The 4% Rule is on a Short Fuse

Institutional leadership helps Dolores Kennedy

Dolores Kennedy is finally ready to retire. It took her a while. Dolores is 70 years old and still owns a coffee shop and its building on Riverfront Boulevard between the Design District and the Lew Sterrett jail on the west side of downtown Dallas. Dolores became a commercial real estate owner when prices were low long before Riverfront became the new name for the less affectionate Industrial Boulevard. After the city built the Calatrava bridge over the Trinity River, the daily life of cops, coffee, donuts, and eggs became lucrative.

Dolores is a strange mix of a workaholic, a liberal activist, and a decently wealthy woman. Pastries and a personality generated a decent cash flow, but her building is now worth a small fortune. A new Virgin hotel, art galleries, and upscale apartments within the throw of a waffle iron changed Dolores’ life. Her commercial building is worth $650,000, and the nest egg is about to be harvested.

Dolores makes her home in modest east Dallas just off Ross Avenue with her husband, Billy. Dolores and Billy have 30-year-old appliances in a shotgun kitchen isolated from a simple dining room and living room, better described as a library. An old cathode ray TV is barely visible among a wall of books. Literate, full-time readers when not working or sleeping, Dolores and Billy share the same love for the life they would have chosen if single. Sleep. Work a full day. Return home to the study carrel.

Judge Dolores and Billy how you wish, but uneducated would not come to mind. Book smart and street savvy, except about financial matters. Luckily, both have had an unrivaled frugality, and money has not flown needlessly out their door. However, it is time for Dolores to join Billy in retirement. What does that look like?

The house is paid for and the Kennedys are old enough to lock in the value of their home when the Dallas County Central Appraisal Districts comes calling each year—a side benefit of being over 65 in Texas where property taxes run high. Dolores and Billy have put off receiving Social Security retirement benefits until now, which jointly will produce $4,000 per month toward their living standard. Drop in a couple hundred thousand of IRA funds and about $450,000 after-tax from the next egg, and some planning needs to get done. Thank God they invited Janette Gibson for dinner.

Janette Gibson Changed the Kennedy’s Lives

Janette Gibson lives three doors down and is the periodic caregiver for the Kennedy pit bull, Angus, when Dolores’s days away are matched by Billy sneaking out to play some pool with his buddies. Obligation built on guilt causes Dolores to invite Janette for a meal twice a year. Good intentions, but Dolore’s frugality is front and center. Dolores portions-sizes the meal with three small batch deli bought microwavable entrees from Kroger. A couple of cocktails, a fabulous tablescape, and a home-cooked dinner have never been served to Janette at the Kennedy home. But Janette knows Dolore’s intentions, and she loves Angus anyway. “All good as far as I am concerned, Janette says with a smile.”

Everyday dinner chatter among the three moved into a sensitive moment when Dolores shared with Janette her contemplation of retirement. “I don’t know if we can afford it.” Janette didn’t know what to think. She could observe a modest life and had no idea Dolores owned commercial real estate in a hot area. Dolores spilled the beans: “Honey, if I am fixin’ to retire, I need to sell my building. Know anybody who can hep?” “I do, Janette said with excitement. I have my license.” That made sense to Dolores. Janette appeared to live well and was home often. Real estate agents were WFH before Covid. The listing agreement signed, and a few phone calls later, Janette had offers to sell the property in about 10 seconds, and that was that. Dolores converted her nest egg to cash.

Paying the Bills During Retirement

Dolores and Billy face the same question that most near-retirees and retirees face. “Can we afford to retire?” A la-la land of rules of thumb, it doesn’t take long to pose the question to a search engine to receive the prevalent response, something akin to: “you can withdraw about 4% of your investments to live on this year, and continue that path forever.” The idea is that the remaining investment dollars will be invested, hopefully with returns that can match inflation, and the number of years in the withdrawal period can be extended. The household gets a cushion in case of better than expected longevity. A 4% rate is common, but it doesn’t matter if the rate is 2% or 7%; Dolores and Billy will have a significant financial happiness letdown if they rely on it.

There are two problems with a retirement income withdrawal rate rule of thumb. First, the rate is not generalizable to every household, and second, it produces an inferiorly informed living standard. Only by luck will a withdrawal rate recommendation coincide with the best household living standard.

Here Comes Charles Schwab

The Kennedy story was intended to be a tete-a-tete measure of the living standard loss when a withdrawal rate rule of thumb is used rather than a dynamic solution produced by the Kennedy’s economics, financial attributes, and longevity. As I wrote in a prior post, it is the difference between an accounting view and an economics view of financial planning.

While preparing the Kennedy case, I nosed around the public domain to learn if the street had changed its approach to the 4% rule.

To my amazement, I found an article on Charles Schwab website, “Beyond the 4% Rule: How Much Can You Spend in Retirement?”

This is a big deal, for it is the first time I have read recent work produced by a major financial player that bumps up against life-cycle theory. Is Chuck a subscriber? Have any broadly read personal finance writers used Schwab’s ideas front and center for a future article? Just maybe the academy has effectively expressed these ideas to be correctly heard.

Here are three phrases pulled from the Schwab piece that summarize their thinking,

1. “The 4% rule is a common rule of thumb, but we think you can do better by finding your personalized spending rate.”

2. “It's a rigid rule. The 4% rule assumes you increase your spending every year by the rate of inflation—not on how your portfolio performed—which can be a challenge for some investors. It also assumes you never have years where you spend more, or less, than the inflation increase. This isn't how most people spend in retirement. Expenses may change from one year to the next, and the amount you spend may change throughout retirement.”

3. “The transition from saving to spending from your portfolio can be difficult. There will never be a single “right” answer to how much you can withdraw from your portfolio in retirement. What's important is to have a plan and a general guideline for spending—and then monitor and adjust, based on your circumstances, as necessary.”

Extending Schwab’s Guidance

The plan for Dolores, Billy, and any retiree or near retiree is to have the optimal, sustainable living standard inform the spending amount. It is calculable and doesn’t need to be inch toward. You can learn how to do it, and I will share resources if you send me a note to team@finplanllc.net. While I cannot yet speak to how Schwab trains their advisors to arrive at their guidelines for spending during retirement, I am going to find out and share it with subscribers.

Share this article if you work with a CFP, investment advisor, or PWM. I can help them if they reach out to me.

As for Dolores and Billy, they can follow the Schwab link to get their retirement planning guidance and get back to their books.