What this article covers
Opher Ganel explains why the classic 4-percent rule, which can fail about 13 percent of the time under current market expectations, is no longer enough as retirement nears. He shows how combining the Guardrails Approach with a three-bucket strategy can raise a starting withdrawal to 5 percent or more while protecting a portfolio from a bear market early in retirement, and two financial advisors weigh in on the 4-percent rule and on annuities as a third safety net.
Key Takeaways
The Guardrails Approach can raise your starting retirement withdrawal from 4% to 5% or more
Developed by financial planner Jonathan Guyton and professor William Klinger, the approach adjusts spending by 10 percent whenever your current withdrawal rate drifts more than a fifth above or below your target. Opher Ganel notes it can lift the initial draw by more than 25 percent while cutting the risk of running out of money more than 3-fold, as long as your budget can absorb a 10- or 20-percent cut.
A three-bucket strategy shields retirement income from sequence-of-returns risk
With a 5 percent draw, the article’s buckets hold 15 percent in cash (3 years of expenses), 25 percent in bonds (another 5 years) and 60 percent in stocks. You draw from stocks after a good year, from bonds if only bonds rose, and from cash if both fell, so you can ride out up to 8 years of bad markets without selling stocks at a loss.
The 4% rule was built for 30-year retirements and a 50/50 portfolio
William Bengen’s 1990s research found a 4 percent inflation-adjusted draw would have survived every period from the 1920s to the 1990s, but only for retirements up to 30 years. Opher Ganel cites Monte Carlo simulations showing it would fail about 13 percent of the time under current long-term market expectations, while one advisor interviewed still recommends it to reduce retirees’ risk of running out of money.
Omar MorilloIf you’re far from retirement (or “work optional” as I prefer to call it), using the good old 4-percent rule isn’t a bad guideline for how much you need to save.
However, as you get closer to the finish line, like me, you’re better off upping your game a few notches.
And it isn’t all that complicated…
How Does the 4% Rule for Retirement Withdrawals Work?
William Bengen published this rule in the 1990s, based on his research that showed this would have worked 100 percent of the time from the 1920s to the 1990s.
Here’s how it works:
- You draw 4 percent of your portfolio in Year 1 of your retirement.
- In Year 2, you increase the Year 1 dollar amount by the inflation that occurred in Year 1.
- Rinse and repeat each further year.
Spiros Vassilakos, CEO & Private Wealth Advisor at Athenian Private Client Group likes the 4 percent rule, for retirees:
We encourage clients who are still working to not use their retirement accounts for income, but to rebalance their portfolio, especially during the last two years to keep up with inflation and rate increases. For retirees, we recommend the 4% rule to reduce the probability they’ll run out of money.
But this works for retirements lasting no more than 30 years. Worse, Monte Carlo simulations using current long-term market expectations show it would fail about 13 percent of the time.
And by “fail,” I mean you’d run out of money and drop into abject poverty in your final years.
Fun — not!
How the Guardrails Approach Lets You Safely Spend More Than 4%
I’ve written about it before, but it bears repeating.
This is perhaps the single biggest improvement in retirement planning I’ve come across since Bengen published his 4-percent rule in the 1990s.
The Guardrails Approach lets you increase your initial draw by more than 25 percent (to over 5 percent) while reducing more than 3-fold the risk that you’ll run out of money!
This approach, developed by financial planner Jonathan Guyton and business professor William Klinger, is a dynamic method for deciding how much you can spend each year in retirement.
Here’s how it works:
- You pick your target draw, which can be 25 percent higher than the 4 percent rule, i.e., 5 percent (depending on your stock allocation it could be as high as 6 percent!), and draw this percentage of your portfolio in Year 1.
- Just like in the 4-percent rule, you adjust the dollar amount by Year 1’s inflation.
- Before drawing the above amount as you would in the 4-percent rule scenario, you calculate the ratio of the new target draw to your current portfolio value. If that fraction drops by a fifth, to less than 4 percent if you used 5 percent initially, you bump up your draw amount by 10 percent. Conversely, if the market crashed and your new ratio would be higher than your 5-percent target by more than a fifth, i.e., over 6 percent, you trim your draw amount by 10 percent.
- Rinse and repeat each year.
To make things easier on yourself, you make sure your retirement budget can survive a 10- or even 20-percent “haircut.”
That way, even if you need to cut spending twice in a row, you can do it without worrying about your mortgage/rent, groceries, or medical expenses.
However, you aren’t home-free quite yet.
If your portfolio crashes early in retirement, you’d draw 10 percent less, but you’d still be selling more shares than planned.
This so-called “sequence-of-returns risk” means your portfolio could drain faster than planned, such that even when the market recovers, the smaller number of shares remaining in your portfolio means you’ll never fully recover and are more likely to run out of money.
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What Stock Allocation Works Best for Retirement Withdrawals?
The 4-percent rule assumed your portfolio would be equally allocated between large-cap US stocks and US treasuries. More recently, Bengen found that adding foreign stocks and corporate bonds can push the safe draw up.
Still, that’s a 50/50 stock/bond allocation.
Conventional advice tells you to subtract your age from 110 or even 100 and use the result as the percentage invested in stocks. Thus, if you’re 65, your stock allocation would be between 35 and 45 percent.
By the time you’re 80, your stock allocation “should” decline to as little as 20–30 percent, which makes it less likely to allow 4 percent draws.
For the Guardrails Approach, however, recent research shows you’d do better on average with a consistent 60- or 70-percent stock allocation. But that means you’d be even more at risk should the stock market crash early in your retirement.
