The “ValueGap” Explained

The reason the 4 percent rule fails so often is that advisors miss that gap between price and internal value, LaBrie says—what he has named the “ValueGap” error.

Again, the portfolio’s value will eventually revert toward the mean historical total return over time. So when the liquidation value of a portfolio is above the historical mean value, the portfolio is expensive, should perform worse than average over time, and will not be able to drive as much income as a fairly valued portfolio throughout retirement. When the liquidation value of a portfolio is below the historical mean value, then the portfolio is inexpensive, should perform better than average over time, and could be used to drive higher levels of income throughout retirement.

A regression of real total returns and historical mean returns can be plotted for any asset class, says LaBrie, making it possible for advisors to determine the ValueGap error for any portion of a client portfolio.

“We have to measure [the ValueGap]—it’s performance value divided by mean value, the ‘TRU Ratio.’ If that ratio is greater than one, then markets are expensive. If it’s less than one, the markets are inexpensive. The TRU Ratio lets us know whether it’s expensive or cheap, and by how much.”

When the TRU Ratio is greater than one, then a client using the 4 percent rule should run out of money during his or her retirement. When the Tru Ratio is less than one, the 4 percent rule will help clients’ accumulation of additional, potentially excess assets during retirement.

The TRU Method

Thus, by bringing the value gap into consideration, the TRU Method allows advisors to create an appropriate withdrawal rate. The data over the past 200 years suggests that advisors who employed the method at any point could have helped clients avoid the prospect of running out of assets in retirement altogether, and would have also made it less likely that a client would unnecessarily hamper his or her standard of living by letting the portfolio grow unnecessarily large.

“If I change the 4 percent approach to the Tru Method, the outcomes change and there’s less dispersion,” says LaBrie. “Retirees would have a higher income that successfully gets them through their retirement.”

There are three steps to using the TRU Method to calculate portfolio withdrawals: