The “4 percent rule” used as a template for many retirement portfolios has been questioned by a new J.P. Morgan report that contends the formula shortchanges retirees.
In the report, J.P. Morgan Asset Management offers up its own portfolio methodology, a “dynamic” model that adjusts retirement withdrawal rates according to client wealth, goals, risk tolerance and other factors.
One of the report’s main criticisms of the 4 percent rule is that it advocates a flat withdrawal rate and fails to adjust to changes in a client’s income, attitudes and life goals.
In contrast with the rule, J.P. Morgan’s dynamic model strives to put client assets to use during retirement by increasing withdrawal rates—and bond allocations—as a client ages.
“A static withdrawal rate is not realistic and leaves you with a tremendous amount of unused wealth,” says Katherine Roy, J.P. Morgan Asset Management’s chief retirement strategist. “In bad market conditions, you run out of money too quickly.”
In J.P. Morgan’s model, withdrawal rates change year to year and fall to 4 percent or below only for clients with a very low level of assets and income. For example, a 65-year-old couple with $500,000 saved and a lifetime income of $20,000 from Social Security, pensions, annuities and other guaranteed sources would start retirement with a withdrawal rate of 5.8 percent. That would increase to 7.6 percent at age 75, 11 percent at age 85 and 17.1 percent at age 95. During that time, bond allocations would go from 24 percent to 39 percent.
Like the 4 percent rule, J.P. Morgan’s model tries to strike a balance, providing retirees with enough income to enjoy retirement while also ensuring they don’t run out of money before they die.
At the higher end of the wealth spectrum, a male client with $50,000 in guaranteed income and $1.5 million saved would see the withdrawal rates rise from 6.3 percent when he’s 65 to 11.9 percent when he’s 85 and 18.3 percent when he’s 95.
J.P. Morgan stressed that the dynamic model allows clients to increase both withdrawal rates and equity allocations the higher their lifetime incomes.
Under the dynamic model, retirees with higher net worth tend to have lower withdrawal rates than lower-net-worth retirees of the same age and lifetime income.
“This is because the actual dollar amount withdrawn is substantially higher and the satisfaction derived from greater withdrawals does not increase proportionally once a reasonable lifestyle level has been achieved,” the report says.
The dynamic model is less volatile than the 4 percent rule, which in many cases can leave clients with either too much or too little in assets, according to J.P. Morgan Asset Management. Data shows that the 4 percent rule has a 5 percent chance of causing clients to run out of assets in retirement, the firm says.
How extensively the 4 percent rule is used by advisors is open to question. While considered a “rule of thumb” in the advisory field, it regularly comes under assault, particularly lately because interest rates are historically low.
“There are advisors who kind of use the 4 percent rule, but naturally and intuitively do what our model calls for,” Roy says.
The 4% Rule Of Dumb?
February 27, 2014
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Comments
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this is an obivious article, no static model can provide anything but a guideline to expectations of future returns as well as consumption needs. there for such models have large degrees of uncertainty modeled, which must be reconciled with outcomes, consuption and lifes changes. there is no certainty of any model. but you have to start somewhere, and I would like to see a complete model such as the one descripted... all of these forcasts have value, but do not be to qwick to dismiss simple, retirees do no always have the same goals.....
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Of course 4% is dumb. It's a simple rule of thumb to help people deal with the uncertainty of an unknowable future - like the 60/40 portfolio rule of equity/debt. The biggest downside of such simple rules is that clients won't pay you for the advice. So you need a proprietary methodology that appeals to common sense and has just enough complexity to demonstrate your value. We wish JPM well with their new methodology.
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Here's the JPM report, fyi ... https://www.jpmorganfunds.com/cm/Satellite?pagename=jpmfVanityWrapper&UserFriendlyURL=contentdet_module&smID=1323375360677
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I have a much simpler method. I target total income and growth at 8% and use a 5% annual withdrawal during the year based upon the portfolio balance at 12/31 of the preceding year or a higher amount if required by IRA rules. This method reinvests the balance of the income so that over time the annual withdrawal keeps pace with inflation and increases without any further calculations. If you don't spend all the withdrawal each year you have a cushion against lean years. Using this method should assure one of not running out of money even if you live to 100.
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Try http://bit.ly/NvrtaK
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Is there an article or report which is available outlining JPM's methodology?