Shortcomings of a “Minimum” Retirement Rule (Part 2)

2. It’s hard to generate withdrawable income when interest rates are low.

One benefit of the 4% rule in many investors’ eyes, is that you can typically get your portfolio to generate the income you withdraw each year. In the past, when rates on savings accounts were typically 4% to 5%, and bond rates were in the upper-single-digit percentages, the 4% rule worked well even with a portfolio split evenly between stocks and fixed-income instruments.

The current environment is much more of a struggle, because many safe fixed-income alternatives pay far less than 4%. To compensate, many investors have moved their portfolios into dividend-paying stocks, accepting higher than normal levels of risk in exchange for finding ways to generate income without having to sell off investments or dip into the principal of fixed-income balances.

There’s nothing inherent in the 4% rule that says you can’t make such sales or dip into principal, and, in fact, it’s expected in later years. But most retirees get nervous spending down their nest eggs, so the current low-rate environment presents a huge challenge.

3. Losses in the bond market are possible.

One big reason the 4% rule has worked so well over the past 40 years, is that the bond market has, generally speaking, provided positive returns to investors. In the late 1970s and early 1980s, the bond market struggled under the weight of high inflation and uncertain geopolitical and macroeconomic factors across the globe, and that sent rates to double-digit percentage levels. Since then, rates have trended lower, and that has added capital gains to the generous income payments that bonds have made.

Now, bond rates are low, and many see them as having nowhere to go but up. That introduces the potential for capital losses in the bond market. Those who invest in funds to get fixed-income exposure are particularly at risk, because unlike a regular bond, you can’t just hold a mutual fund or exchange-traded fund to maturity and get back your principal. The potential for low or negative bond market returns puts that much more pressure on stocks in order for the 4% rule to work.

The 4% retirement rule serves as a useful guide, but it’s not perfect. By realizing some of the shortfalls of this rule, you can make your own refinements that will tailor it to your particular needs.

Original article by Dan Caplinger via The Motley Fool March 4, 2016

http://www.fool.com/retirement/general/2016/03/04/3-serious-problems-with-the-4-retirement-rule.aspx

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