Financial planner William Bengen famously declared in the early 1990s that retirees can deduct 4 percent from their portfolios every year (plus adjusting up each year for inflation), and not run out of money for at least 30 years. Analysts and academics verified Bengen’s data and supported his assertion.
All a savvy retiree had to do was have a mix of 60 percent stocks and 40 percent bonds, live on 4 percent or so (again, adjusted for inflation) each year and never have to worry about running out of money. So, a retiree with a $1 million nest egg could live on $40,000 a year for 30 years and never have to consider getting a job as, say a greeter at a giant retailer.
But recently The Wall Street Journal suggested that the 4 percent rule may no longer stand – this despite the recent highs achieved by the Dow Jones Industrial Average. Perhaps you heard the collective gasp.
The Journal points out that while the Dow is soaring to record heights, growth has been sluggish over the past decade-plus. You’ll recall the Dow almost hit 12,000 at the end of 1999. Now, more than 13 years later, the Dow is about 25 percent higher. And 25 percent over 13 years is only about a 2 percent appreciation.
I hate to take issue with venerable WSJ, but I believe the 4 percent rule still holds true – for those with income-generating investment portfolios.
Remember, if you can live on just the income produced by dividends, interest and distributions produced by your investments, you don’t need to worry about how long your principal will last – it will outlive you.
True, we are currently in a period of muted returns with the Dow up only around 25 percent in the last 13 years and 10-year government bonds barely paying 2 percent per year. But a well-crafted income-focused portfolio consisting of stocks, bonds, real estate investment trusts and preferred stocks, can still generate a yield or “cash flow” of 4 percent. If we experience even moderate growth in the stock market over the next decade, such portfolios should grow beyond that 4 percent cash flow. So 10 years from now, a larger nest egg should be able to produce a higher level of income while still using 4 percent as a benchmark.
This is how your income should, over time, be able to keep pace with inflation. This is why I still believe the “4 percent law” has legs.
Here are just a few examples of diversified investments that get very close to producing that magic 4 percent (from an income perspective):
XLU Utilities Select Sector ETF 3.85% yield*
PFF S&P U.S. Preferred Stock Fund 5.9% yield
AMJ JP Morgan MLP Index Fund 4.7% yield
The prices for these exchange trade funds will go up and down, but the amount of income they produce should stay relatively stable. The income, too, is subject to change, but it should have a bias over time to increase.
So, focus on the cash flow or yield part of the investing equation and you should find the 4 percent rule is still alive and well.
*Yields according to data found on www.morningstar.com at time of original publishing 3/18/2013