Conserving Client Portfolios

by | Sep 25, 2017 | Reading for Results

Conserving Client Portfolios During Retirement

by William Bengen

Written in 2006, Bengen popularized what is known as the “4% Rule.” This work on distribution and withdrawal planning for sustainable retirement income has become the de facto standard against which different withdrawal strategies in retirement are measured.

What is the 4% Rule, is it relevant and how can it help you?

Let’s start with relevance. Bengen delivers a rigorous treatment of a primary financial concern that many people share regardless of income and asset levels. Namely, how much money can you spend and how long will it last in retirement. It’s certainly relevant to my client base of mass affluent and high net worth clients as well to 401k participants’ in plans that I manage, where asset and income levels are widely dispersed. It’s mostly true the more affluent tend to have more spending flexibility, but the fear of running out of money is equally valid regardless of financial circumstances.

The Future is Uncertain

We face three core uncertainties in planning for retirement income: unknown life expectancy, unexpected future expenses, and uncertain market returns (and their sequence). Bengen identifies the key dilemma facing most people as they near or live in retirement: How to manage these uncertainties for safe outcomes without compromising living standards? Or worse, running out of money.

Adding to the stress of managing against an uncertain future, healthcare costs continue to rise at an unhealthy rate, interest rates are near historic lows, and stock market valuations are higher than long-term averages. A study by The Center for Retirement Research at Boston College shows that absent a Congressional fix, Social Security could shrink by as much as 25% for future retirees. In addition, as pensions have been on the decline since the 1980s, the responsibility for saving enough and spending wisely in retirement has shifted to individuals. The lack of financial literacy in the United States means that many people lack a fundamental awareness of important financial concepts. Consequently, their chances of sustainable success can be hurt by saving too little, spending too much, overinvesting or underinvesting for their age and lifestyle goals.

How to Manage the Risk?

Bengen attempts to answer if there is a reliable way to plan and invest to manage these uncertainties and ensure you don’t go bust before you die. How much money can you safely withdraw from your portfolio? Is it the right spending level? How to know if adjustments in spending or lifestyle are needed? How much flexibility do you have? And how long will it last?

Bengen ran multiple tests with different asset mixes and withdrawal rates. With 63% stock, 37% bonds, the 3% withdrawal rate didn’t run out of money, but living standards are compromised by low spending; the 6% withdrawal test allowed for more spending, but portfolios ran out of money almost 50% of the time. That’s not a tradeoff most people want to make with their one and only retirement!

Lower withdrawals are safer; higher withdrawals mean higher odds of running out of money. No shocker there, right? The logic is simple. Finding the right balance between capital conservation and living well is not when faced with various future uncertainties. As a good and thorough analyst, Bengen methodically tested by trial and error until he found a mix that struck a sensible balance between sustainable spending and lifestyle needs. And that is how the “4% Rule” was born.

What is the 4% Rule and is it Useful?

Bengen calls the “4% Rule” Safemax. The rule says that if you begin with a 63% stock, 37% bond portfolio and withdraw 4% of the portfolio after your first year in retirement and increase your spending every subsequent year for rising prices (inflation) you should be able maintain your lifestyle with a high degree of certainty for thirty years.

Two key insights emerged from his analysis that would surprise most people. First, Bengen found the Safemax 4% Rule results held true with stock allocations that ranged between 45%-65%. The respective portfolio account balances varied but each survived the 30-year test. This illustrates how holding bonds with their historical lack of correlation to stocks, has served as a strong complement in portfolios. The second insight is that for allocations of less than 37% stock, Safemax declined sharply. Bonds are stable, but too much stability limits growth and can jeopardize your spending in retirement. Risk can increase if you’re too conservative.

The Methods: Rear-View Mirror vs. the Crystal Ball

Bengen’s quantitative approach is deterministic. He used actual historic stock, bond, and inflation data beginning from 1926 to test the 4% Rule against varied assumptions for withdrawal rates, asset mix, and portfolio longevity. He cites the increasingly popular stochastic approach, better known as Monte Carlo simulation which randomizes market returns subject to mathematical rules to forecast results. He compares the strengths and weaknesses of each method and concludes that both require judgment in their application.

Is the Safemax 4% Rule safe to fund your retirement?

Rules of thumb are seldom as safe as they appear. The author advises caution in using the “4% Rule.” Simple strategies can be a benefit, but they must fit your facts and circumstances. Adjustments may be required as life events unfold. Oversimplification can prove catastrophic or can result in someone not enjoying their golden years by overly strict spending rules. Often overlooked is that the 4% Rule doesn’t take taxes into account. Taxes can be complicated. He doesn’t delve too deep here, though it’s important to note there are ways to minimize taxes that serve to extend portfolio life.

Summing It Up

I like that Bengen didn’t present his evidence with a heavy-handed or ideological view. He’s careful to note that historical evidence is a less than perfect guide to the future. Markets can and have changed. Likewise, forecast methods and crystal balls are still a guess no matter how sophisticated the math. We can’t reliably predict when or by what magnitude a change may occur. Prudent planning techniques can mitigate risks, but there are always costs and benefits to understand.

Effective distribution planning requires a full view of client goals, assets and liabilities, and their tolerance for loss. The adviser’s proper role is to help the client understand their options, what the tradeoffs entail, and what range of outcomes are reasonable to expect. If a financial risk exists the client cannot tolerate, protection of some sort is required. With one chance to retire well, even the most carefully crafted plan requires periodic monitoring to ensure its tracking toward the intended result.

Jerry Matecun helps business owners and individuals with key planning and investment considerations vital to build and protect business value and personal assets.  For a no cost, confidential conversation regarding your situation, please call or email Jerry at 949-273-4200, 616-499-2000 or

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