One of the things that really frosts me…is the financial planning industry that insists on using rules of thumb such as the “set and forget” tools – specifically the 4% and 60-40 rules. The idea that one number will serve you throughout your entire retirement is absurd. [Let me explain why.]
The original article has been edited here for length (…) and clarity ([ ])
The 4% Rule
Take the 4% rule first, which states you should withdraw 4% of your nest egg each year in retirement. It puts such a crimp in our money lives in retirement when we could be enjoying other things. It’s just too restrictive. Plus, it’s based on numbers from the four worst years in the market’s history. It’s just dumb. Think of it this way. Can you imagine setting a single number as the basis of your spending for the rest of your life when you were 25? Ridiculous! Before you scoff at that 25 number, remember that many of us will spend 30 years in retirement. 30 years would be from 25 to 55, so that’s a fair comparison.
The Monte Carlo approach, on the other hand, factors in a number of different scenarios that allow you to plan and adapt your spending as your situation changes and it makes a whole lot more money available for you to enjoy. That’s just one alternative. There are others.
The only good news is that the 4% rule isn’t damaging. The worst-case scenario is that it scares us into being thrifty during our golden years and is too restrictive but the other too-often-used rule of thumb for diversification, the 60-40 rule, can spell big trouble down the road.
The 60-40 Rule
The 60-40 rule states you should have 60% of your money in stocks and 40% in bonds or similar lower-risk holdings. My question for the set-and-forget advisors is “Who uses this dumb tool and when?” At 55? At 60? At 65? When do we shift gears? Is it one day at random, or is there a preset date when we sell 40% of everything and buy a bunch of bonds? Really? That’s the most obvious problem but here’s where this set-in-stone stupidity ramps up our risk. As we age, we shouldn’t necessarily stay with a number that worked for us 20 years earlier. At 80, don’t you think we might change the risk level in our portfolio to allow for the dwindling number of years we have to recover from a sell-off?
Use your age as the percentage you should hold in less-risky investments. It makes so much more sense. At age 55, have 55% in lower-risk holdings. At 60, 60%. At 70, 70%. It isn’t a set-and-forget tool – thank God – and it does require you to be more vigilant and dynamic about your portfolio, but it also allows you to reduce your risk every year as you age and that makes so much more sense than the one risk level of the 60-40 rule. It’s fluid and allows you to start anytime. In fact, it allows you to adjust your portfolio when almost no one does but should: from day one.
I’m not a member of the “last check we write should bounce” club. I have responsibilities that require I leave behind a good-sized chunk of change, but 4% is way too tight, and I have been around this block too many times to not see the risk in the 60-40 idea.
The only advice I have for you is this: If your financial planner is using either of these set-and-forget tools, he isn’t doing his job. I’d start looking for a new planner.
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