Have you heard of the 4 percent rule? I’m guessing you have as it seems to be some magical number espoused by traditional financial advisors and bloggers alike.
The idea is that you should safely be able to withdraw 4 percent of your portfolio to live on for retirement. Theoretically the 4 percent is based on the idea that, over time, portfolio yield should outperform 4 percent and result in principal preservation.
Is it really that simple? Maybe it is. Maybe that’s all you need to do and it will work out for you. As you may have guessed, I’m more than a little skeptical of the rule myself.
Why? Well, for one thing, I’m a real estate guy. I like income producing assets with tax benefits that I can see, touch and feel. Admittedly, that’s just my bias.
The bigger problem with the 4 percent rule is that it is based on old data. Specifically, the modeling uses data from 1926 to 1976. To me, that’s a little concerning.
You see, the underlying assumptions of the 4 percent rule are that most of the most of the portfolio income is produced from dividends and fixed income.
What is fixed income? Fixed income comes from bonds of course and bond yields are reflective of interest rates. I don’t need to remind you that we are at historical low interest rate levels now and our president is advocating for negative rates.
How does that make you feel about the 4 percent rule now? It makes me very concerned for my high-paid professional colleagues—doctors, lawyers and engineers who are following the 4 percent paradigm like it is religion. While it may work out, it sure doesn’t sound like a risk that I would want to take.
We live in unparalleled times. How in the world can we use hundred year old data to guide us into retirement? No way I’m doing that. But the problem is that most of our colleagues will and all we can do is watch them like an accident ready to happen, hoping they will survive.
In the meantime, we need to continue to educate ourselves. Financial education is our best weapon defense against going broke.
In line with that, my guest on Wealth Formula Podcast today is an author and educator that I have invited to teach us about the biggest financial sector on earth: the bond market. Without understanding the bond market, you cannot understand the economy. Don’t miss this interview!