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The 4% Withdrawal Rule in Retirement: It’s Not For Everyone!

The 4% Withdrawal Rule in Retirement: It’s Not For Everyone!

For over 35 years, I have often heard about the 4% withdrawal rule. This rule implies that you
can withdraw 4% of your portfolio to supplement your income every year, while still preserving
or growing your account value. If you look at just the last 11 years, with an investment in the
S&P 500 stock index, an investor would have taken their 4% withdrawals, and still seen the
value of their account more than double!

For example, if you had a $1 million dollar portfolio using the 4% withdrawal strategy with a
60/40 blended portfolio of stocks and T-bill bonds over 30 years, you would pull out $40,000 a
year and never run out of money. However, my fear is that most investors, and many financial
professionals, consider the 4% withdrawal theory as a “one size fits all strategy!” However,
“Does this theory still work today even though it was developed back in 1994?” My feelings is
that it really depends, because everyone’s situation is different and so are the markets! There
are risks that investors need to consider, so I’m going to touch on a few:

This theory has the benefits of hindsight to prove the results, but we shouldn’t use this as a
prediction of future performance, or any guarantees! Given some of the facts, I’m really
concerned by the many Dalbar Studies of Investor Behavior, that suggest most that investors
hold equities for only about 4 years, and bonds even less at roughly 3 years on average! If you
aren’t willing to stay invested for 30 years, this means that most investors wouldn’t even
benefit from this strategy! Also, the results of this study assumed a portfolio with a 60/40 blend
of stocks and bonds, but we know that interest rates are at historical lows. Unfortunately, T-
bills are paying very low interest currently, and would struggle further if interest rates rise
because newer bonds would have higher yields, making them more appealing. This would seem
to really impact the potential returns of a 60/40 stock and T-bills portfolio, requiring equities to
appreciate even more to pick up the slack if bonds underperform! However, while there are
reasons that could affect the 4% withdrawaI scenarios, I think the single biggest risk is
something called the Sequence of Returns Risks (SRR)!

The Sequence of Returns Risk is the fear that market declines in the early retirement years will
harm overall returns. The last 20 years typifies the potential risks off SRR, and the added roller
coaster drama of emotions for investors. Even though we have enjoyed great returns over the
last 11 years, many investors witnessed the early decade of 2000 to 2009, when the stock
market experienced long periods of little to no returns. with the stock market! When you
consider early market drops with your portfolio, couple with withdrawals, it could affect
dramatically affect the longevity of your portfolio. With most retirees fearing “outliving their
money” as the biggest risk in retirement, the possibility of running out of money presents an
enormous risk, uncertainty, and SRR could really reduce portfolio values!!

For example, assume that you are taking out your 4% income during the early years of
retirement, and the market experiences negative returns. Assuming $1000 invested in the stock
market, pulling out 4%, or $40, and the market drops 10%, this would reduce your account
down to $864. Then, let’s assume that the market goes back up 15% the next year, your
account has recovered only to $993, you have still lost money over the last 2 years. It illustrates
the impact of SRR to your portfolio, and that you are having to play catch-up just to get back to
a positive account! I remember a client that had a $1 million dollar portfolio, which she saved
over 40 years of working very hard. She had retired in 2006. Unfortunately, by the time that we
were referred to her in 2009, her million dollar portfolio had dropped to $685k in only 2 years.
She had pulled out 5% to supplement her income ($50,000), but the market also dropped 10%
in her first year. The next year she still pulled out the $50k, but her account dropped another
15%! In roughly 2 short years, her account was down to $685,000! Besides being deeply
concerned, she was very upset and felt that she was going to have to go back to work or risk
running out of money! This demonstrates how destructive the Sequence of Returns Risk can be
on a portfolio, and the gamut of emotions investors can experience!

My fear is that despite being in the midst of the longest running bull market in history, most
investors don’t fully appreciate the disruptive impact that SRR can cause on account values. At
the very least, underestimating the emotions required to ride out any storms!! Bear markets do
happen, with research suggesting that they happen about every 6 years, last about 22 months
and drop about 39% on average. We only have to recall earlier this decade from October 2007
to early March of 2009, when the S&P 500 dropped 50%, to understand the possibility of
negative returns! As a matter of fact, if Dalbar’s research suggests that most people hold stocks
and bonds for less than 4 years, many investors during this period would have realized
considerable losses! A lot of people have forgotten that time, so I fear a heightened level of
complacency! What happens at real signs of trouble or the markets hit another really rough

As we discussed, If bonds underperform and stocks need to pick up returns, the 4% withdrawal
theory based on a 60/40 blended portfolio, could have different results moving forward. It
probably means that retirees will have to assume even more risk for returns, accepting more
volatility with stocks! This is probably ironic because most of them will want to preserve more
of what they have, with less risk and more predictability, So this begs my final question, “What
happens if you saw your portfolio drop 20, 30%, or even 40% and just retired, will you be able
to stay the course?” The Sequence of Returns Risk is very real and something that could
definitely rear the ugly side of its head at any time!

Next time, I’m actually going to share some strategies that will get you through this!! Providing
valuable solutions that can reduce risk, give you higher income and even grow your money over
the long term, so you don’t want to miss it!!

Pat Moran is a managing partner, founder of Healthiermoney, and financial coach with 35 years of
financial services experience. If you want to learn more, ask to attend their next event or feel free to call him at
(602) 789-3099. Healthier Money has a seminar at Grimaldi’s in Old Town, Scottsdale on April 13 & 15 RSVP
@ (We will provide solutions to offset this risk!)

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