Enter the Buckets Strategy…
How the Bucket Strategy Protects Against Sequence-of-Returns Risk
Here, you divide your portfolio into 3 buckets:
- Enough money in cash and cash equivalents (e.g., high-interest savings accounts, money market accounts, certificates of deposit or CDs, etc.) to cover the next 3 years of your excess expenses above non-portfolio income (i.e., after subtracting from your budget such things as Social Security benefits, annuity payments, rental income, etc.). If your target is drawing 5 percent of your portfolio in Year 1, this would make the short-term bucket 15 percent of your portfolio.
- Next, enough money in bonds or bond funds to cover another 5 years’ worth of excess expenses. Again, assuming your planned draw is 5 percent, this medium-term bucket would be 25 percent of your portfolio.
- Finally, your long-term bucket holds the remaining 60 percent of your portfolio in stocks and stock funds.
Which Bucket Should You Draw From Each Year?
The final piece of this Bucket Strategy is determining which bucket to use each year. Here too, the rule is simple.
- If your stock bucket rose in value over the past year, draw your 5 percent from there.
- If your stocks dropped but your bonds rose in value, draw your 5 percent from your bonds bucket.
- If both your stock and bond buckets dropped in value, draw your 5 percent from your cash bucket.
Periodically, you’ll need to rebalance your buckets.
For example, if you drew from your cash bucket and the following year, your stocks and/or bonds did well, replenish your cash bucket from whichever one (or both that) did better.
If your planned draw is lower because you don’t need as much, you can reduce your cash and bonds buckets accordingly. For example, if 4 percent is enough for you, your three buckets would be 12 percent cash, 20 percent bonds, and 68 percent stocks.
Why Guardrails and Buckets Work Better Together
The advantage of this approach, when combined with the Guardrails, is that if you have the bad luck of hitting a bear market just as you planned to retire, you can use your cash bucket for up to 3 years, and your bonds bucket for up to another 5 years if needed, without badly impacting your portfolio’s ability to recover.
And since bear markets rarely last longer than 3 years, let alone 8 years, even a bad sequence of returns shouldn’t scuttle your retirement plan.
If you want to add a third safety net, Omar Morllo, CFP®, Founder of Imperio Wealth Advisors, www.imperiowa.com suggests another allocation option:
When planning for retirement, understanding and mitigating the sequence of returns risk is crucial. Including a low-fee annuity in your asset allocation strategy can be a prudent way to counter this risk. By allocating a portion of your retirement funds to an annuity, you create a guaranteed income source, which can be especially valuable in years when other investments underperform.
This strategy helps in two ways. First, stability – annuities provide a predictable income unaffected by market volatility. This stability can be reassuring, especially when other investments are fluctuating. Second, mitigating longevity risk – Having a secure, predictable income can help reduce the risk of outliving your savings. Annuities, combined with a prudently managed portfolio, can provide benefits because one can guarantee a portion of their retirement income. However, it is critical to understand the risks, fees, and expenses associated with annuities. The guarantees offered by annuities are subject to the claims paying ability of the issuing insurance company.
The Bottom Line: Combine Guardrails and Buckets for a Richer, Safer Retirement
There you have it.
Combining two stellar ideas (or three) should let you enjoy a far richer retirement than the 4-percent rule would, with a far lower risk of failure, even if you hit an extended bear market early in retirement.
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Frequently Asked Questions
What is the 4% rule in retirement?
You withdraw 4 percent of your portfolio in your first year of retirement, then increase that dollar amount each year by the prior year’s inflation. William Bengen’s 1990s research found this would have worked in every historical period from the 1920s to the 1990s, but only for retirements lasting up to 30 years.
How does the Guardrails Approach to retirement withdrawals work?
You start with a higher target draw, such as 5 percent, and adjust it for inflation each year. If your withdrawal as a share of your current portfolio falls by more than a fifth (below 4 percent), you raise spending by 10 percent; if it rises by more than a fifth (above 6 percent), you cut spending by 10 percent. The article suggests building a budget that can survive a 10- or even 20-percent cut.
What is the bucket strategy for retirement?
You split your portfolio into a cash bucket covering about 3 years of expenses above non-portfolio income, a bond bucket covering another 5 years, and a stock bucket holding the rest. Each year you draw from stocks if they rose, from bonds if stocks fell but bonds rose, and from cash if both fell, then replenish the cash bucket after good years.
How do you protect a retirement portfolio from sequence-of-returns risk?
The article recommends combining the Guardrails Approach with the bucket strategy, so a bear market early in retirement can be covered from cash for up to 3 years and from bonds for up to another 5 years without selling stocks at depressed prices. One advisor interviewed also suggests a low-fee annuity as a third safety net, while cautioning that annuities carry risks, fees and expenses.
What stock allocation should retirees use with the Guardrails Approach?
Conventional advice subtracts your age from 100 or 110 to set your stock percentage, which would mean 35 to 45 percent in stocks at 65. The article notes that recent research shows the Guardrails Approach does better on average with a consistent 60- or 70-percent stock allocation, which is why pairing it with cash and bond buckets matters.
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Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.
About the author
Contributing Writer, Wealthtender
My career has taken some unexpected turns, from earning a PhD in experimental high-energy physics, to conducting cosmic-ray research in Antarctica, to supporting NASA projects and programs, to running my own consulting business. I also run several other small businesses and help my wife run her Marriage and Family Therapy practice.
Those experiences taught me to question assumptions, think critically, and recognize that real-world decisions of any significance rarely have simple answers that apply to everyone. Today, I bring that perspective to writing about personal finance. Drawing on my analytical background, business experience, and research, I explore financial decisions, challenge conventional wisdom, and help readers understand the tradeoffs that can affect their financial well-being. To complement my own research and experience, I also weave insights from financial professionals into my articles, drawing on their expertise and real-world experience helping clients navigate financial decisions and challenges.
At medium.com/@opher-ganel, you can read more of my articles and subscribe to receive email notifications when new ones come out.