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

By Jeff Benjamin

May 19, 2013 @ 12:01 am (Updated 5:57 pm) EST

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.”

  @IN Wire

Apr 18 09:00PM
Control yourself: Better time management, better business http://t.co/rm9jbKMbKr
Apr 18 06:17PM
Crosby, Stills & Nash Primer http://t.co/1oTcjIDROO

Career Center

Explore your opportunities and be informed for your next move.

Company Type
Firm Type
Clearing Firm
Presented by

Most Watched Video

7:12The 2 biggest factors driving growth in active ETFs

Ugo W. Egbunike Dir. Of Business Development, ETF.com Greg Crawford Deputy Editor, InvestmentNews

Video Spotlight
1:47People are Living Longer. Good News or Bad News?

Sponsored by Oppenheimer Funds Inc.