By: David Macchia

ap_logo22Advisor Perspectives | November 30, 2021

Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.

For almost 30 years, a large segment of the financial advisor community has recommended to investors an approach to generating retirement income commonly known as the “4% rule.” The premise behind this methodology is that if you have an investment portfolio comprised of stocks and bonds, you will be able to draw down annual income beginning at 4% of the portfolio’s value; in subsequent years, you will be able to make withdrawals that keep pace with the rate of inflation (CPI).

I’m not a fan of the 4% rule.

If I had the power to ban its use by “constrained” investors,” I would do so. When confronting the challenge of creating retirement income, clients must understand if they are a “constrained” investor. (Read about why this is important.)

What are the problems with the 4% rule?

It was developed using “backtesting,” a process that projects financial results based upon historical investment performance. The justification for the 4% rule was based upon historical investment performance during the period between 1925 to 1995. But what is the value of relying on historical investment results when today’s economy looks so different than in the past? For example, in 1994, the five-year Treasury yield was 6.69%. Today’s five-year Treasury yield is only 1.33%.

In contrast to the past, the U.S. economy is structurally unrecognizable. Economic growth is driven by credit growth. For example, to generate economic growth last year, and to keep propelling stock prices upward, the Federal Reserve pumped $3 trillion into the U.S. money supply through quantitative easing, The Fed’s balance sheet assets are an extraordinary $8.6 trillion. That’s a 1000% increase since 2008! It’s no coincidence that asset prices have climbed consistently during this period.

Economically, we’re living in a very, very different world, one with radically transformed drivers of economic growth. To keep the economy expanding, credit growth must increase by a minimum of 2% annually, adjusted for inflation. The problem is that the total volume of credit is so massive, it’s hard to generate an annual increase that is sufficient to meet the 2% threshold. Are we approaching the tipping point? All advisors should ask themselves how long they believe the Fed can continue to print money at such unprecedented levels to keep stock prices high?

Those changing conditions are being recognized in the financial advisor community. Just this month, Morningstar completed an analysis that recommended lowering the supposedly “safe” withdrawal rate from 4% to 3.3%. I applaud this because it means that people are rethinking the efficacy of relying upon outdated investment assumptions as justification for assumed levels of income that retirees will be able to “safely” withdraw from their investment portfolios.

I would go further. Much further.

There is no “safe withdrawal rate.” Why? Because there is a fatal flaw that underlies the hundreds or thousands of analyses and academic papers that have been written been based upon “backtesting” to justify the 4% Rule: All of them assume that the investor never sells any of the investments. Think back over your own experience. During a period of significant market declines or extreme volatility, has fear ever driven you to sell some of your investments? If you’re a financial advisor reading these words, I ask you, does the “never sell” assumption align with your own experiences with clients?

In February 2009, I chaired the Retirement Income Communications Conference sponsored by the non-profit Retirement Income Industry Association. I will never forget a New Jersey-based advisor who approached me during a break. With tears in his eyes, he thanked me for having just described an alternative approach for generating retirement income that offered important advantages over the 4% rule. I was struck by the advisor’s tender emotions. I asked him why he made the decision to attend the conference.

He replied, “I know now that I need to do it differently.”

In February 2009, we were reeling from the market breakdown that had accelerated beginning in September 2008. Financial advisors were taxed with managing their clients’ emotions during a horrible period of uncertainty and fear. Managing client relationships through this crisis was a burden that many advisors shouldered. Some lost clients. Many clients sold out of their investments at what proved to be exactly the wrong time. Some who allowed fear to drive their decisions to sell were retirees. Their result was permanent impairment of their retirement income.

The New Jersey advisor had lost several of his most valuable clients. At the advisor’s urging, each of his clients had used the 4% rule. The advisor’s emotions were driven by a sincere regret that he had let his clients down, and that the result of his recommendation of the 4% rule was a lifelong reduction in his clients’ standards-of-living. Sadly, the advisor’s regret was justified. I tried to console him by stating that we could not have foreseen the crisis.

Not all advisors faced the same emotional turmoil that the New Jersey advisor suffered. Also in 2009, the large independent broker-dealer, Securities America, held an advisor conference which, in part, supported advisors who had embraced the time-segmentation approach to generating retirement income. Since 2006, my firm had been providing Securities America’s retirement income platform with a time-segmentation income/hybrid plan. Not surprisingly, the advisors who had recommended time-segmentation were in a quite different place with their clients, in contrast to those who had recommended the 4% rule. Even in the face of scary economic uncertainties, the time-segmentation adoptees found it easy to keep their clients fully invested. At its conference, Securities America made the wise decision to have a panel of time-segmentation advocates explain their favorable experiences in managing clients through the crisis. (Securities America is now part of AdvisorGroup.)

Having issued this condemnation of the 4% rule, I call your attention to my earlier statement that I would ban its use with many investors. In contrast to “constrained” investors, the 4% rule works well for an “overfunded” client. The problem, of course, is that most retirees are not “overfunded.” Consequently, we need a better approach to preserve the financial security of our clients in retirement. Urgently.



David Macchia is an author, retirement income industry entrepreneur and founder of Wealth2k, Inc. He is the developer of the widely used The Income for Life Model® as well as the recently introduced Women And Income™, the first retirement income solution developed for women investors.

Reproduced with permission from Advisor Perspectives, Inc. All rights reserved.