The 4% Rule - Can I Distribute MORE From My Portfolio??

According to the U.S. Department of Health and Human Services in 2022, more than 10,000 people turn 65 every day in the United States.

If you find yourself in the same situation, you're probably wondering how much income you'll be able to take from your portfolio while still attempting to keep the value from falling to zero during your retirement.  This is a complicated question with a lot of pieces to address, but this video attempts to help answer this

This video takes a deep dive into distribution strategies from portfolios in an attempt to help you maximize the amount of distributions you take over your retirement lifetime. Not everyone is able to adjust their spending during times of economic uncertainty, but if you have a high amount of discretionary spending (as opposed to mandatory spending) and you're willing to be flexible, this strategy may work for you.  

As always, please don't hesitate to reach out with any questions!

Link to the Full Article at Vanguard

Video Transcript...

Well, it's a beautiful day. I’m out for a walk, and I want to talk about the 4% distribution rule from portfolios. We've all probably heard of it. It suggests that you can distribute 4% per year from your portfolio and inflate that each year with the rate of inflation. But, it seems like the numbers are suggesting we can maybe spend more than that. So let's take a look.

Vanguard came out with a study that discussed three different strategies. One of them, similar to  the 4% rule, suggested a fixed distribution that increases annually with the rate of inflation. Strategy number 2 was one that's fully volatile with the portfolio. So, if you pick a 4% distribution rate, if your portfolio goes up 10% next year, you increase your spending 10%. If it falls 10%, you decrease your spending 10%. So, that's a much more volatile spending strategy. And then they discussed some kind of a middle ground, which they call a dynamic spending strategy. In this strategy, you have a cap and a floor on how much you can increase and decrease your spend each year, dependent on how your portfolio's doing and incorporating inflation. So, let’s unpack all of this.

Basicallys they're proposing the middle strategy where you can increase your spending up to 5% per year, and you can decrease it 2.5% per year based on your portfolio. So theoretically, you start at a 4% distribution rate on a $1,000,000 portfolio, that's $40,000 a year. So next year, year 2, your portfolio spend can go up to $42,000 or down to $39,000 depending on the backdrop of the portfolio and how it did that year.

So let's take a look at some numbers. We have a three year projection we're looking at in this Vanguard article. In the 3 years, the portfolio return in year 1 is 10% and then 5% and 5% for years 2 and 3, respectively. Inflation this whole time was 3%. And it maps out what that would look like.

So, year 1,  if you have a $1,000,000 portfolio, you have 10% return, that's a $100,000. But you spent $40,000 or 4%, so your ending value is $1,060,000. So that's the number that you use to compare where your spending should be. You use the real adjusted portfolio value at the end of each year. So if you take 4% of that, it would go above the cap of $42,000. So we're limited to our cap of a 5% increase in spend to $42,000. And then each year, you look again. Year 2 in this case was a 5% return. So when you look at that value, you end up actually decreasing your spend in year 2 in this case. Because you had 5% return again, it decreased again in year 3.

So if you're comfortable or if you're able to, financially, reduce your spend during periods of market weakness, or periods where the portfolio return was less than your spend rate plus inflation, then you could theoretically start with a higher distribution rate.

So in this case, we're still using 4%, but the good news is they actually suggest that you can use a higher starting spend rate. So this chart here shows their proposed beginning spending rate, depending on whether you're doing a fixed distribution amount or if you're doing this more dynamic spending strategy. Also, they show 3 different portfolios. A more conservative 20/80 portfolio, a middle of the road 50/50 portfolio, and a more aggressive 80/20 portfolio. And they show, basically, what your starting distribution rate should be, based on the duration of your expected retirement time horizon. So, you can see, the dynamic spending strategy allows you, worst case here to spend 10% more in year 1. And, it allows you to spend potentially up to over 30% more, depending on your portfolio and time horizon. So, some good news there.

They're saying, starting with a 4% distribution, you may be able to start with a higher distribution rate if you are willing to accept some volatility in your spending each year, dependent on how your portfolio's doing. So as always, if you have any questions on any of this, feel free to reach out. Obviously, this starts with the assumption that you have a properly built and constructed portfolio. If you want us to take a look at yours and make sure it is, we're happy to do so. But thanks for watching. Have a great week and we'll see you next time.