The 4% Rule ‘Myth’ Debunked

Often as financial planners we get asked “How much money do I need to retire one day?”

The answer is not a simple one, as ‘it depends’ on lots of things.

We often share as a rough ‘rule of thumb’ that you can work on looking at a drawdown rate of 5%. This means that taking all your investments into account (excluding your home) you can draw 5% out per annum and the capital should sustain you for the rest of your life.

A quick example, if you have R10m to live off in retirement you should limit your draw to R500,000 a year or R41,666 per month. This will allow the capital to grow and hopefully, the next year your 5% draw will have grown in rand terms.

The 5% drawdown guide assumes you are at retirement age and that your income will increase annually by inflation. Some planners have said that 5% is too high and that one needs to be more conservative. For some time now a rate of 4% has been put forward as a better guide.

Where the 4% “Rule” Came From

Bill Bengen studied nearly 400 hypothetical retirees, each retiring on the first day of a quarter (Jan, Apr, Jul, Oct) from 1926 onwards, almost 100 years of data.

Here’s what Bengen found:

• Most retirees could start with a drawdown rate of close to 5% and their money would last.
• Only one unlucky retiree on the 1st October 1968, needed to set their rate at 4.1%.
• On the other extreme, some retirees could have afforded to withdraw as much as 14%, depending on market conditions when they retired.

The important lesson: there is NO single “safe” number. Context matters.

The Dynamics That Matter

When deciding your retirement drawdown, you need to pay close attention to:

• Market valuations – If stock markets are expensive when you retire, you need to be more conservative. If markets are cheap, you may have more room to increase the levels.
• Diversification – Do not rely on any single stock market. Your portfolio should include local and offshore shares, bonds, property, and cash. Equities are your best friend in retirement.
• Flexibility – You should be ready to make small adjustments to your lifestyle and drawdowns, depending on how markets and your portfolio perform.
• Rebalance regularly – keep your investments aligned with your plan.

Building a Sustainable Retirement Income

To give yourself the best chance of sustaining your lifestyle:

Make small adjustments to drawdown and spending as needed, not drastic changes when it is too late.

And always remember, inflation is your real enemy in retirement. A diversified portfolio, including some assets that may feel “unfashionable,” is often your best defence. The shares or equities in your portfolio are the inflation busters, you need them to do the heavy lifting over a long period.

The so-called “4% rule” is not a rule at all. Retirement spending is dynamic and must be tailored to your circumstances, the markets, and your goals.

At Veritas Wealth we use a financial planning model and together, with you, set out your lifestyle goals in monetary terms. We make a number of assumptions and depending on a number of factors, decide what drawdown rate is optimal and acceptable to you. It is an incredibly dynamic process and needs to be revisited at least once a year.

We encourage you to work closely with your financial planner in these review sessions and lean on third-party perspectives when setting your drawdown. With the right strategy, you can enjoy a sustainable, rewarding lifestyle throughout your retirement years.