Is it time to shatter the retirement rules you’ve been told to follow?
- The traditional 4% withdrawal rule may not suit everyone; personalized withdrawal rates are recommended.
- Morningstar suggests a safe withdrawal rate of 3.7% for a balanced portfolio over 30 years.
- Research indicates a 100% stock portfolio may outperform the traditional 60/40 investment strategy.
- An all-equity strategy could allow for lower savings rates while generating higher wealth over time.
- Despite its volatility, an all-stock approach might be less risky than conventional retirement strategies.
Rules are meant to be broken, right?
For decades, financial gurus and advisors have repeated two major retirement strategies: the 4% withdrawal guideline and the 60/40 investment portfolio. These particular rules can be helpful conversation starters, but they don’t work for everyone.
In fact, a growing body of research is flipping these retirement savings tenets on their heads.
Here’s a closer look.
The 4% withdrawal rule
In 1994, financial planner William Bengen’s research in the Journal of Financial Planning introduced the now-famous “4% rule,” suggesting that was the magic “safe” number retirees should aim for when making their initial savings withdrawal, followed by inflation-adjusted withdrawals each subsequent year.
The idea is that the “Bengen rule,” as it is sometimes called, ensures that your nest egg won’t deplete before 30 years. Assuming you retire at age 65, a 4% withdrawal rate should last you until at least 95, his research shows.
Three decades later, that rule is still often recommended. But financial research firm Morningstar says that your “safe” withdrawal rate hinges on your length of retirement and your portfolio allocation.
Assuming a 30-year retirement and a portfolio with 20% to 50% stock allocation, a withdrawal rate of 3.7% is ideal, Morningstar’s research found.
Generally speaking, the longer your retirement and the higher your stock allocation, the less you should withdraw annually. For a 20-year retirement, you should be able to safely withdraw 5% each year, but if you’re looking to spend 40 years work-free, Morningstar recommends not exceeding 3.1%.
And if you have an extremely aggressive portfolio, like the following study suggests, you’d want to withdraw even less, as little as 2.7% a year.
The 60/40 retirement investment portfolio
As you near retirement, financial advisors often recommend an incrementally conservative investment strategy. Typically, you’d start with the traditional 60% stocks, 40% bonds (aka 60/40) portfolio and then move more of your investments into bonds or cash as you retire and age.
But research from a trio of finance professors at Emory University, the University of Arizona and the University of Missouri found that an all-gas, no-brakes retirement savings strategy far outperforms the 60/40 approach. The same is true for target-date funds.
They say that a 100% stock portfolio is the way to go. In terms of diversification — if you can call it that — you should allocate 33% to U.S. stocks and 67% in international stocks, under their model. You read that right: All equities. No bonds.
The authors found this approach “vastly outperforms” all other portfolios they measured in terms of building and preserving wealth in retirement, sustaining retirement spending and generating inheritances — or in other words, having large amounts of retirement savings left over after you die.
They determined this by comparing various portfolio options for a hypothetical couple who started saving for retirement at age 25. All else equal, the study found that an all-equity strategy could allow the couple to save less of their income before retiring since their returns would be higher.
In terms of retirement wealth, you’d need to regularly save 16.1% of your income in a target-date fund and 19.3% in a 60/40 portfolio to produce the same amount of money as a 10% savings rate in an all-equity portfolio.
On the other hand, when the savings rates were equal, the all-equity portfolio generated 50% more wealth than the 60/40 portfolio, and 39% more than the target date fund.
There are drawbacks, of course. Stocks are very volatile and a 100%-stock portfolio “can inflict intense psychological pain,” the authors wrote, when the market tumbles. “One worry is that some investors will abandon their investments rather than stay the course.”
But, they say, the other investment strategies are also volatile — and in some cases more risky, they argue — than going all stocks due to the risk of outliving one’s savings.
“Our results, as a whole, do not suggest that the all-equity strategy is safe,” they wrote. “They merely suggest that it is safer than common alternatives.”