The real problem with any of the so-called ‘safe withrawal rates’ that we explored yesterday – with 4% currently being perhaps the most popular amount advocated – is that they all assume a fixed annual spending amount, but are actually generated by a totally volatile (some would say random) portfolio.
We’re trying to fit a square peg (fixed annual spending) into a round hole ( a ‘random walk down Wall Street’) 😉
But 7m7y readers have an even more fundamental problem with planning our ‘retirement’ based on this type of common industry wisdom: we are planning on retiring early, hopefully, with a very large Number and a soon Date!
Most retirement models assume a 30 to 35 year retirement lifespan …
… I don’t know about you, but I retired at 49 and intend to live AT LEAST another 40 years 🙂
Many of my readers will be aiming to reach their Numbers even sooner .. and, may expect to live even longer!
The bottom-line: traditional retirement planning models don’t work, because we need money that will last as long as we do … we need a Perpetual Money Machine, because we don’t know how long we will live once we stop working.
A Perpetual Money Machine is anything that:
a) Protects your capital over the long-run, even allowing for the ravages of market changes and inflation, and
b) Produces a reasonably reliable stream of income, that also (at least) keeps pace with inflation.
Neither stocks nor bonds – the traditional tools of retirement investing – fit the bill for us:
1. Stocks are too volatile, and the income tends to be artificial (e.g. so-called dividend stocks attempt to fix the level of dividend provided even as the company’s profits fluctuate).
[AJC: Raiding marketing, R&D, and other seemingly non-essential budgets in lean years in order to protect the dividend stream is – to my mind – the mark of a poorly run company]
2. Bonds provide a very safe return, but the % returned each year is too low, meaning – at least, to me – an unnecessarily reduced lifestyle, especially after allowing for reinvestment to try and keep up with inflation.
That’s why my Rule of 20 is exactly that: a planning rule, NOT a 5% spending rule!
[AJC: Otherwise, I would have called it the 5% Rule, d’oh!].
In other words, my advice for PLANNING your Number, is to decide what initial income you want and multiply that by 20 in order to find your Number …
… but, my advice for LIVING your Number is to turn on your Perpetual Money Machine and live off whatever it happens to produce, after allowing for taxes and provisions against inflation and contingencies.
I agree if you can live on what your investments produce over inflation you’ll never run out of money.
Does it still make sense to plan using the rule of 20 when you don’t think you will be able to reliably pull out 5%?
It seems to me use a more conservative rule say 25 or 30.
Also, you could still use stocks- you would need some other income sources too- bonds or cash to draw upon in down years.
-Rick
This response does not exactly pertain to this writing, but I thought perhaps would be an interesting perspective on 401 K’s’ Its borrowed from an article I recently read.
from:Dan Solin (Huffpost Blogger)
I recently reviewed a large 401(k) plan. I found many of the problems which make these plans such a rip-off: Mostly proprietary, high expense ratio, under performing, actively managed funds, conflicts of interest, revenue-sharing, hidden costs and fees and the misuse of “fiduciary” by an adviser to make the employer believe he is assuming liability for the selection and monitoring of investment options when all liability remains with the employer. Nothing new or surprising here.
Until I found the one index fund in the plan.
It was an S&P 500 index fund with an expense ratio of 0.50%. That seemed odd since the plan administrator had its own S&P 500 index fund with an expense ratio that was a fraction of that amount.
If there is one thing I have learned over the years, it is that the goal of the securities industry is to separate you from your money. Almost all of their actions can be understood in that context.
So why would an administrator bypass its own low cost index fund for a much higher cost one from a third party?
For two good reasons:
First, it receives revenue sharing payments from the third party.
Second, an index fund with a high expense ratio is going to have historical returns that under perform the index. When these returns are shown to plan participants, and compared to the high expense ratio, actively managed funds from the fund family of the administrator, most plan participants are going to select the proprietary funds.
An index fund with a high expense ratio should be an oxymoron. Yet, brokers continue to advise investors to buy these funds. Academics who study investor behavior call this phenomenon the “Index Funds Rationality Paradox.”
A leading study concludes this conduct is “…largely driven by an identifiable group of unsophisticated investors that buy funds through brokers.”
However, this is not the case with 401(k) participants if their only choice is one of these unsuitable index funds. They are caught between a rock and hard place: Either they buy an expensive index fund that will under perform the index or a more expensive, actively managed fund that is likely to do the same.
Either way, the mutual funds and the plan adviser win and the participants lose.
The employer is either ignorant of these shenanigans or doesn’t care. It believes the plan doesn’t cost it anything.
These guys are good!
I found this quite interesting . Might be yet another reason not to like 401 K’s
I say once you’ve built your number and are ready to move into MM301, put most of it into incredibly hand-picked, strong cash-flowing real estate!
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