Broker Check

The 4% Rule is Outdated

January 05, 2022

If you have ever heard “the 4% rule,” you know that higher inflation and smaller returns mean that 4% could easily turn into 3.3% or lower. For retirees, the better approach could be to eliminate the 4% rule and take a more hands-on, dynamic approach to investing.

The main problem with “the 4% rule” is simply a rule of thumb. A rule of thumb can help people understand a complex, abstract process more easily, but it doesn't apply to every scenario. When so many people are leaving the workforce and living on their life savings - a symptom of the great resignation - the limitations of the 4% rule are little known.

What is the 4% rule?

The 4% rule, based initially on a sampling of thousands of potential market return scenarios, held that a same-age couple who retired at 65, withdrawing 4% from their retirement savings the first year and adjusting for inflation every year after, were unlikely to outlive their money. This, of course, assumes that they make no portfolio or spending changes for the remainder of their lives.

Unfortunately, this is simply not a realistic approach to retirement.

Finding the correct withdrawal rate for past Generations is even more critical now. A retiree could live off of income from bonds in the 1980s when they yielded an average of 4 to 5%. Today, they typically yield about 1.5% or lower. After factoring in inflation, the Returns on bonds are often negative.

Some retirees believe that investing more heavily in stocks will help make the difference because we have seen a long bull market over the past decade. Still, many retirement financial experts are concerned that short-term stock returns could be as little as 5%. This is about half of the historical average returns and less than the increase in the Consumer Price Index in 2021.

With negative overall returns on bonds and stock portfolio returns that are unable to outpace inflation, it's little wonder that many experts are beginning to reject the 4% rule.

How can today’s retirees avoid running out of money?

Naturally, many retirees today are concerned about running out of money. For those whose retirement savings are only in cash, Morningstar research predicts that for the next 30 years, they will be able to withdraw a maximum of 2.7% per year.

For those whose nest egg is completely invested in stocks, that number rises to 2.9%. Morningstar predicts that the highest “safe withdrawal rate” will be for those who have 40% to 60% of their portfolios invested in stocks. Those individuals may be able to safely withdraw up to 3.3% of their portfolios each year without the elevated risk of outliving their money.

If you’d like more insights to help you protect and grow your retirement savings, contact our team of professionals today.