What is a "Safe Withdrawal Rate" for your retirement? There is a new paper from Morningstar about the 4% rule being back and now being revised to be the 4.7% Rule. Is this too high or too conservative? Is it too general to have a single number for clients who have different financial circumstances? What do I recommend, and why?
Safe Withdrawal Rate Research
In the original iteration of this, engineer-turned-financial-adviser Bill Bengen did the math in the early 1990s and in 1994 published his findings. He determined that the "safe" withdrawal rate was 4% initially and then adjusted annually for inflation. In his research, he found that this rate allowed a 50% stock / 50% bond portfolio the highest likelihood of not running out of money over a 33-year retirement period. In his new work, Bengen now says that the new "SAFEMAX" withdrawal rate under poor market conditions is now 4.7% in the first year followed by annual adjustments for inflation.
In his new study, he concludes that starting out at a retirement nest egg distribution rate higher than 4.7% increases the risk of outliving your money. Take less, and you run the risk of leaving too much to your heirs and you might have needlessly sacrificed your own retirement lifestyle.
In practical terms, this would mean that if you needed $50,000 in your first year of retirement to come from your retirement nest egg, then you should target to have about $1,063,000. If you only needed $25,000 from your portfolio, then you'd need to start your retirement with about $530,000.
But the dollar amount needed isn't going to remain static. What's important is the purchasing power of your portfolio not simply the account value. If inflation runs hot, then that $50,000 per year may need to be higher to account for the impact of inflation. (Otherwise, you'll need to make adjustments to your spending and also make substitutions of what you buy. You might need to do this anyway regardless of the impact of inflation on your lifestyle.)
Lower Equity Allocation Given Inflation Concerns
Bengen goes on to say that market uncertainty plays a role here. As a retiree, you don't want the market to surprise you and drop into a correction just as you stop working. In financial advisor speak, this is "sequence of return" risk. In retiree speak, this is bad timing. To void this risk, Bengen recommends reducing the equity portion of a retiree portfolio to around 30% given current stock prices and concerns about inflation.
But now this begs the next question: How does a retiree investor make enough money from a portfolio that is now recommended to be "lighter" on the stock side? While bond yields have been going up as the Fed has ratcheted up rates saying that their rates will be higher for longer, yields on fixed income aren't all that high (historically) to make up for this. And dividends from Blue Chip stocks are in the 2% to 3% range.
The ideal situation is to avoid having to sell your principal and just live off the portfolio's returns (from capital appreciation, interest, and dividends). But is there a way to invest so that a retiree investor can generate enough to cover the new safe withdrawal rate?
Retirement Investing Focused on Income Not Appreciation
While it's nice to have a "rule of thumb" for discussion, it is too restrictive to settle on a single number. In practice, I'll start with a modified version at 4.5% and then use my software to make future adjustments up or down depending on inflation and whether the client's portfolio has performed. That said, there are limitations of using this type of analysis. In reality, an income-focused portfolio can be positioned to generate 6%, 7%, or 8%+ if it includes income-generating investments like closed-end fund (CEFs). Oftentimes, these investments will be comprised of the same elements as many mainline index funds. But because of the way CEFs are structured, they can produce a higher yield than even just holding the stocks that make up the index (like the FAANG stocks). And if a retirement portfolio is generating a higher yield, an investor may not need to have saved as much. Or if an investor hasn't saved a lot, then having a higher yielding portfolio means that the retiree can still get that dollar amount that was targeted. Depending on expenses, Social Security, and other income (from rental property as an example), then the amount needed from the portfolio may not need to be as much or the amount of the withdrawal may be lowered which further preserves the principal.
This is the goal of the MarketFlex No Withdrawal Income-Focused Portfolio. We believe that there is a better way. In the MarketFlex portfolio models, the focus is on income not the hope of appreciation. To counter the risk of the stock market, the equity alocation is already in the 40% to 50% range. Instead of just holding index funds that are top-heavy with FANNG stocks, the target is lowered. And to counter-balance the relatively low dividend yields of popular Blue Chip stocks, the portfolio includes higher-yielding commodity and Treasury Inflation Protected Securities funds as an inflation hedge. Finally, popular mutual fund or ETF index funds are supplemented with bond and equity Closed-End Funds (CEFs) that typically generate more than 5%, 6%, and even 8%+.
