Allow me to summarize here a debate that has been talked about in the financial media that I am just skimming for you. This is an excuse to raise the issue of payouts at retirement age in the face of strong headwinds.
With “major headwinds” you will understand that I am talking about inflation coupled with the recent de-stocking of pensioners.
So the subject of the debate is: Does the 4% rule still apply?
But what is it?
The 4% rule
This is a benchmark like that which requires 70% of your lifetime earnings to be earmarked for retirement (the “70% rule”).
The approach is that you should withdraw 4% of your wealth in the first year of retirement and then keep up the pace each year, increasing withdrawals to match inflation. This method ensures that there is practically no risk of running out of funds.
For example, with $500,000 in your RRSP, you should withdraw no more than $20,000 at age 65, and $20,600 the following year when inflation is at 3%, then $21,218 a year later, and so on.
Such a rule is based on certain parameters, including the composition of the portfolio and therefore an expected return. It was originally based in 1994 on an allocation of 55% US equities and 45% bonds, which has since been refined.
Very approximately
The “thumb” rules (pardon the Anglicism) all have the same flaw: they don’t take context into account. The one we’re talking about here doesn’t work with very cautious investors or with the most dynamic. It’s enough to start retirement with a bad string of returns, it doesn’t last anymore. On the contrary, retirees can sometimes see their portfolio growing despite withdrawals. They don’t benefit from their money.
“It still has the quality of reminding us that with withdrawals of 2% we are probably depriving ourselves for nothing and that with 10% we risk running out of money,” emphasizes Daniel Laverdière, Director of Private Banking at the National Bank 1859 center of excellence.
A changing rule
The rule is often modulated in the specialized media according to the mood of the moment. In times of optimism, the 4% rule becomes the 6% rule. And when pessimism takes over, you can guess what they’re saying.
Given the high valuation of stocks (which limits their growth potential) and the risk that weighed on bonds (we could see interest rates rising), Morningstar firm set a growth rate of 3.3% in November, which is on hold should in order not to consume his capital during his lifetime.
Recently, the creator of the rule in question, American Bill Bengen, claimed to have cut his spending (he’s retired). Most surprisingly, he admitted to the Wall Street Journal that his holdings were 70% cash, which has nothing to do with the portfolio composition his model predicted. (Note that experts often do not follow what they preach.)
“I will not go to restaurants too often. I lead a pretty simple life. I don’t travel much. I’m happy with a deck of cards and three other bridge players,” the famous financial planner told the American daily.
“Living” Payout Plan
Since 1994, the 4% rule has been the subject of countless analyzes and criticisms. Even its creator has reinterpreted it in many ways over the years.
Note that it was formulated at a time when the financial services industry was much less resourced than it is today. The vast majority of financial planners today have powerful software that allows them to determine optimal payout strategies that take tax implications into account.
However, software, like the 4% rule, has a major flaw: changing circumstances. Life is not smooth like an Excel file. Because of this, you should review your payout schedule from time to time.
When your portfolio suffers market losses, especially when the cost of living is skyrocketing, you should cut back on spending. This means delaying car replacements, postponing a trip, reducing the frequency of restaurant meals, etc.
On the other hand, if your wealth is appreciating faster than expected, you can indulge yourself a little more. Be careful, there is a trap here. One must avoid taking advantage of all the margin that the good performance of one’s investments offers.
On days with changing wind direction, this safety distance will always come in handy.
