Thursday, December 1 2022

Stop the presses! The 4% spending rule may be in effect after all, at least for now.

I refer to famous research by William Bengen in 1994 which focused on how much a retiree could withdraw from their portfolio each year and ensured that they would not run out of money during a 30-year retirement. Using US stock and bond data from 1926 to 1991, he discovered that a portfolio of 50% stocks and 50% bonds could withdraw an amount equal to 4% each year. the net worth of the portfolio at the start of retirement (adjusted for inflation).

Increasingly in recent years, studies have shown that this 4% rule needs to be reduced, to reflect the distinct possibility that expected returns on stocks and bonds in coming years will be lower than they were. over the past decades. In reality, as i reported recentlya new study found that the safe spend rate should be as low as 1.9%.

Since this column was published, however, I have discovered a strategy that avoids this depressing rate of spending. In fact, with this strategy, you can lock in a spending rate above 4% for the next 30 years.

The strategy is very simple in concept, although as I will describe later in a minute, it is not a panacea and it takes some effort to execute. The strategy calls for building a ladder of individual TIPS – Treasury inflation-protected securities – with a different bond maturing each year of your retirement. TIPS, of course, are similar to traditional treasury bills and bonds, except that their quoted yields are higher and higher than changes in the consumer price index. If they are held to maturity and assuming the US government does not go bankrupt, you have a guaranteed inflation-adjusted return for the life of the bond.

Allan Roth, the founder of Wealth Logic, an investment advisory firm, from whom I heard about this strategy, told me in an interview that he was initially skeptical of this TIPS strategy, thinking that it was too good to be true. So he put his money where his mouth was, investing a million dollars of his money into building a 30-year-old TIPS ladder.

It worked. He now has a portfolio that will provide a guaranteed cash flow of $43,000 adjusted for inflation each year for the next 30 years, or 4.3% of the portfolio’s starting value. (A article by him on the Advisor Perspectives website provides more details.)

Since this 4.3% guaranteed spend rate is so attractive, you might take this TIPS ladder strategy for granted. But there are several things to keep in mind about this:

  • The return on this strategy is as attractive as it is because TIPS returns are now significantly positive. But, as you can see from the attached chart, these yields have spent a lot of time in negative territory in recent years. For example, the 10-year TIPS is currently showing a real yield of 1.70%, compared to minus 1.15% a year ago. The spend rate you can lock in with this TIPS ladder strategy depends on the prevailing TIPS returns when you create the ladder, probably when you retire.

  • The TIPS Ladder strategy can only last for 30 years, as it is the longest maturity TIPS offered by the US Treasury. This is a disadvantage, for two reasons. First, according to actuarial tables, there is almost a 25% probability that a member of a 65-year-old couple who retires today will live to be over 30 years old. Second, with a portfolio of 60% stocks and 40% bonds, there’s a good chance, but not a guarantee, that it will be worth a lot when you (and your spouse) die and allow you therefore leave a legacy to your heirs. You give up this possibility when you opt for the TIPS Ladder strategy. For this reason and others, Roth recommends that it be just one element of a comprehensive retirement plan, but not the only element.

  • The TIPS Ladder strategy requires investing in individual TIPS. This is important to know because almost all of us who have ever invested in TIPS have done so through a mutual fund or ETF. The market for individual TIPS is relatively illiquid and bid-asked spreads can be significant. Moreover, it is quite complex to allocate the right amount to each rung of your ladder so that you have a constant inflation-adjusted cash flow for the next 30 years.

  • There are currently no TIPS maturing between 2033 and 2039, which means that the TIPS ladder will have a number of rungs missing. Roth offered a workaround, which he discusses in his article I linked to above.

Uncredited


The bottom line? For now, and as long as that window of opportunity exists because TIPS yields are as high as they are, and as long as you’re willing to do the extra work to buy just the right amount of the various TIPS from different maturities, you can lock in a 30-year spending rate of more than 4%.

The existence of this strategy is not incompatible with the conclusion of the study I mentioned earlier, according to which the rate of security expenditure could be as low as 1.9%. Richard Sias, professor of finance at the University of Arizona and one of the co-authors of this study, pointed out in an email that their study did not say that you would definitely run out of money at the end of the day. retirement if your expense ratio was above 1.9. %. Rather, he found that to be sure you won’t run out of money, you and your financial planner may need to assume such a low rate when planning for retirement.

This is an important distinction.

Sias added that it’s always possible for stock and bond markets over the next 30 years to be above average, just as it’s always possible for TIPS returns to be high when you retire. But no possibility is guaranteed, and that is their view.

Social Security

Given this uncertainty, Social Security becomes an even more important piece of the retirement financing puzzle than it was before. That, in turn, means it’s crucial to dispel the many myths about Social Security that have scared off many retirees and near-retirees, and a new book helps do just that.

It is written by Martha Shedden, co-founder and president of National Association of Registered Social Security Analysts, whom I previously interviewed for my Retirement Weekly column. Her new book is titled “Avoiding Social Insecurity: The Retirement You Want, The Social Security You’ve Earned,” in which she interviews yours truly. She informs me that Kindle readers will be able to Kindle readers will be able to download the book for free on November 17 and 18, then here is your chance to read it for free. (For the record, I receive no financial compensation from the book.)

Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be contacted at [email protected].

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