'4% rule' shouldn't be a rule, Wade Pfau says

May 19, 2013 @ 12:01 am

By Jeff Benjamin

In the debate over whether it is better to base a retirement income withdrawal rate on predictable historical returns or one that focuses on basic retirement needs, it appears that the jury is still out.

“Do you want to focus on the probability of failure or the magnitude of failure?” said Wade Pfau, associate professor of economics at the National Graduate Institute for Policy Studies.

Mr. Pfau, who has led the conversation over new ways to manage a retirement income portfolio, presented his food for thought last week when he spoke at the Retirement In-come Summit.

The two schools of thought, as he ex-plained them, include a “probability-based” approach of establishing a 4% withdrawal rate, and the “safety-first” approach that involves taking defensive measures to ensure that basic retirement needs are met.

The investment approach for the probability-based strategy, for example, relies on systematic withdrawals and typically applies a total-return perspective.

PYRAMID APPROACH

In the safety-first approach, by contrast, the portfolio assets are matched to goals, and lifetime spending potential is the focus, as opposed to maximizing wealth.

In a model arranged as a pyramid, the bottom layer in the safety-first approach is dedicated to essential needs, followed by a contingency-fund layer, discretionary-expenses layer and finally a legacy fund at the top.

“Volatile assets are not appropriate for basic needs,” Mr. Pfau said. “You think of essential versus discretionary.”

The fact that Mr. Pfau wouldn't commit to one approach over the other underscores the need for flexibility and open-mindedness on the part of financial advisers.

“Risk is not whether a portfolio goes up or down in value; it's the risk to one's lifestyle that matters,” he said. “The risk is that events will take place that would force someone's lifestyle or consumption to divert from where they want to be.”

Part of the argument for a safety-first approach is that amid low interest rates, a 4% withdrawal rate could challenge a lot of portfolios, which could result in more risk than some clients can stomach, Mr. Pfau said.

“There's a lot more to retirement income than just the 4% rule, especially in a time like this when interest rates are so low and we have an overvalued stock market,” he said. “I think it's important to think more holistically about retirement income, and I'm trying to be agnostic about these two different schools.”

0
Comments

What do you think?

View comments

Recommended for you

Featured video

Events

Why does social media matter for financial advisers?

Social media is a reflection of who you are. But who are you as a financial adviser? Debra Bednar Clark of DB & Co. offers some solutions to enhance your practice.

Video Spotlight

Help Clients Be Prepared, Not Surprised

Sponsored by Prudential

Recommended Video

Path to growth

Latest news & opinion

Brace for steepest rate hikes since 2006 in new year

Citigroup, JPMorgan Chase predict average interest rates across advanced economies will climb to at least 1 percent in 2018.

Why private equity wants a piece of the RIA market

Several factors, including consolidation in the independent advice industry and PE's own growing mountain of cash, are fueling the zeal to invest.

Finra bars former UBS rep for private securities transactions

Regulator says Kenneth Tyrrell engaged in undisclosed trades worth $13 million.

Stripped of fat commissions, nontraded REIT sales tank

The "income, diversify and interest rate" pitch was never the main draw for brokers.

Morgan Stanley fires former Congressman Harold Ford for misconduct

Allegations against the wirehouse's former managing director include sexual harassment, which Ford denies.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print