"I think the profession has gotten worse because of Monte Carlo simulations," he says. "I don't think Monte Carlo simulators work. Because all they really do is [use] expected returns ... basically, they just take some daily, monthly returns on stocks and just randomize them."
He says that, to paraphrase Vanguard founder John Bogle, all Monte Carlo does is put these questionable expected returns in a blender "and they give you all these infinite things that could happen based on Gaussian, standard distribution bell curves. My issue with them is that it always goes back to garbage in, garbage out."
Munson says that the problem with the 4% rule is not that it doesn't work, but that it's not used properly, and by that he means risk is not properly factored into the equation. "The reason 4% has always been a golden rule is because it's so low and because it can sustain quite a bit," he says. "Over a 25-year period of time, there is the opportunity to retrench. That's something financial advisors never want to tell their clients. They want the arrogance of certainty. ... But you may have to retrench if you have global catastrophe." Still, he adds, "We just don't see that at 4% withdrawal rates if people are managing risk properly."
What Munson says that he practices at his firm is risk budgeting, which he says is not yet a popular practice "in the pie chart world." He suggests that a pie chart with 60% equities and 40% bonds starts to look different if risk is factored in. It may have the risk of 80% equities and 20% bonds depending on the market volatility.
"If people start risk-budgeting, they'll have less problems with the 4% rule."
As of October 1, 2011, he says, to reflect the real risk of a 60/40 portfolio meant that he had to be 30% in cash, which was what he was in. (His current moderate portfolio is 36.14% equity, 30.39% bonds and 33.47% in cash.) He says he does not do this to time the market but for the simple reason that the volatility index (VIX) is at a high level of 40. And that means the rest of the portfolio of stocks and bonds is too risky. In January, on the other hand, when volatility was much lower, the firm's moderate portfolio was 73.82% in equity, 28.07% in bonds and 0% in cash.
"If you have a portfolio today, you have to keep adjusting it to whatever that long-term historical risk is. That's just building on the pie chart." To this end, he uses mainly passive ETFs.
Graydon Coghlan, a San Diego-based advisor with 11 offices in California, says that his approach is to take out 4% to 6% a year depending on the client and then give a cost of living adjustment of 3% per year. The investments are determined by the clients' age, income need and the amount of risk they're willing to take.
"Depending on that, we will invest in ETFs, mutual funds, dividend-paying stocks and individual stocks and annuities," he says. "We will invest in all types of things, including any fixed-income vehicles and REITs. These have good yields right now so if [the clients] are willing to lock up their money for there to five years, they can get a nice 6% yield on that." He will also do indexed annuities.
The reason sometimes strategies can get harmed, he says, is that clients' comfort level is much lower, and that steers them to investments that won't grow as much and won't allow Coghlan to pay them a cost-of-living adjustment. "If they have all REITs and fixed-income vehicles and dividend-paying stocks and they're using that full amount of the yield, there is no growth, so that means there's no COLA," he says. "So that's the tough part."