Creating retirement income from your portfolio.

There is a 4% “rule” that suggests you can start at a 4.2% spend rate of your portfolio value, with annual increases adjusted for inflation. The idea is to create sustainable income that will last 30 years or more. This post looks to a Globe & Mail article (and chart) from Norm Rothery. We’re creating retirement income at various spend rates and looking at the outcomes.

The ‘problem’ with the 4% rule is that it is based on the absolute worst outcomes including retiring just before or during the Depression of 1929. In this post on MoneySense Jonathan Chevreau shows that in most periods (with a US-centric portfolio) a retiree could have comfortably moved that spend rate to the 6% range. If we use the 4% rule there’s a good chance we’ll leave a lot of money on the table. We will lead a lesser retirement compared to what the portfolio was offering. As always, past performance does not guarantee future results.

The 4% rule suggests that each $100,000 will create $4,000 in annual income with an inflation adjustment.

All said, we do need to manage the stock market risk. Balanced portfolios are used for the 4% rule evaluations. The portfolios are in the area of a 50% to 60% equities with the remainder in bonds. The studies will use the stock markets and the bond market indices. For example the S&P 500 (IVV) for U.S. equities and the aggregate bond index (AGG) for bonds. Investment and advisory fees will directly lower your spend rate. A 5% spend rate becomes a 3.0% spend rate with advisory and fund fees totalling 2%. Taxes are another consideration.

Creating retirement income

Here’s the wonderful post (sub required) from Norm Rothery.

And here’s the chart that says it all, creating retirement income from 1994 at various spend rates. A global balanced portfolio is used, I will outline that below.

As Norm states, your outcome is all about the start date. Here’s how to read the chart. Each line represents a spend rate and the current portfolio value from each start date. For example, on the far right we see the portfolio value from the 2024 start date. Of course, it’s still near the original $1 million. On the far left we see the current portfolio value (inflation adjusted) with a 1994 retirement start date. If we look at 2010 on the x axis (bottom) we see the current portfolio value from a 2010 start date. At a 5% spend rate, the portfolio value is near the original $1 million.

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The portfolios have a 60/40 split between stocks and bonds, and more specifically put 40 per cent in the S&P Canada Aggregate Bond Index (Canadian bonds), 20 per cent in the S&P/TSX Composite Index (Canadian stocks), 20 per cent in the S&P 500 index (U.S. stocks), and 20 per cent in the MSCI EAFE Index (international stocks).

1994 was a wonderful retirement start date. In and around the year 2000 and just before 2008 provided unfortunate start dates. We see the 2000 start date with 5% and 6% spend rates go to zero.

Some retirees get lucky, some don’t.

That unfortunate retirement start date

In a separate post Norm looked at creating retirement income from that unfortunate year 2000 start date.

In a recent Sunday Reads post I looked at that chart and retiring during the dot com crash. You’ll find plenty of other commentary in that link, including what happened to the all-equity portfolio as it tried to take on that severe market correction. Also for consideration, it might be more about your risk tolerance and emotions compared to the portfolio math. That post also shows that retirees with more conservative portfolios feel free to spend more. Your emotions can certainly get in the way of your spending plans, and hence your retirement lifestyle.

Be sure to understand your risk tolerance.

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Keep in mind that you will have to take taxes into account. And again, the fees paid. They all reduce the money that ends up in your pocket.

Creating retirement income final thoughts

Norm’s wonderful research suggests that the 4% rule is a very good rule of thumb for a global balanced portfolio. It is important to know how hard we can push a portfolio when we are looking to maximize income over a longer period. It can help you determine what portfolio value you need to enable your retirement start date.

That said, as you’ll read below, we should be prepared to go off-script. The 4% rule is only a starting point.

An optimal situation would be to self direct, manage your own portfolio to keep fees super low. You can use an advice-only planner to obtain that optimized cash flow and financial plan. Or do the necessary research to discover the optimal order and rate of account harvesting from RRSP/RRIF/LIF, TFSA, taxable accounts, pensions, CPP and OAS and other income.

You can play around with retirement calculators or rent the retirement cash flow software.

With more growth (more equities) we can likely nudge up our spend rate. Moving to a balanced growth model (75% to 80% equity) might allow us to move to a 5% spend rate with more chance of success. That retiree would have to have a very high risk tolerance level. They might have to be prepared to embrace …

A variable spend rate

When I posted Norm’s chart on Twitter the most common reply from investors and advisors was to suggest a variable 0r dynamic spend rate. The following is from the very good Loonies and Sense blog –

I would always advocate for flexible withdrawal methodologies. The “4% rule” is problematic and the first few years of decumulation can make or break you. Being flexible in the first few years can help a LOT.

We can spend a bit more (say 10% to 20% more) in periods of robust returns. We would cut back spending below the 4% level when times are tough for portfolios. I will encourage you to do some research on variable spend rates. Here’s a post from Morningstar.

Given that retirement portfolio success comes down to total return and risk, I embrace the defensive sectors for retirement. My research shows that lower volatility equities will enable a greater and more durable spend rate. But I will have to be prepared to embrace that variable spend rate strategy.

Match the retirement account to the task

We match the time horizon and goals to the portfolio’s asset allocation. Accounts that have a shorter time horizon should be in conservative portfolios. For example, if you plan to spend most of your RRIF account within the next 5 to 7 years, a balanced portfolio would be suitable. We want to protect against the short term risk of a stock market collapse. If the time horizon becomes less than 3 years, you’re in cash or ultra short bonds.

Accounts that have a very long time horizon can be in balanced growth (75% to 80% equity) models. Some retirees roll the dice with all-equity portfolios.

When we embrace a cash flow plan, the 4% rule will go out the window for some accounts when we spend down in quick fashion.

The mandated RRIF schedule will also ask you to sell down accounts at a rate well above the 4% rule. But keep in mind that we don’t have to spend the assets, we simply have to remove them from the RRIF accounts. It becomes more of a tax headache and a financial planning chore.

Thanks for reading. I hope you enjoyed this brief outline of the 4% rule and spend rates. We’ll see you in the comment section. Got retirement questions? If I don’t know the answer, I certainly know the advisor or planner who does.

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