Page 31 - Investment Advisor January/February 2022

The 4% Rule Is Dead.

What’s an Advisor to Do?

Flexible spending seems like an optimal approach, as

does the right mix of stocks, bonds and risk analysis.

BY MICHAEL FINKE

new Morningstar report has resurrected debate about This is both an empirical question (I can look at retiree
the safety of the 4% withdrawal rate in a world of spending data and estimate average essential expenses) and a
A low bond yields and high stock valuations. Plugging personal/emotional question (do you consider a gym member-
more realistic portfolio returns into a Monte Carlo simulator ship or dog grooming an inflexible expense?). Some retirees
reduces the safe withdrawal rate (10% failure) to 3.3%. may consider 70% of their budget inflexible, while others aren’t
The report makes the very important point that fixed with- willing to budge on 90% of their lifestyle. This has important
drawal rates aren’t that realistic. When faced with a bear mar- implications when creating an investment plan because risk
ket, most retirees will cut back. Likewise, if retirees get lucky, requires spending flexibility. Too often a fixed withdrawal rate
they should be able to spend more. Flexible spending, which rule is portrayed as free of spending flexibility risk.
allows spending a bit higher or lower than a fixed withdrawal This cannot be true. If there wasn’t a chance that risky
rate guideline, seems like a much better approach. investments would underperform safe investments, advisors
But acknowledging the need for flexible spending is an could simply short Treasury bonds and invest more in stocks
important caveat to the 4% rule, one that opens the door to to give their clients a better retirement.
a better and more realistic approach to matching investment The risk of stocks underperforming bonds, especially in a
risk with the amount of spending risk a retiree is willing to retirement time horizon where returns in the first decade have
accept. Going from spending $40,000 on a $1 million portfolio an outsize impact on lifestyle, is real. Ignoring this risk, or dis-
to $35,000 sounds easy enough, but it means that the retiree missing it based on a small series of historical U.S. returns, isn’t
has to be willing and able to cut back. the most precise way to plan.
One of the most important questions I’ve heard an advi- For many traditional financial planning clients, a spending-
sor ask a client when developing a retirement income plan is focused retirement income plan isn’t needed because they’ll
simply “how much do you need to live on?” The point of the likely never outlive their savings. However, a larger number
question is to understand how much of a retiree’s budget each of mass-affluent retirees is truly at risk of outliving savings or
month is inflexible. making painful spending cuts if their investments go south.

JANUARY/FEBRUARY 2022 INVESTMENT ADVISOR 29