A well-known approach to addressing prudent retirement spending is known as the “4% spending rule.” This guideline states that retirees with a diversified portfolio balanced between stocks and bonds can safely withdraw 4 percent of their initial balance at retirement, then adjusting the dollar amount for inflation each year thereafter.An inflation-adjusted withdrawal rate is intended to provide a predictable stream of withdrawals that keep up with inflation.
Conversely, using a percentage-of-portfolio withdrawal method, the retiree withdraws the same percentage annually from the prior year-end portfolio balance. The dollar amount will fluctuate with market performance, and while the portfolio balance and withdrawals may shrink, the portfolio is unlikely to ever be fully depleted.
In practice, retirees are likely to incorporate a hybrid spending method—spending moderately in years when the market is up and spending less when the market experiences prolonged downturns.The factor that has the biggest impact on withdrawal rates is the retirement planning time horizon. For most people, an estimate of how long the retirement portfolio will be needed can be based on the investor’s current health and anticipated longevity, as determined by statistics, and history. An estimate of age 90 is a reasonable default given today’s longer life expectancies. For a 65-year-old married couple today, for example, there is a 72 percent chance that at least one spouse will live to age 85, a 45 percent chance that one will live to age 90, and an 18 percent chance that one will reach age 95!
With today's yields near historic lows retirees, whose dividends and interest combined are less than 4 percent are often reluctant to spend from principal to make up for the deficiency. And many are wondering whether 4 percent is still a reasonable spending goal.I feel it is a reasonable starting point for investors who follow a total-return spending approach. A total-return approach is one in which investors remain appropriately balanced between stocks and bonds, and diversified across varied asset classes so that portfolios may potentially benefit from both dividends and interest and appreciation of capital (i.e. stocks moving up in price).
Instead of changing the portfolio to chase income, by reducing equity exposure and adding bonds it may be wise to consider the total-return approach to allow for spending both from portfolio cash flow and from the potential increase in the portfolio value.This empirically decreases the odds of outliving your portfolio.
