Don't Disregard Good Rules Based on Bad Information
It seems that every now and then I have to defend one of my little thumb rules of investing. This time it is the 4% rule. Thing is that I didn’t come up with it, it was never an “absolute,” the originator has disowned it, and 4% isn’t always the number.
This rule answered the question, “How much can I take out of my retirement savings each year and know my money will last?” The answer is 4%, with a whole bunch of caveats. I’ve gone into those in the past and won’t dwell on them now. But in the March 4 edition of The Wall Street Journal report on Investing in Funds and ETFs, Kelly Green stated that the 4% rule probably doesn’t work any more. The reason? As the financial crisis has shown us, if you have heavy losses in the first few years of your retirement, there are serious doubts that your investment nest egg will be substantial enough to make a fullomelette.
Yes, I’m arrogant enough to pick a fight with The Wall Street Journal. First, they don’t care; second, they won’t notice; and third, I’m right.
To be fair they aren’t the only ones spouting off this sentiment. Many financial writers have been attacking both Modern Portfolio Theory and the 4% rule using the recent idiocy on Wall Street as their proof. There are a few things wrong with this.
The methodology they used was rarely mentioned (in the few places that attempted to back it up compared apples to oranges). So let’s skip to when they thought the 4% rule would be in trouble.
Without going into the details, there are four scenarios that cause Green and others their concern. The first two were during the Great Depression and the ‘70s: Those in the early years of their retirement saw big drops in the stock market and poor returns over time. Massive drops along with dismal returns in the ‘70s caused one magazine to declare the “death” of equities. Also in the ‘70s, rampant inflation and a bad bond market (they tend to go hand-in-hand) caused another one of these scenarios. If you were around back then you will remember our double-digit hyper-inflation.
So, all four of the 4% rule- busting scenarios they gave have already occurred and the 4% rule would have worked each time. Again, I’m not sure the methodology they used to determine it wouldn’t have worked, but I used reality and rather like the results.
All that said, I do see one scenario where the rule might be in trouble: A sustained combination of low interest rates and moderate inflation that causes the average return on bonds to be less than inflation for a decade or longer.
In conclusion, feel free to ignore the rule if you want. I don’t think it will hurt too badly. After all, my experience isn’t that people are convinced by the “rule” to spend more than they would have otherwise. Instead, I find that it is almost impossible to get most retirees to spend as little as 4%. So by all means, spend even less if you want.
This article was published under the title "Begging to differ with WSJ on rule" in the Wichita Falls Times Record News on June 23, 2013.