Opinion: Customers need alternatives to the 4% rule

For nearly three decades, many financial advisors have relied on a total return strategy to generate retirement income for their clients. According to this conventional wisdom, if retirees stay 50% to 75% invested in stocks and withdraw 4% a year to fund expenses, their nest eggs will be enough to carry them safely through a 30-year retirement, regardless of are market conditions.

This 4% rule, created by financial advisor and researcher Bill Bengen in his famous 1994 study, is rational and historically proven advice. But here’s the problem: In today’s inflationary climate, it’s very difficult to keep up with retirement. How can I know? Because the now-retired guy who invented it doesn’t stick to it. In a recent Wall Street Journal article, Bengen, citing unprecedented economic conditions and high stock market valuations, recommended retirees limit their spending and cut their drawdown by 4%. (A November 2021 Morningstar report endorsed a withdrawal rate of 3.3%.)

It’s interesting. But the real revelation is that Bengen adjusted his personal portfolio to 20% stocks, 10% bonds and 70% cash, violating his own rule’s requirement to remain invested in at least 50% stocks. . This revelation should have financial advisors around the world taking notice: even the creator of the 4% rule failed to live up to its fundamental principle when markets got tough during his own retirement.

I am not criticizing Bengen. Retirement can be scary and these markets are tough, so any choice that brings comfort is fine with me. But his example illustrates a larger point: it’s one thing to tell clients to swallow their worries and ride the market roller coaster to retirement and quite another to do so. The 4% rule makes sense, and if nothing very unusual happens, you’ll be fine. It’s a great way for advisors to project safety into a strategy based on investments that carry inherent risk.

But Bengen’s decision to restrict his lifestyle and shift most of his portfolio to cash just nine years after retirement illustrates how difficult it can be for clients to be coldly rational and emotionally detached from financial decisions when their retirement security is at risk. It can be scary when the paychecks stop coming and the wallet starts to shrink, and no amount of logic can silence those emotions and quell the desire for security.

Consideration of clients’ tolerance for income risk and desire for security should begin before retirement begins, with planning that considers their financial and emotional needs. For clients who have sufficient assets and can handle market volatility, a probability-based total return strategy for retirement income may be the right approach for these times.

But for those who aren’t comfortable in the markets, a guaranteed income component in the portfolio in the form of an annuity can help alleviate many of the fears expressed by Bengen in the article – about the lack money, capital protection and the harsh consequences of a bear market at the start of retirement. And, it can be a lot more productive for a retirement plan than spending money.

We can learn a lot from the Bengen experience. Her story underscores that retirement security is as much about considering emotional well-being as it is about making financial decisions. When it comes time to discuss retirement income with your clients, find out how comfortable they are with income risk and suggest strategies that fit their needs and wants. For many advisors, this means going beyond simply offering investments. This will allow retirees not only to support, but also to enjoy their retirement.

Photographic illustration by Councilor Barron; Courtesy of DPL Financial Partners


David Lau is founder and CEO of DPL Financial Partners, which specializes in the development and distribution of low-cost, commission-free insurance and annuity products, product discovery tools and education for RIAs and individual investors . Since going to market in 2018, DPL has worked with over 20 insurance companies to bring a suite of no-cost products to its turnkey insurance management platform for paying advisors.

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