The 4% Rule of Thumb is Back. 

Low interest rates had put the oft quoted rule of thumb in jeopardy. 

The question everyone on the cusp of retirement asks is “how much can I take from my investment portfolios”.  It is never an easy question to answer – and that is what keeps people like me in business. 

For those who want to do a rough estimate, though, the 4% rule used to provide a good rule of thumb to follow.  The idea was that a retiree invested in a typical balanced portfolio (60% stocks, 40% bonds) could safely withdraw 4% of his or her portfolio, then increase that amount every year by the rate of inflation.  Studies had shown that over the past 50 years or so, that strategy would have safely seen retirees through almost every 30 year rolling period, without running out of money. 

In recent years financial planners began to call the 4% rule into question.  The reason was low interest rates.  They pointed out that all of the periods included in the studies included higher interest rates, or declining rates that were beneficial to bonds.  With rates stuck at 1% for the past several years, it seemed that the 4% rule needed to be reconsidered. 

Well, in this new article, the experts at Morningstar express the opinion that due to higher interest rates, the good old 4% rule appears to once again be valid.  

Planning implications: 

You are 65 and planning to retire soon.  You have $1,500,000 in retirement plans and investments.  You and your spouse expect to receive a combined $60,000 in social security benefits.  Based on your lifestyle today, you think it costs you about $100,000 a year to live.  The 4% rule indicates that you can safely withdraw up to $60,000 (4%) of your portfolio in your first year of retirement.  When added to social security, that should be enough to cover your projected expenses, with a little cushion to cover the unexpected. 

Rules of Thumb Aren’t a Plan! 

Rules of thumb are simply tools to do a rough estimate.  Financial planning is a lot more complicated than applying a simple percentage.  For instance, if all of your money is in after tax savings, your withdrawal need is less than someone who is going to need to pay taxes on IRA or 401k distributions.  Should you withdraw a bit more at first so you can let your Social Security benefit grow larger?  Your expense need may not be a straight line – maybe you have a mortgage that will be paid off soon, or maybe you will downsize your home in the future.   A real financial plan considers all these myriad complications. 

Good economic news is always welcome – and this Morningstar report shows that interest rates running higher than the rate of inflation (at least for now) is good news for savers and retirees, even if it is causing pain for home buyers and borrowers.