May 27, 2022
Written By: Andrew Hallam
Fifty-four-year-olds Chris and Louise Phinney worked hard to build a retirement portfolio. They own some revenue-generating real estate and a portfolio of ETFs that’s worth about $1.3 million. Chris worked for the German company, Bosch, until he retired in 2017. Louise will retire from her international teaching job later this year. But the recent stock market dump has given them the jitters.
They’re wondering if they could still safely follow the “4 percent rule.” This rule suggests Chris and Louise could withdraw about $52,000 from their portfolio this year. That’s because 4 percent of $1.3 million is $52,000. In the years that follow, they could increase those withdrawals to match the rising cost of living, and their money should last at least 30 years.
But with US stocks down this year about 18 percent, to May 20th, 2022, Chris wonders if his money could last the couple’s lifetime. Would the 4 percent rule work?
Back-tested rolling 30-year periods, beginning in 1926, suggest Chris and Louise’s money should last at least 30 years. For example, from 1929-1932, US stocks dropped about 87 percent. As terrifying as that would have been, someone could have retired in 1929 with a diversified portfolio of 60 percent stocks and 40 percent bonds, withdrawn 4 percent in their first year and made annual adjustments for inflation or deflation over the next 30 years.
After retiring at history’s worst possible time, they would have still had money left after three decades of withdrawals.
However, people are living longer than they did in the past. Many, like Chris and Louise, are also retiring at much younger ages. That means young retirees, especially, are likely to live longer than another 30 years.
And while that might increase the risk, it won’t always change the game. It’s entirely possible that Chris and Louise could withdraw $52,000 this year (4% of their $1.3 million) and then increase withdrawals for another 45 years, taking them to 99 years of age.
For example, assume one of the Rockefeller descendants retired in 1972 with $1 million: 60 percent US stocks and 40 percent intermediate government bonds. She would have withdrawn $40,000 in her first retirement year. Each year after that, she would have made adjustments to cover inflation. Some of the earliest years of her retirement would have been downright hairy.
During the 1973-1974 meltdown, US stocks crashed about 46 percent. Adding to the fear, Ms. Rockefeller would have also faced high inflation levels. As a result, she would have withdrawn a lot more every year. In 1973, she would have withdrawn $44,963. In 1976, she would have withdrawn $56,642. By 1979, she would have withdrawn $74,647 and in 1981, she would have needed to withdraw a whopping $91,484. Yes, inflation ran like a pack of thieves.
Let’s assume Ms. Rockefeller was thirty years old when she retired in 1972. She spent the following 51 years volunteering with a community of budding Scientologists. According to portfoliovisualizer.com, if she continued to withdraw an amount that aligned with inflation, her annual withdrawal would have increased from $40,000 in 1972 to $271,341 in 2021.
You might wonder whether her portfolio could have sustained the market crashes of 1973-1974; run-away inflation in the 1970s and early 1980s; the stock market crashes of 2000-2002; the financial crisis of 2008-2009; and the recent decline in 2022. The answer would be, Yes.
This is mind-boggling stuff, so I’m going to lay it out:
Ms. Rockefeller would have retired with $1 million in 1972.
After 51 years of ever-increasing withdrawals, she would have pulled a combined $7,685,350 from her portfolio. Yes, that’s $7.68 million.
And by May 2022, her portfolio would have still been worth about $5.1 million.
However, unlike Chris and Louise Phinney, Ms. Rockefeller wouldn’t have needed to brave a stock market crash during the first year of her retirement. If a crash had occurred in 1972 (when she made her first annual withdrawal), she would have a lot less than $5.1 million today.
For example, assume Ms. Rockefeller retired in 1973, not 1972. In 1973, US stocks fell 18.18 percent. The following year, they plunged a further 27.81 percent. By May 2022, she would have still had money left. But instead of $5.1 million, she would have had $1.7 million remaining.
Of course, that’s still a roaring success. But it goes to show how a market decline in a retiree’s first year can have a big, long-term impact.
However, neither a market drop nor inflation is the greatest risk to a retiree’s portfolio. For example, assume someone retired with $100,000 in 1973: 60 percent US stocks, 40 percent bonds. Stocks fell about 46 percent over the next two years. After the first two years of retirement, the portfolio would have slumped from $100,000 to just over $69,000. The cost of living was also ramping up. Between 1973 and 1981, inflation averaged 9.5 percent per year.
Would most retirees have had enough faith to stay the course? In most cases, I would say, No. They would have freaked out, seeing their portfolio fall so hard in just the first two years of retirement. They would have likely tinkered with their allocation. They might have sold everything at a low. Yet, if someone retired on the eve of the 1973 crash, then endured the 1974 crash, plus run-away inflation, the money (if they withdrew an inflation-adjusted 4 percent) would still have had lasted more than 40 years (you can see a year-by-year table in this column).
Life doesn’t offer a guarantee…nor does the 4 percent rule. Future stock returns might be lower than they ever were in the past. Inflation might be higher than it ever was before. That’s why you should treat the 4 percent rule as more of a guideline than a rule. Retirees could withdraw a little less during market down years. And if, after several years, their portfolio values swell, they could sell a little more.
More important, however, is remembering that our reactions to fear are more damaging than anything the markets or inflation could ever hit us with.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas
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