4% Rule: Good or Bad?
The 4% withdrawal rate rule is a popular guideline for retirees who want to ensure that their savings will last throughout their retirement. The rule states that retirees can safely withdraw 4% of their portfolio balance in the first year of retirement, and then adjust the amount withdrawn for inflation each year. This rule has been shown to be effective in helping retirees maintain their purchasing power and avoid outliving their savings.
However, the 4% withdrawal rate rule is not without its risks, especially during times of market volatility. One of the biggest risks is that retirees could experience a sequence of returns risk, which is when their portfolio experiences negative returns in the early years of retirement. This can deplete their savings more quickly and make it more difficult to maintain their desired lifestyle.
Market volatility can also make it more difficult for retirees to rebalance their portfolios. Rebalancing is the process of adjusting the asset allocation of a portfolio to ensure that it remains aligned with the investor’s risk tolerance and investment goals. During times of market volatility, it can be more difficult to sell assets that have declined in value and buy assets that have increased in value. This can lead to the portfolio becoming riskier or underperforming the market.
Here are some specific examples of how market volatility can impact the 4% withdrawal rate rule:
- Sequence of returns risk: A retiree who retires in a bear market and experiences negative returns in the early years of retirement may have difficulty maintaining their desired lifestyle. For example, a retiree with a $1 million portfolio who withdraws 4% in the first year of retirement would withdraw $40,000. However, if the portfolio experiences a 20% decline in the first year, the retiree would only have $800,000 left. This would reduce the retiree’s annual withdrawal amount to $32,000, which may be insufficient to meet their needs.
- Portfolio rebalancing: During times of market volatility, it can be more difficult for retirees to rebalance their portfolios. For example, a retiree with a 60/40 portfolio (60% stocks and 40% bonds) may want to sell some of their stocks and buy more bonds when the stock market declines. However, if the stock market is volatile, it may be difficult to sell stocks at a good price. This could lead to the retiree’s portfolio becoming more risky than they intended.
How to Mitigate the Risks of Market Volatility
There are a few things that retirees can do to mitigate the risks of market volatility:
- Use a more conservative withdrawal rate: Retirees who are concerned about market volatility may want to use a more conservative withdrawal rate, such as 3% or 3.5%. This will give their portfolio more time to recover from market downturns.
- Start with a larger portfolio: Retirees who have a larger portfolio will be able to withstand market downturns more easily. They will also have more flexibility to adjust their withdrawal rate if needed.
- Have a diversified portfolio: A diversified portfolio is one that includes a variety of asset classes, such as stocks, bonds, and cash. This can help to reduce the overall risk of the portfolio.
- Work with a Retirement Risk Advisor: A Retirement Risk Advisor can help you to develop a retirement plan that takes into account your individual needs and risk tolerance. We can also help you to rebalance and adjust your withdrawal rate as needed.
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