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Most retirees will fund a portion of their lives by making withdrawals from their retirement accounts. The common rule of thumb is that retirees can withdraw 4% from their accounts each year, adjusted for inflation, with a high probability that their assets will last a lifetime.
The 4% rule initially came about in the 1990s from financial planner William Bengen; it’s also associated with the so-called Trinity study (learn more about the Trinity study here). There’s a lot to like about the 4% rule: it’s easy to understand, and it’s been arrived at independently by various researchers. And having a sustainable income in retirement is a top priority for most retirees.
But the 4% rule has come under scrutiny after the tough market environment of the last 15 years. People who retired in the early 2000s faced two bear markets, including the losses of 2008-2009, and people who retire in bear markets run a higher risk of running out of money because they’re often withdrawing from their portfolios while their portfolios are losing value; by the time the market eventually recovers, they may have depleted more of their portfolios than they had hoped.
Recent low bond yields and what some perceive to be high stock valuations have led some researchers to suggest a more conservative 3% payout, but a 3% withdrawal rate is not very attractive to most investors nearing retirement, and that 1% difference implies that you’d need 25% more savings in order to enjoy the same income.
We think the 4% rule is still a good rule of thumb when planning ahead for retirement, but even the Trinity study acknowledged that retirees may need to adjust their withdrawals in retirement. The study concluded that its retirement calculations should be used solely as a planning guide and that people should expect changes both up and down along the way.
The Importance of a Balanced Portfolio
The Trinity study found that in order for the 4% rule to work, retirees have to have at least 50% invested in equities. The FundX Conservative Upgrader Fund (RELAX) is a balanced fund that currently has roughly 60% invested in core equity funds.
Above, we continue the example from the How Much Do You Need to Retire? article and assume an investor who retired with $1,500,000. If this investor held the FundX Conservative Upgrader Fund (RELAX) on December 31, 2002 and withdrew 4% a year (taken monthly and adjusted for inflation), the investor’s retirement portfolio would have grown to $2,256,970 after taking roughly $700,000 in withdrawals—about half of their initial investment—through March 31, 2014. If the investor didn’t take any withdrawals over this time period, this investment in RELAX would have grown to $3,741,524.
The 4% rule also assumes that investors stay invested in a portfolio that holds at least 50% in equities throughout retirement, even though their portfolios will fluctuate over time. As the chart shows, it wasn’t always easy for investors in RELAX to stay invested. These investors experienced many ups and downs during this time period, including the 2008 financial crisis. But investors who stayed invested in RELAX were able to pay themselves a 4% income stream and grow their portfolios faster than inflation—even during some of the most challenging market years ever.
Whether or not you choose to use RELAX for your balanced portfolio in retirement, the Trinity study found that in order to withdraw 4% a year, adjust your withdrawals for inflation, and still make your money last 25 years, you’ll need to have at least 50% invested in stocks. Stocks, however, are volatile. While you may be able to avoid volatility by avoiding stocks, you may also run the risk of running out of money.
Performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance of the fund may be lower or higher than the performance quoted. Performance data quoted current to the most recent quarter- and month-end may be obtained by clicking here.