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Opinion: Retirees Need Alternatives to the 4% Rule

David Lau
May 13, 2022


Opinion: Retirees Need Alternatives to the 4% Rule

For nearly three decades, many financial advisors have relied upon a total returns strategy to generate retirement income for their clients. According to this conventional wisdom, if retirees stay 50% to 75% invested in equities and withdraw 4% annually to fund spending, their nest eggs will be sufficient to get them safely through a 30-year retirement, regardless of market conditions. 

This 4% rule, created by financial advisor and researcher Bill Bengen in his famous 1994 study, is rational, historically proven advice. But here’s the thing: In today’s inflationary climate it’s super difficult to follow once you’re retired. How do I know that? Because the now-retired guy who invented it isn’t sticking to it. In a recent Wall Street Journal article Bengen, citing unprecedented economic conditions and high market valuations, recommended that retirees rein in their spending and lower their 4% drawdown. (A November 2021 Morningstar report endorsed a 3.3% withdrawal rate.)

That’s interesting. But the real eye-opener is that Bengen has adjusted his personal portfolio to 20% equities, 10% bonds and 70% cash—violating his own rule’s requirement to stay invested in at least 50% equities. This revelation should cause financial advisors everywhere to take note: Even the creator of the 4% rule did not abide by its fundamental tenet when the markets got tough during his own retirement.

I’m not criticizing Bengen. Retirement can be scary and these markets are tough, so whatever choices bring comfort are OK by me. But his example illustrates a larger point: It’s one thing to tell clients to swallow their worry and ride the market rollercoaster through retirement and it’s another thing entirely to do it. The 4% rule makes sense and, if nothing very unusual happens, you’ll be fine. It’s a great way for advisors to project security into a strategy built upon investments that carry inherent risk. 

But Bengen’s decision to curtail his lifestyle and move most of his portfolio to cash just nine years into his retirement illustrates how hard it can be for clients to be coldly rational and emotionally detached about financial decisions when it’s their retirement security at risk. It can be scary when the paychecks stop coming and the portfolio starts shrinking, and no amount of logic can silence these emotions and quell the desire for security.

Addressing a clients’ tolerance for income risk and desire for safety needs to start before retirement begins, with planning that takes into account their financial and emotional needs. For clients who have sufficient assets and can stomach market volatility, a probabilities-based total return strategy for retirement income may be the right approach for these times.

But for those uncomfortable riding out the markets, a guaranteed income component in the portfolio in the form of an annuity can help alleviate many of the fears Bengen expressed in the article—about running out of money, protection of principal and the harsh impacts of a bear market early in retirement. And, it can be far more productive to a retirement plan than moving to cash.

We can learn much from Bengen’s experience. His story underscores that retirement security is as much about taking into account emotional well-being as financial decision-making. When it comes time to discuss retirement income with your clients, determine their comfort level with income risk and offer strategies that align with their needs and desires. For many advisors that means expanding beyond just offering investments. Doing so will position retirees not only to endure, but enjoy, their retirement.