Since 1994 the single greatest number impacting retirement portfolios is “four.” This number became the industry standard retirement annual distribution percentage once William Bengen showed that investors could safely distribute four percent annually from a 50/50 stocks and bonds portfolio without running out of money during any rolling thirty-year period since 1926. (1) According to Morningstar, historically low starting yields on bonds and high relative valuations on equities should have advisors rethinking the four percent rule. They suggest a distribution rate closer to 3.3%. They go on to say that the rate of withdrawal can be increased if several things change such as distribution flexibility, inflation hedges, time horizon, and success rate desire.
The paper is helpful but neglects to make two key points:
1. Retirement distributions should be calculated based more heavily on the needs of the retiree, not solely their portfolio.
2. Retirement needs to be redefined.
Needs Based Distribution
Retirement needs are just as complex, if not more, than life before retirement. The lump sum expenses for home repairs, hospital bills, new cars, and vacations happen both before and during retirement. Additionally, the income needs for each client may shift from year to year. This complexity is the reason communication between clients and advisors is essential. For example, if there is a need for cash that can be forecast in the coming year, it gives the advisor an opportunity to reallocate funds in preparation. Adjustments like this could potentially increase a client’s distribution rate and time horizon in meaningful ways.
Historically, being retired meant not working and that your income came from passive sources such as social security, investments, and pensions. Recently, however, retirement is being redefined as the freedom to choose if you would like to keep working. If you do want to work, what kind of work would you enjoy? How many hours would you like to work each week? This financial freedom to choose has given many of our clients a profound sense of agency, which can only be experienced in what one might call retirement.
These two factors profoundly impact how we approach a client’s overall strategy. They hammer home the importance of consistent, in depth and wholistic conversations between clients and advisors for retirement planning.
- Eric Puckett
1. https://www.morningstar.com/lp/the-state-of-retirement-income