Many financial experts suggest that withdrawing 4 percent of your savings each year adjusted for inflation will make your savings last the rest of your life. But you should think through whether you can actually implement the 4 percent withdrawal rule, which involves spending the same percentage whether the market tanks or soars. Here’s why the 4 percent rule may not work for you.
You will probably want to spend less when your investments perform poorly. The safe withdrawal rule involves taking out the same inflation-adjusted amount each year, even when your investments lose value. But it can be uncomfortable to continue spending freely if your nest egg balance drops severely, especially once it dips below the initial amount you had at retirement. Almost everyone will start spending less well before the portfolio gets into serious trouble, which bodes well for portfolios surviving periods of low returns, but it’s not following the 4 percent rule.
You might want to invest more conservatively in retirement. The safe withdrawal rate is calculated based on a fixed asset allocation throughout retirement. But many experts suggest increasing your bond allocation in retirement because most people need stable portfolio values to combat the decreasing ability to earn a living as you age. Investment advisors seldom suggest fixing the stock and bond mix for the duration of retirement, but the 4 percent safe withdrawal rate depends on this crucial fact. You will need to decide whether you want to change your asset allocation to become more conservative as you age in order to protect your assets or whether you will be able to stick to a more risky asset allocation for multiple decades.
The 4 percent rule requires annual rebalancing. To follow the 4 percent rule exactly you need to rebalance at the end of each year without fail. Some people prefer to rebalance on their birthday, with dividends or when valuations get out of whack. These other strategies can work too, but they’re not the 4 percent rule.
You need to spend an inflation-adjusted amount every year. Some people may have a completely linear spending pattern, but most people have lean years and times when they spend much more than usual. You could have a medical emergency or need to repair your car or replace your roof. Spending the same amount adjusted for inflation each year is likely to be impossible.
Your costs might not go up each year. You may not need to take inflation adjustments each year in retirement. I find it annoying to pay more for the same thing after it goes up in price. I know that’s just inflation, but I would rather skip the expense than keep paying more for the same thing. And I’m not alone either. Many people find they spend a similar amount of money year after year in retirement by adjusting their spending. Obviously, this is great news in terms of portfolio viability. Choosing lower cost alternatives instead of trying to keep up with inflation can help your savings last longer.
There’s no predicting how your investments will perform. It’s impossible to know the safe withdrawal rate for people retiring today in advance. This can be an uncomfortable thought for those thinking about retirement, but there’s also the potential for upside surprises as well. If shifting your safe withdrawal rate from 4 percent to 3.8 percent helps you sleep better at night, it might be worth considering.
The 4 percent rule requires that you follow a strict set of guidelines. But it can be more useful to remain flexible in retirement and take additional precautions to insure your savings will last the rest of your life. Skipping a few inflation adjustments and adjusting your spending when costs go up can both do a lot to help your savings last longer. Take this into account next time you are worried your nest egg won’t last.
David Ning is the founder of MoneyNing.com .
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Why the 4 Percent Rule is Difficult to Follow originally appeared on usnews.com
