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Say Goodbye to the 4% Rule… and Maybe the 3% Rule

by AOG Wealth Management

AOG Wealth Management - Preparing Financial PlansWhen I started preparing financial plans in the early nineties, advisors commonly stipulated that investors should be able to count on withdrawing 5% per year of the principle balance from their investment accounts during retirement. If investments grew between 3% and 5%, on average, in addition to providing 5% income annually, that return would enable investors to confidently budget for current expenses, but also know that they would have a hedge in future years against rising expenses caused by inflation.

In the late 1990s, when annual portfolio returns of 20% and more were common, I recall planners discussing a “paradigm shift” or “new normal.” Many planners theorized that with the advent of the internet and the “new economy” that stock market gains would continue as far as one could imagine, portfolios would support growth to hedge inflation, and annual withdrawal rates in retirement could be 6%, 7%, 8% or even 9%! Oh for the days!

The last five years have witnessed historically low rates of interest for bonds, cash and cash equivalents. Investors seeking income, particularly retirees have had to scramble for yield in a prolonged environment of sub 1% checking/savings/money market rates, a 10-year treasury rate that has spent more time around 2% than toward 3%, and an S&P index that has paid around 1.5% in income.

This Wall Street Journal article is actually from March of 2013, almost two years ago. The writer captures the thinking of many financial planners, and notes the failure of various models to produce even a 4% annual income stream while attempting to grow principle faster than real inflation. Since interest rates have declined over the last two years, I have seen musings in professional literature postulating about the death of even a 3% annual income capability.

What is the solution? I believe that AOG Wealth Management identified the correct solution more than a decade ago. By modifying the model used by major university endowment funds (e.g. Yale, Harvard & Stanford) and adding non-traditional asset classes (real estate, energy, private equity and debt, managed futures) to the traditional stocks, bonds and cash, it may be possible to sustain a 5% annual income stream while still growing principle equal to or greater than inflation. Individual portfolios have to be customized according to risk tolerances, available assets and goals. I will expand on our solution in subsequent articles.

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