Retirement: Is The 4% Rule Still Valid?

by: Roger Nusbaum

There were a couple of articles this week about retirement planning. This one from MarketWatch says the 4% withdrawal rate doesn't cut it anymore because people are living longer and this one from the Washington Post (via Barry Ritholtz) casts serious doubt on our collective ability to do the job of planning our financial futures.

The MarketWatch article found some research that concluded that 3.5% was about right when today's longer lifespans are factored in. The article also discussed some work-arounds that the financial services industry has come up with, which includes dividends only and figuring a way to absorb fluctuating withdrawal amounts.

The WaPo article mentioned that in 1983 31% of households were at risk for not having enough to maintain their standard of living in retirement and in 2009 that number had gone up to 51%. We all have seen various statistics about how little we have saved--things like no one in America has more than $25,000 saved (slight hyperbole). This article was also about financial literacy and the extent to which we are incapable of managing our 401ks.

The most useful thing about the 4% rule is that it creates a benchmark of understanding of what a piece of money can realistically do and what it can't. My last post about this seemed to ruffle a lot of feathers in the Seeking Alpha version but the big idea should be that each person must figure out a solution that works for them and whatever it is about their circumstance that is unique.

A $1 million portfolio can most likely handle $30,000 to $50,000 but not $80,000-$100,000, and this often comes as hard medicine to people fortunate enough to accumulate that much. Obviously the less you spend the better chance you have of not running out of money. Beyond that, whether you index it for inflation, which would be more complicated, or just take out 1% every quarter it is very unlikely to make a difference (a 5% withdrawal still has a very high success ratio). I prefer simpler and would encourage simpler but each do-it-yourselfer needs to do whatever they think makes the most sense.

Obviously I place a lot of importance on the expense side of the equation. For most people this is easier to control than the portfolio performance. Without a mortgage, car payments or credit card bills to pay, what then becomes essential spending? Various monthly utility bills, various insurances, various taxes, groceries and gas for the car covers most of it. Then add the one-offs which we have no control over and the everyday fun expenses like eating out or movies but the everyday fund expenses can usually be controlled.

Beyond that it gets into bigger fun expenses that may or may not be affordable. The last big item I can come up with (although I am pretty tired from a very long hike) is any sort of family obligation like caring, financially, for a relative (our own potential cost like this is covered in insurances and and one-offs). Not everyone has visibility to this and people tend to have their own ideas about how much they actually need to help a relative.

I also think monetizing a hobby or interest is a great way to relieve some of the financial burden and remain engaged (this whipped up a hornets nest in the comments the other day). Someone who can "retire" without drawing from the portfolio one way or another for five or ten years (this will probably take years to plan) obviously has a much better shot of having their money last and not having stress over their finances as they age (or maybe less stress anyway).

One new possibility for me might be fire department related. If I last for a while as the fire chief of our department (I hope/plan to) then down the road there might be a chance to offer training for new chiefs of similarly situated departments. There are classes like this and as of now there is no way to know whether I could do this it is just a thought. For the one or two readers from earlier in the week who got very upset about my hazmat instructor, our department has no pension and gets no tax revenue, we are a non-profit and there are no permanent employees (we do pay for weekend shifts during the fire season).