The 4% "Safe Withdrawal Rate" Rule Of Thumb

     A widely circulated nugget of conventional wisdom is that in order to make a retirement portfolio last 30 years, retirees should withdraw no more than 4% of their portfolio in the first year, and then withdraw the same amount, with inflation adjustments, each succeeding year. Various studies, including the famous Trinity study, conclude that retirees should employ such a defensive spending approach to compensate for the risks of their equity investments.

     But here's a striking irony. As of mid-October 2008, Treasury Inflation Protected Securities (TIPS) boasted real yields of approximately 3%. A laddered, 100%-TIPS, tax-deferred portfolio yielding 3% real would sustain a 5% safe withdrawal rate over a 30-year period.

     Yes, that's right. A 100%-TIPS tax-deferred portfolio yielding 3% real would not only be less volatile than a diversified, part-stock portfolio, but also safely sustain a much more generous level -- 25% more generous, in fact -- of retirement expenditures than a diversified portfolio to which the 4%-SWR rule was applied.

     True, as of mid-October 2008, TIPS yields were well above their historical averages. But even a TIPS portfolio that yielded only 1.3% real would sustain a 4%, inflation-adjusted, safe withdrawal rate over a 30-year period. That is, it would safely sustain just as generous a level of retirement expenditures as a risky portfolio, to which the 4%-SWR rule was applied, but with a lot less heartburn.

     Yet the conventional wisdom -- invest aggressively and spend defensively -- persists. Financial advisors advise their elderly clients to invest a significant portion of their savings in stocks in order to pursue their greater expected returns, but -- because of the risks -- to live more frugally than they might if they chose a safer, less-volatile, 100%-TIPS alternative. Unfortunately, few retirees are even informed about this safer alternative.

     The conventional wisdom is better tailored to helping retirees die rich than live rich. For wealthy retirees who can easily afford to retire and who desire to leave a substantial inheritance to their heirs, this isn't bad advice. But retirees who can barely afford to retire deserve to know about the TIPS alternative.

     TIP$TER was designed with this purpose in mind. Prospective and future retirees should compare the risks and rewards of an aggressive but diversified part-equity-based investment approach with a much safer alternative -- a 100%-TIPS tax-deferred portfolio -- and then decide whether the potential rewards are worth the risks.