I realize it’s most likely a lost cause, but I wish people would stop calling the “4% rule” a “rule.” I can’t recall the last time I met a financial planner that told clients the best way to manage their resources through their retirement would be to start by spending 4% of their nest egg and increasing that spending every year in lockstep with inflation.
Good planners are not keen on recommending the 4% methodology, primarily because they recognize there are too many variables that affect an individual client’s outcomes. They typically find value in it as a point of reference or perhaps a guideline, but as a “rule,” no way.
The biggest reason for rejecting the rule, at least in my experience, is that clients don’t want to comply with it. When we discuss with clients the sustainability of cash flow and the survivability of their portfolios, the 4% rule often looks attractive at first. After all, that figure came about because that level of spending never failed. Many people entering retirement gravitate toward conservative approaches. But the more deeply they think about the assumptions that gave birth to 4% as the optimal number, and the more they consider such a restricted spending plan, the more the approach loses luster.
The few clients I have worked with who at first intended to follow a steady spending plan all failed to stick to that plan. Talking with colleagues around the U.S. over the years has only validated my viewpoint that people don’t spend money in that way. Such a steady pace of spending is simply not reality.
There are a lot of reasons for this. Life happens, as they say. Whether it’s a new cost or a new opportunity, unexpected expenses pop up. When faced with really good or really bad portfolio performance, clients often change their spending. When times are tough, they reduce their expenses. When things are going well, they spend more. This is totally natural.
More than a few times, clients have started their retirement with the intent to spend at a steady, inflation-adjusted rate only to find that inflation was not eroding their purchasing power as much as they anticipated. In such cases, many stopped increasing the withdrawals.
Frequently, we find new retirees who simply don’t want to start off with such a low level of cash flow. In most cases, this is not a matter of them simply wanting to spend more money because they are want-it-all and want-it-now spendthrifts. Those exist, of course, but most people have more practical, personal reasons for wanting to spend more.
The 4% rule in most portfolio sustainability studies assumes the cash flow needs to be maintained for a minimum of 30 years. At first blush, this makes good sense and appeals to that initial conservatism that many new retirees have. However, after some contemplation, many retirees find the assumption to be overly conservative because they either don’t believe they will live that long or, more commonly, don’t believe they’ll be spending that much in their 90s.
The odds are good that they are correct. Actuarial tables differ slightly but offer very similar statistics. One tells me that a healthy couple, both aged 65, face an 18% probability that at least one of them will live to be 95. Eighteen percent is a big enough number that we can all accept it as a real possibility, but it also means that 82%—four out of five—couples that we plan for won’t need their money to last 30 years. That is a lot of money that they could have spent on themselves, people they love or causes they care about.
A pet peeve I have is that too often commentators suggest that if you spend more than 4%, or whatever percentage they advocate, you are instantly risking bankruptcy and that Cinderella’s carriage will turn into a pumpkin. Bill Bengen, the writer of the original paper that spawned the “4% rule” (he never called it that), was quoted in a Forbes.com piece saying, “It is a misconception that following a SAFEMAX leads to terminal poverty.” Fact is, even at a 4.5% rate, 96% of the time, the amount of assets at the end was more than the amount at the beginning of the 30-year period.
Most of us know someone who has lived at least into his or her mid-90s, but few of us know people that age who spend what they spent when they were 65, adjusted for inflation. The 95-year-old who still plays golf or travels the world is a rare exception, not the norm. It is a simple fact of life that as we get older, we slow down. The elderly tend to spend their time doing things that cost less.
By contrast, new retirees often want to do things early in their retirement that cost substantial amounts of money. The couple who retire and immediately take to knocking off the more elaborate and expensive items from their “bucket list” are not some kind of urban legend. They are a reality and, in many ways, a perfectly sensible reality. No one gives us tomorrow.
Recently, a new 70-year-old client had us examine how much he could spend over the next couple of years without forcing his wife to be “stuck at home” after he passes away. He has cancer, but his wife, 65, is healthy. They know the more they spend now, the less there will be later. The diagnosis made them believe that their time together is more valuable than the money. Who are we to disagree? But if we take 4% as a “rule,” that’s where the conversation is headed.
We don’t need a cancer diagnosis to find people interested in spending more early in their retirement. I find it actually quite common. Part of the reason for that is their increased vitality. My clients, the “Smiths,” are good examples.
For 40 years, they watched their spending and pinched their pennies, all to be able to retire one day with few financial concerns. They have no mortgage or debt and they have only modest committed expenses. They are taking art classes, they have learned to kayak, and they are frequently seen by smoking hogs at events for various civic groups. They are withdrawing about 5.5% of their assets and, man oh man, are they having fun!
The Smiths do not worry about running out of money. The reasons they do not worry may be instructive to anyone advising retirees and identifying clients who could truly handle more spending early in retirement.
First, the Smiths have owned investment assets during periods of bad economies and bad markets. They have made good decisions and bad decisions and learned why their choices were either good or bad. This gives them confidence in their investment plan and should allow them to maintain a balanced portfolio indefinitely.
Second, they have the ability to reduce their expenditures without having to limit their lifestyle. Most of their spending is truly discretionary. They can employ a dynamic spending plan rather than a rigid one—like that modeled under the 4% studies.
Third, because they have flexibility in their spending, they do not believe they need a high level of certainty to proceed with the spending they currently enjoy. Put in Monte Carlo terms, they do not need a super-high success rate to feel comfortable with what they are doing.
Fourth, we have done real financial planning with them. This helps them better understand the range of possibilities and the trade-offs that apply to their decisions. Planning is a collaborative process, not a onetime event. They know we will revisit our assumptions and incorporate whatever changes may come.
Lastly, what has garnered the most confidence is that we have identified the trigger points that would warrant a scaling back of their withdrawals. This will be important if the bear growls again, if the couple underestimate their spending or if future returns are as low as some believe they will be. We have also identified trigger points to resume higher spending levels should the couple experience better-than-expected results.
The planning work we have done doesn’t offer any of our analytics as a crystal ball. It simply identifies what can get out of whack and exactly what we should do about it. The client is prepared.
There is an adage in sports, “Pressure is something you feel when you are not prepared.” Well-prepared clients can enter the unknowable future with confidence that they can adapt to whatever may come.
Dan Moisand, CFP, has been featured as one of America’s top independent financial advisors and practices in Melbourne, Fla. You can reach him at email@example.com