TD Ameritrade Discusses The 4% Rule And Savings: 'Be Disciplined And Make Changes Based On Rational Decisions'
In light of the upcoming Congressional vote on a bipartisan bill that is said to possibly affect over 1.5 million people, retirement tips and tricks have once more tiptoed out of the shadows and into a conversational spotlight.
Benzinga spoke with TD Ameritrade (NYSE: AMTD) Director of Retirement Matt Sadowsky, following his comments about one well-known retirement tip that he believes has become obsolete. In a previous release, Sadowsky commented that the "4 Percent Rule" — an advisory guideline suggesting that a yearly 4 percent withdrawal from retirement funds should last 30 years — is "not appropriate anymore."
“What was once a good recommendation has gotten lost in translation over the years,” Sadowsky said, “Take for instance Baby Boomers, Generation X and now their kids, Generation Z – three completely different generations that each face different life expectancies, have invested in different economic climates with varying inflation expectations, interest rates and market valuation.”
In speaking with Benzinga, Sadowsky replied to four concerns over the broken 4 Percent Rule.
Don't Lose Sight Of The Big Picture
BZ: What are the implications of the broken rule?
MS: The 4 Percent Rule is a rule of thumb, not a law. It is a good starting point for determining a safe withdrawal rate, but it should not be followed blindly. An individual needs to take into account not just current and projected market conditions, but also their personal financial situation.
If the 4 Percent Rule truly is broken, the unfortunate truth is that we won't really know for certain, or to what extent it's broken, for another 30 years. We will have greater visibility along the way, and individuals should modify their withdrawal strategy as the markets dictate, but also as their own personal situation changes (for instance, changes in health might dictate a different time horizon).
A withdrawal strategy must be dynamic; You can't take a ‘set it and forget it' approach. But it is important to be disciplined and make changes based on rational decisions, not on knee-jerk emotional reactions to market movements.
The Current Situation May Or May Not Be The 'New Normal'
BZ: If the rule is truly broken, do you recommend a replacement rule? Is there any evidence yet that could determine what percentage would be appropriate?
MS: Many people's understanding of the 4 Percent Rule is broken. For example, some people forget or are unaware that 4 percent is the initial withdrawal amount, but that the rule calls for increasing the amount by the rate of inflation every year. Also, the rule applies to not just any portfolio; Rather, it assumes a Balanced Portfolio (e.g. 60 percent equity/40 percent debt).
Often misunderstood is that the withdrawal rate is based on a 30-year time horizon –- anyone with a shorter time frame should feel more confident that the ‘safe withdrawal rate' will not exhaust the portfolio. Similarly, anyone with a longer time frame might consider reducing the withdrawal amount.
Critics of the 4 Percent Rule often cite currently low interest rates and bond yields, as well as high asset valuations as reasons for the 4 Percent Rule being broken. The question is if this is the ‘new normal' -- Will we see protracted lower portfolio returns than the historical returns that the 4 Percent Rule is based on?
BZ: Can you go into a bit more depth regarding your insights on historical data and performances as related to the 4 Percent Rule?
MS:The 4 Percent Rule assumes that the historical performance of asset classes relative to each other will be similar to the future. However, the recent financial crisis illustrated a breakdown in historical correlations and co-variances between asset classes: several asset classes that have traditionally performed inversely to each other, instead, all decline in value.
The key question for some critics is: Do we believe we have enough historical data and have we seen enough historical market patterns to have confidence in the modeled scenarios that the 4 Percent Rule is based on? Most models are based on data going back to the 1920s, with market cycles that include the Great Depression, the Internet bubble, oil crises and several recessions along the way. Some critics point to the recent market environment since the financial crisis as evidence that we need to observe more market cycles and financial history before we will have an accurate model for a safe withdrawal rate.
Consider Guaranteed Lifetime Income In Light Of The Vote In Congress
BZ: How could the vote in Congress regarding retirement pensions affect the 4 Percent Rule?
MS: A reduction in retirement pensions places more burden on the individual to invest his or her retirement assets and spend down their nest egg properly. The more income sources that an individual has that will last their entire life (like pensions), the more confident they can be that they won't run out of money.
If guaranteed income from pensions is reduced, the inverse is true and optimizing a withdrawal strategy becomes more important. One possible implication is that the individuals may increasingly seek to purchase annuities to replace the guaranteed lifetime income from pensions.
Regardless How Much Time Until Retirement: Strategize
BZ: Obviously, more can be done by Gen Yers and Boomerangs, but what can those who are in retirement or preparing to retire soon do in order to arm themselves against potential financial insecurity over the next decade?
MS: One common approach is to bucket assets by time horizon (e.g., into five-year buckets consisting of a 0-5 year bucket, a 5-10 year bucket, and a 10+ year bucket, or some variation) and draw down each bucket over the course of each five-year period. More aggressive investments can go into the 10+ year bucket and more liquid, conservative investments in the 0-5 year bucket. This approach can give individuals more visibility into how their assets should be drawn down over time and more discipline to spend within their means.
Those who are concerned about making their nest egg last might also consider increasing the amount of income streams that are guaranteed to last for life. Social Security, pensions and annuities are some examples of guaranteed lifetime income sources. One strategy is to delay Social Security as long as possible (to age 70) in order to maximize the annual income amount once the payments begin.
Annuities can also be supplement to Social Security, and deferred income annuities (DIA) are one type of annuity that is gaining increasing awareness and adoption. A DIA locks in a guaranteed cash flow stream starting at some point in the future and lasts for the rest of the individual's life, similar to Social Security. Annuity guarantees that the individual will always have a cash flow stream, even if he spends down the rest of the portfolio (because the 4 Percent Rule fails or for any other reason).
Knowing that a cash flow stream will kick in at a future date, the individual can have more confidence and flexibility to spend down the portfolio and enjoy their money during the years before the cash flows from the annuity kick in.
BZ: Thank you so much for taking the time to speak with Benzinga.
© 2017 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.