Does Your Investment Advisor Understand?

Does Your Investment Advisor Understand The 4 Percent Rule? For years, investment advisors have told their clients about the 4 percent rule, which is a principle that dictates how much money can be sustainably withdrawn from a retirement account each year. According to the rule, retirees can withdraw 4 percent of their assets during the first year of retirement – and then, use that 4 percent as a baseline for their subsequent withdrawals (while adjusting for inflation) every year thereafter. By that premise, the retiree’s money would last at least 30 years, which is estimated to be the remainder of his life.

The 4 percent rule has been a cornerstone of responsible retirement planning for 20 years – but unfortunately, many of today’s investment advisors are failing to embrace it. Instead, there is a prevailing belief among those advisors that they are somehow smarter, or “better,” than the 4 percent rule. In other words, they believe they can “beat” it.

The Mistake of Withdrawing More than 4 Percent

Consequently, those advisors make the mistake of telling clients they can withdraw anywhere from 7 to 10 percent of their retirement assets on an annual basis; clearly, that is a far cry from 4 percent. By nearly doubling the amount that can be safely withdrawn every year, those advisors are putting their clients in a very precarious position. It’s not just risky; it’s downright dangerous.

Here’s a hypothetical scenario to illustrate: If a retiree has a $600,000 retirement account, and his investment advisor tells him he can withdraw 10% from it every year to live on for the rest of his life, that means he withdraws $60,000 a year. It only takes simple math to conclude that doing this means his money will run out in 10 years – which, hopefully, is not the rest of his life. What will that retiree have to do to create more income for the next 20 years of his life? Some advisors will say, “Just make more investments.” But is that the wisest choice?

You Can’t “Out-Invest” the 4 Percent Rule

Advisors who would recommend trying to beat the system by making more investments are not necessarily keeping the client’s goals in mind, whether or not they know it. Typically, these advisors mean well – but because they only focus on accumulation, they do not understand retirement income streams.

They believe that by simply taking more risks, they can try to “out-invest” the consequences of withdrawing up to 10 percent a year – and they do so to their clients’ peril, because there is no way to know how these investments will perform. Unfortunately, there is no way to invest oneself out of the consequences of this dangerous retirement income strategy. The 4 percent rule is there for a reason, and that reason is to protect the retiree.

What’s Even Better? Less Than 4 Percent

In fact, experienced investment advisors know that it is actually wiser for the retiree to withdraw less than 4 percent per year. Think about it: If 4 percent is the rule, how will retirees ever save enough to maintain their current lifestyle? If you need an income of $80,000 per year during retirement and you are using the 4 percent rule, then you need to have $2 million saved in order to live on that 4 percent. Do most retirees have that kind of money in savings?

Not at all; in fact, the average 401K is worth less than $600,000. That makes using the 4 percent rule very difficult, and the risky 7 to 10 percent strategy described earlier nearly impossible. If a retiree wants to sustain his portfolio and have enough income to live on for the rest of his life, it is much smarter to withdraw even less than 4 percent every year, while sustaining his portfolio with low-risk investments that offer a good rate of return.

A CERTIFIED FINANCIAL PLANNER™ professional can explain more about those low-risk investments; if you are interested in learning more, call (888) 994-6424 to speak with a retirement income professional today.

All numeric examples and any individuals shown are hypothetical and were used for explanatory purposes only. Actual results may vary.