Recently, we’ve been writing a lot about the 4% rule—specifically, how the 4% rule has been debunked—but now it’s time to qualify that statement. There is a way to take 4% income in retirement, depending on your investment strategy and how you allocate your resources.
The basic premise of the 4% rule is that if you invest in a balanced portfolio and then withdraw 4% of that money per year as your income, you’ll have money throughout your retirement. That approach doesn’t work! The 4% rule assumes that you’ll use your investments pro rata to generate income and then take the same distribution from the profits, whether those profits are up or down. As a general strategy for retirement, it’s a stupid thing to do! The classic 4% approach guarantees you’ll run out of money in retirement.
JP Morgan recently put out a study proving that the 4% rule doesn’t work. That same report could have come from any big firm because they all do retirement planning the same way. Almost all of them advise people to invest in a diversified portfolio and take some pro rata distributions for your income. This strategy leaves you dependent on the market to generate income. JP Morgan’s study acknowledged that economists and investors aren’t as confident about depending on the market as they used to be. Everyone used to believe that clients could take 4% income and their money would last through retirement, but now they’re saying that income should be 2 or 3% instead.
Why are advisors concerned that the market won’t be able to generate income for you? This year, the market is down 20%. Economists at JP Morgan expect significantly lower returns for the foreseeable future; Economists at Vanguard, Schwab, Fidelity, Blackrock, and other reputable firms are assuming the market will not return well over the next ten years.
JP Morgan’s study found that S&P and 500 have earned roughly 10% per year for the last ten years, but their long-term capital market assumptions forecast predicted that returns will be less than half of that over the next ten years. That means that the market will run about 5% per year over the next ten years. Most economists agree with these predictions and warn that the market won’t return well over the next ten years.
At the same time these smaller returns are happening, we are also expecting higher inflation. Part of the 4% rule is that you bump up your income to account for inflation as it reduces the purchasing power of your dollars, and taxes could rise in the future. The bottom line is that your portfolio’s ability to generate retirement funding will be reduced.
I agree with everything the studies are saying. In the coming years, the market will be hard-pressed to deliver income to clients. That’s why you shouldn’t use the market to deliver income! The purpose of investing in the market is long-term growth, not predictable yearly outcomes.
Unfortunately, any time you talk to an advisor they tell you they’re going to build a balanced portfolio for your retirement planning, and it’ll be fine. They tell you to trust the market and that it always rises over time. They’re not accounting for the fact that the market also has lots of times when it’s down! If you’re trying to take income when your portfolio is going down, you will find yourself with a big problem!
What’s the solution? How do you structure your accounts successfully? It doesn’t matter how much you have, the strategy to structure your portfolio in retirement is the same regardless of the dollar amount. We’ve been using this strategy for years and years and years, and we’ve found that this process works well when the market is up, and it also protects you when the market is down, and that protection is the key.
If you’re thirty years old and have lots of years in front of you, even though the market is down now, you can relax because you’re in the process of adding money. You’re not going to take that money out any time soon. When you’re adding money, you want the market to be down because that’s good for growing your money. What if you’re a lot older than thirty? What if you’re nearing retirement, and you plan to take money out soon, or you’ve already retired and are taking money out now? When the market is down, it’s no longer a good thing for you! When you’re putting money in, you want the market to be down so you can buy low, but when you’re taking money out, you want the market to be high. Since the market is low right now and will be low for at least the next ten years, you’ll need a new game plan.
This plan is easy, in concept. The application may be a little more challenging, and it’s something you must ensure you do the right way. Imagine your money all sitting in one big pot. You’re going to take some of that money and put it into something you can use to generate income. You’ll spend that down to zero, and it will hopefully last for twenty years if you do it the right way. The rest of your money you can set up for growth.
Let’s say, that you retire with a million dollars. Following the 4% rule, you want your yearly income to be $40,000. You need to take approximately $600,000 and put it in a high-quality indexed annuity portfolio. A high-quality indexed annuity portfolio is issued by an insurance company and is designed to have no market risk. You can take $40,000 per year from there, and it will probably last twenty or twenty-five years.
With twenty to twenty-five years of income covered, you can take your remaining $400,000 and put it in a market portfolio. Now you have time for the market to go up and down. What if the market is down by 20% in one year, and you lose eighty grand? That’s ok! You don’t need that money now; you will have a steady income for the next twenty years! The market rises over time, so you can trust it to grow your money when you don’t have to worry about year-to-year fluctuations.
This strategy helps provide income stability and overall growth in your portfolio. You won’t have to worry about the market going up or down. Your retirement is protected.
Here’s the big question: if you’re retired, or approaching retirement, is your advisor helping you set up a plan like this one? You need an income plan. We haven’t even touched taxes yet; we’ve just talked about how to strategically position your money so that it serves your needs in retirement. If you don’t have a well-structured plan, and your advisor isn’t helping you make one, you owe it to yourself to give us a call. We’ll set you up with a free analysis and put together a free, personalized Retire Right Report. We’ll make sure you’re in the best possible position in terms of retirement planning. If you want to prepare for another down year like we just had, now is the time to make a plan.
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