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Strategies for a successful retirement

Why the 4% Rule Sucks

The 4% rule, which proposes that retirees can safely withdraw 4% of their retirement portfolio's initial value annually, adjusted for inflation each year, is a reasonable place to start, but it doesn't fit every investor's situation.

Below are key reasons why the 4% rule may not be suitable for every investor, along with additional considerations to help retirees find a more personalized approach.

• You might have more or less years: The formula is based on a 30 year horizon. However, retirement age is changing. People are living and working longer, which means you may have more or less than 30 years to enjoy retirement. The average remaining life expectancy of people turning 65 today is less than 30 years, which means you might be able to go for a higher rate. Similarly, people who retires at a very young age may have more than 30 years to enjoy after retirement, which makes the 4% rule not suitable.

• Unreliable data: Analysis by Charles Schwab Investment Advisory, Inc. (CSIA) projects that market returns for stocks and bonds over the next decade are likely to be below long-term historical averages. Thus, it doesn’t give a true picture of what’s to come. Most experts agree that this data offers an unreliable or high withdrawal rate.

• It's a rigid rule: The 4% rule is based on assumptions, i.e.: that you will increase your spending every year by the rate of inflation. It doesn’t link spending to your portfolio performance. Furthermore, it assumes that you never have years where you spend more, or less, than the inflation increase. Most people do not follow this formula and it is common for expenses to change year after year during retirement.

• It applies to a specific portfolio composition: The rule is for people who have invested 50% in stocks and 50% in bonds. There are very few such people. Most investors have a diversified portfolio, which makes the rule unsuitable for most.

• It neglect costs: The rule presumes that any applicable taxes or fees are expenses covered by the withdrawn funds. For instance, if you withdraw $50,000 and incur $4,000 in taxes and fees by the year's end, these costs are deducted from the $50,000, resulting in a reduced amount available for spending. 

• Ignoring market volatility and sequence of returns risk: One significant drawback of the 4% rule is its failure to account for market volatility and the impact of sequence of returns risk. This risk refers to the order in which returns on your investments occur. If the market takes a downturn early in your retirement, it can erode your portfolio's value faster than expected, especially if you are withdrawing 4% regardless of how well or poorly the market performs. Adjusting withdrawals based on portfolio performance, rather than following a rigid rule, can help mitigate this risk.

• Limited flexibility for lifestyle adjustments: The 4% rule assumes retirees maintain the same spending habits year after year, merely adjusting for inflation. However, spending needs often change throughout retirement. Early retirement years may be filled with travel or other lifestyle costs, while later years might see higher healthcare expenses. A flexible approach to withdrawals allows retirees to align spending with their actual needs and life stages rather than sticking to a static percentage.

• Ignoring other income sources: Many retirees rely on more than just their investment portfolio for income; Social Security, pensions, annuities, or part-time work are all common additional income sources. The 4% rule doesn’t account for these and may, therefore, lead to overly cautious or aggressive withdrawal rates. Considering these income streams can help tailor a withdrawal strategy that better reflects an individual's unique financial picture.

So, look at your situation and think of a rate that works for you. Also, do not shy away from changing the rate as your situation changes.

Finding Your Unique Approach to Retirement Withdrawals

Rather than relying on a one-size-fits-all rule like the 4% withdrawal rate, retirees should consider a flexible approach that adapts to their lifestyle, portfolio, and economic circumstances. Strategies like the guardrails approach, dynamic adjustments, and the bucket method all offer customizable alternatives to traditional withdrawal rules. Retirees should feel empowered to explore these options, possibly with the help of a financial professional, to create a sustainable plan that evolves with their needs over time. This way, they can enjoy a more secure and fulfilling retirement that reflects their unique goals and resources.

Here’s a video with some interesting information:

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Nothing in this newsletter is financial advice. Always do your own research and think for yourself.