Then we’d know exactly how much we needed to save to have a safe and comfortable retirement. We’d know how long we would need to make our money last. We’d know how much we would need to spend each year. And, crucially, we’d know how much our investments would earn each year.
Alas, for the real world! We don’t know how long we’re going to live (which is the argument for lifetime annuities). We don’t know what will happen to inflation (which is the argument for inflation-protected Treasury bonds, or would be if they weren’t already overpriced). And, no, we don’t know how much our investments will earn each year.
I’m always amazed at the confidence with which people who work in Money, Inc. claim they can make forecasts. What they don’t know, or don’t tell us, is that those forecasts are based on some very sketchy assumptions.
Among them: That the future will look like the past. And especially like the ‘American’ past.
Our country drew a royal straight flush during the 20th century. Our major international competitors destroyed themselves in wars. Our remaining enemy posed such a threat that the whole country got behind huge public investments in technology and infrastructure that transformed the economy: We can thank the Cold War for the federal highway system, the space race, the internet and plenty more. Oh, and our ‘old world’ rivals helped us out by letting everyone with “get up and go” er… get up and go. How much of America’s spectacular rise came from the flood of immigrants that hit these shores between 1870 and the 1920s?
With all this, it’s not really surprising that U.S. stock market returns were among the best in the world for a century — the Great Depression notwithstanding.
What does this have to do with our retirement planning?
Plenty.
The so-called ‘4% rule’ is a mainstay of retirement thinking. It says that we are almost guaranteed to be OK in retirement if we keep our money in stocks and bonds, withdraw 4% of our portfolio (or less) in the first year of retirement, and thereafter just raise the withdrawals in line with inflation. (This usually assumes a typical ‘balanced portfolio’ of 60% stocks and 40% bonds, such as, for example, that tracked by the Vanguard Balanced Index Fund
VBIAX,
and many others.)
Do that, goes the argument, and we’re 95% likely or better to make our portfolio last for 30 years.
It’s an argument that many have taken to heart. It’s become a standard rule of thumb for retirement planning.
The problem? It’s based entirely on those wonderful numbers from U.S. stock markets over the past 100 years. The 4% rule assumes that your stocks (and bonds) will do as well in the future as they did for the happy investors of yesteryear.
The risk here is obvious. If we don’t get those happy returns, the 4% rule can fail….
Read More: Opinion: Think you can rely on the 4% rule in retirement? Think again.