Are you counting on 4%?
For just a moment, think about retirement. If you’re reading this at work, chances are retirement seems pretty darn appealing. How will you enjoy this part of your life? While retirement can be exciting to imagine, you must also think about how you will pay your bills. What withdrawal rate will you need to actually be able to live off of your portfolio?
For decades, conventional wisdom has held that, as a rule of thumb, you can withdraw 4% from your portfolio each year, plus an annual increase for inflation, with a high probability that you will outlast your money. But using the 4% rule as a guideline for financial planning can potentially derail your retirement.
Financial experts arrived at the 4% number using a statistical tool known as the ‘Monte Carlo’ analysis. The problem is that the Monte Carlo analysis assumes a normal distribution of past events. Based on this, historical returns are projected into the future with a given degree of certainty. In other words, these experts assume that stock market returns will fall on a bell curve – a nicely ordered, normal distribution.
In textbooks, this makes all the sense in the world (and the graph sure makes a pretty picture). But in the real world, this logic is unequivocally untrue and dangerous. Improbable events, outliers to the bell curve, happen all the time in financial markets. An effective long-term investment strategy must take potential volatility and real-world occurrences into account.
Even if the bell curve were accurate, the 4% rule of thumb is based on other errors. For example, the studies on which the 4% rule of thumb is based all use historical returns before fees. Even a small difference in the fees you pay on your investments will add up over time and can significantly impact long-term returns and therefore the long-term sustainability of the portfolio.
It’s amazing to me that the academic studies ignore such large differences! Think of the impact on your financial security this difference makes. Although we believe you should do your best to keep investment fees to a minimum, it is also important to make sure you never underestimate the effect fees can have on your overall financial well-being.
The 4% method also completely ignores longevity. The current life expectancy for those in the United States is approximately 79 years old, however, there are many who easily live past that point. The average expenditures per year are around $51, 100, but that doesn’t include emergencies or any big expenses you want to make. Your goal is to have more money than you need throughout your retirement, but with the 4% method, you’re relying on averages – that you’ll always have just enough based on what’s standard.
But the most significant problem with the 4% rule is that it ignores what you really want. If you are like most people, you just want to have enough money in retirement to live comfortably and without worry. To be clear, “live comfortably” means you do not want to try to live on 4%, even adjusted each year for inflation, because you do not want to cut your standard of living. In fact, most of us want to expand it, at least in the early years of retirement.
Think about it. Let’s say you have managed to save a million dollars for retirement. At 4%, that means you can withdraw $40,000 a year in the first year, pre-tax to live on. By the time you pay Uncle Sam 25%, you are left with $30,000. The sorts of people with the incomes necessary to save a million dollars don’t have a lifestyle that can be supported on $30,000 a year — even with Social Security.
Lest you begin to panic, the 4% model is not the problem. Investment advisers and journalists who ignore the errors in the model are the problem. You need an investment strategy that is engineered to give you the ability to support a desired lifestyle indefinitely into the future without work or worry. Quite frankly, life will never fit in a neat bell curve. Reality includes bear markets, volatility, and disruptions.
The Snider Investment Method was designed to succeed in the real world. Does that mean its right for you? We think there’s a good chance it is, but you have to see for yourself. The best way to do that is to join us for a free information session or webinar. You’ll take away an understanding of who we are and what our strategy is. We’ll even show you detailed examples of you can use the Snider Method in your own portfolio.
