The 4% Rule Is Dead...continued

rogernusbaum

Lance Roberts had a blog post syndicated at Zero Hedge about the death of the 4% rule which of course is the portfolio withdrawal rate viewed as safe for not outliving your money. Lance notes that obstacles to the 4% rule include that we are collectively undersaved with many of us having no retirement savings at all. The assumptions underlying the 4% rule which was derived by William Bengen back in the mid-1990's were built on interest rates that no longer exist. Lance mentions yields from treasuries back then being closer to 5% versus 0.5% now.

The blog post not only cites the problem it also provides a list of suggestions on how to mitigate the death of the 4% rule to extent it really is dead. The way I view the world, I think of it as retirement withdrawal strategies need to evolve and/or be more flexible than they once were. A retirement account is a potential income stream that is most commonly paired with Social Security as another income stream. There is no reason that we must limit ourselves to just two income streams. Besides the few of us who will get a pension, other income streams can be real estate, a monetized hobby, a post retirement career that may or may not be part time or anything else that you might be able to apply to your situation.

The most common application of the 4% rule is that you start at 4% of your initial balance and then adjust that withdrawal amount up for inflation each year. That never made any sense to me. I'm sure people do it but if you start taking $40,000 in year one, are you really going to increase it by $200 for the year if the rate of inflation is 0.5%? I just don't see it. A tweak that I suggested many years ago was that no matter what your balance is, 4%. If this year your account balance drops by 5% then what you'd take would also drop by 5%. More specifically, take 1% of your account balance every quarter. If you have $800,000 this quarter, take $8000, if next quarter it is $785,000 then take $7850 and so on. The first time I posted that someone pointed out that you'd never run out of money and while that is theoretically true the approach really is about increased flexibility. It requires the flexibility to have your income vary and it creates more flexibility in the face of some sort of expensive external shock.

People put a lot of effort into creating a sustainable retirement account both in terms of years of saving but also with brainpower to devise and then maintain their portfolio. It is legitimately a lot of effort. I think just as much effort needs to go into creating another income stream whether it is one of the things I mentioned above or something else. This is especially true if in crunching your numbers your conclusion is something like "yeah, that should be enough." In that instance you are more vulnerable to something going wrong.

I am walking the walk here. Regular readers will know that in early 2017 we bought the cabin next to ours and have turned it into a vacation rental. We've been very lucky with it but it takes a lot of work. My wife does the cleaning and the marketing and I interact with guests to check them in and address any issue they might have. Just this weekend I spent about an hour getting our guest unstuck (he misjudged a turn with his 2WD truck). For this to continue to work, we need to be physically capable of doing the work which ties into my posts about diet and exercise. Staying able bodied increases optionality in creating a third income stream for retirement.

If you can pull together some sort of reasonably reliable third income stream then you can get by taking a lot less than 4% from your portfolio. If you have $1 million and plan on taking $40,000/yr, so 4%, but you're pulling in $2000/mo from your hobby-job then you only need $16,000/yr which is a withdrawal rate of 1.6%. Even if your hobby-job only last for your first five years of retirement, you relieved the portfolio's burden for a decent chunk of time. While I have a job I don't want to retire from, I doubt I'll have a meaningful income from it at 80. Will I still have a meaningful income at 70? I have no idea, but it is more prudent to plan as if I won't.

Lance had one suggestion that I want to dive into a little which was to avoid being house rich at the expense of being cash poor. I think his context is not to take a bunch of cash and pay your mortgage off in lump sum fashion coincident to your retirement if that lump sum would be a lot of money relative to your savings. If you have a $50,000 mortgage balance with $1 million in the bank, then maybe Lance would say go for it but if you have $600,000 in the bank and owe $400,000 then don't do it. On this point, I like the idea of planning ahead of time. If you're 50 and have a good amount of money saved then maybe start to pay a little extra on your mortgage while still contributing some, even if less to your 401k.

This relates to what I think is a crucial concept which is to work on getting your fixed expenses as low as possible heading into retirement. The easiest ways to do this would be to make sure you are mortgage free before your retirement date and to have cars that you're willing to drive for 15-20 years that are also paid off. This does two things; creates the potential for needing less money from your portfolio than you thought as well as optionality in case you ever need to buy something expensive. For us, we have an eleven year old ATV. We need it to plow our road in the winter to keep our vacation rental open for business (another task where fitness can matter sometimes). Sometimes there can be some volatility with how well the ATV works and I can see needing to replace it unexpectedly one day. Even with a used one (that would be our preference), we might need to make payments and that would be easier to handle if our only fixed expenses are insurances, utilities and food.

Finally, I will throw in raising extra cash to mitigate an adverse sequence of market returns. It would be easy to envision the crash from the first quarter not recovering as quickly as it did and a retiree not being able to take a pay cut from their portfolio. If you have the next two years covered, either in actual cash or the type of fixed income holdings that won't fluctuate, then it becomes much easier to weather an unluckily timed (normal) bear market. Obviously, a third viable income stream also helps mitigate an adverse return sequence in the markets too.

I've been saying for years that retirement is a problem/challenge to solve. The more work you put in, the better off you'll be. In the last few years I've been fond of quoting/paraphrasing Joe Moglia in saying that no one will care more about your retirement than you.