Podcasts Business Retirement Starts Today Improving the 4% Rule, Ep # 193

Improving the 4% Rule, Ep # 193

Published: May 24, 2021, 8 a.m.

I\u2019m sure you\u2019ve all heard about the 4% rule for retirement planning. This rule is great for speculating your likelihood of success, but it isn\u2019t always the best rule to follow in practice.\xa0

Druce Vertes at\xa0AdvisorPerspecives.com\xa0offers a different approach to implementing the original 4% Rule. On this episode of Retirement Starts Today, we\u2019ll dive into his technical article which explores the idea of making the normally rigid 4% rule more flexible to maximize spending for different levels of risk aversion.

I\u2019m always looking for innovative ways to help you turn your retirement portfolio into income and that\u2019s exactly what we\u2019re\xa0exploring\xa0this week. Tune in to hear how to tweak the 4% rule and maximize your spending in retirement.\xa0

Outline of This Episode
  • [2:52] Infinite risk aversion
  • [9:04] Constant relative risk aversion
  • [14:06] Thoughts on 401K rollovers
What exactly is the 4% rule?

The original 4% rule was theorized by Bill Bengen in the 1990s. This rule is handy for napkin math but doesn\u2019t allow much flexibility and it may be overly cautious.

The 4% rule states that you can invest an equal amount in stocks and bonds and withdraw 4% of your starting portfolio during each year of retirement. As long as you adjust for inflation each year, you would never exhaust your money over the course of a\xa030-year retirement. Have you used the 4% rule to help you calculate the likelihood of financial success of your retirement?

How can one make the 4% rule more flexible?

Our retirement headline this week is titled\xa0Beyond the 4% Rule: Flexible Withdrawal Strategies Using Certainty-Equivalent Spending.\xa0It examines what would happen if we explored options beyond Bengen\u2019s 4% rule. It asks, what\xa0flexible\xa0rules would maximize spending for different levels of risk aversion? The author used the programming language\xa0Python\xa0to maximize certainty-equivalent spending. This led him to three generalized rules based on one\u2019s risk tolerance.\xa0

3 rules for 3 separate risk tolerance categories

For those that are completely risk-averse, Bengen's 4% rule is the safest bet. The fixed constant withdrawal level never experiences a shortfall or reduction in withdrawals.\xa0

The next category is for those who don't mind plenty of risk in their portfolio. This is why this rule is not recommended for most people. It finds the withdrawal amount that historically maximized spending irrespective of market volatility. This risk-neutral category is for those that can tolerate reductions in spending or shortfalls in some years as long as they are offset by gains in other years.

For those that fall somewhere in between the two ends of the risk tolerance spectrum, different rules apply which trade off higher mean withdrawals against the risk of lower withdrawals.

Using some of these rules, a retiree could achieve\xa0more than the 4% expected withdrawal rate. All of these models are simplifications, but they are useful and allow you to visualize the choices between different rules that have varying levels of risk tolerance.

Visualize your retirement spending

The author strived to create a simple model to help people understand strategies that may improve on a fixed withdrawal at varying levels of risk aversion. You can test out the different rules by using\xa0this online tool\xa0which allows you to try out and visualize each one.

It\u2019s always refreshing to learn about new ways to live off your retirement savings. Vertes\u2019 idea splits the difference between the 4% rule and a dynamic distribution plan. This hybrid plan would allow for higher spending in good markets and a scientific way to gradually reduce portfolio withdrawals when the market dips.\xa0

Listen in to hear how each of these rules could play out with concrete examples using actual numbers. You\u2019ll also hear Joe\u2019s question regarding multiple 401Ks.\xa0

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