conversely, an “Upside Failure,” where higher than average returns mean the retiree could have taken more income than they did without depleting their portfolio during their lifetime. Complicated stuff, right? But we knew there had to be a better way. Looking at 200 years of actual market production and valuations, we discovered critical “gaps” in the valuation of investment portfolios and the actual withdrawal rates that would make the most sense for retirees needing to keep a steady retirement paycheck.

To overcome these gaps, we mathematically engineered a calculation that seeks to optimize your regular retirement paycheck by constantly adjusting your portfolio over the course of your retirement to reflect changing market rates and economic factors. The goal is to create a consistent, reliable and optimal paycheck you can count on throughout the life of your retirement.

Meet Rick and Linda, two identical hypothetical retirees.*

Each has a portfolio balance of $1,000,000 and each is entirely invested in the same 4% rule compliant investment fund. Rick retires immediately and withdraws 4% ($40,000) per year with a 3% annual inflation adjustment. Linda waits to retire 3 years later. During that 3 years, there is a significant market drop and Linda’s original $1,000,000 portfolio is now worth $600,000. Rick has faced the same drop, but because he has already taken 3 years of income, his balance is only around $510,000. Under the 4% Rule, Rick is expected to continue to withdraw over $40,000 annually. Under the same 4% Rule, Linda may now start taking her income at only $24,000 (4% of $600,000).

Linda is taking far less income, yet she now has considerably more money even though they have an identical investment portfolio (Linda could be withdrawing more than 4%). Both Rick and Linda each face problems now. Rick may run out of funds early (4% is too high) and Linda may not be able to enjoy the kind of retirement she hoped for because they both believed 4% to be their optimal withdrawal rate.

In cases where the chosen static withdrawal rate proved to be too high (Rick), the result was premature depletion of the retirement portfolio. In cases where the static withdrawal rate proved to be too low (Linda), failure to maximize income may result in unnecessary sacrifices to lifestyle choices.

Conversely there are other instances, where returns in the earlier years of retirement are higher than average, similar to Linda’s outcome, there is an unnecessary compromised standard of living, as the retirees eventually learn they could have successfully taken much more income without depleting the portfolio during their lifetime.

*For illustrative purposes only.