Why Traditional Retirement Rules May Fall Short in Today’s Markets

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Rules are made to be tested, and retirement planning may be no exception.

Recent research is challenging two long-standing retirement guidelines: the 4% withdrawal rule and the classic 60/40 investment mix. While both can serve as useful starting points, two recent reports suggest they do not fit every retiree.

One report from a financial research firm says retirees should generally withdraw less than the widely cited 4% benchmark. Another study, which resurfaced on the research network SSRN, argues that a much more aggressive stock-heavy portfolio may actually be safer than a 60/40 allocation.

Here is a closer look.

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The 4% withdrawal rule

Financial planner William Bengen introduced the now-famous 4% rule in a 1994 study published in the Journal of Financial Planning. The idea was that retirees could begin by withdrawing 4% of their savings, then raise that amount each year to keep up with inflation.

Also known as the “Bengen rule,” the concept was designed to help a retirement portfolio last 30 years. In practical terms, a retiree who starts withdrawing at age 65 could expect the money to last into their mid-90s under that framework.

Even now, the rule is widely repeated. But new findings from Morningstar show that a “safe” withdrawal rate depends on both portfolio allocation and the length of retirement.

For a 30-year retirement and a portfolio invested 20% to 50% in stocks, Morningstar found that 3.7% is a more suitable withdrawal rate.

In general, the longer the retirement horizon and the more stock exposure a portfolio has, the less someone should withdraw each year. Morningstar said a 20-year retirement could support annual withdrawals of 5%, while a retirement lasting 40 years should stay at or below 3.1%.

For an especially aggressive portfolio, the recommended withdrawal rate could be even lower, as little as 2.7% a year.

The 60/40 retirement investment portfolio

As retirement approaches, advisors often suggest gradually becoming more conservative. The traditional approach is the 60/40 portfolio, with 60% in stocks and 40% in bonds, followed by a shift toward more bonds or cash later in life.

But a debated study by three finance professors from Emory University, the University of Arizona and the University of Missouri argues that a far more stock-heavy strategy can outperform the 60/40 model. The same conclusion, they say, applies to target-date funds.

Under their model, the best approach is a portfolio made entirely of stocks. For diversification, if that term still applies, they recommend 33% U.S. stocks and 67% international stocks. In other words: no bonds at all.

The authors said this strategy “vastly outperforms” other portfolio types in building and preserving retirement wealth, supporting spending in retirement and creating inheritances, meaning more money can be left behind after death.

They reached that conclusion by comparing portfolio options for a hypothetical couple that began saving at age 25. Holding all else equal, their analysis found that a stock-only strategy could allow the couple to save a smaller share of income before retirement because returns would be higher.

When it comes to retirement wealth, the study said a person would need to save 16.1% of income in a target-date fund or 19.3% in a 60/40 portfolio to match the outcome of saving 10% in an all-equity portfolio.

With equal savings rates, the all-stock portfolio produced 50% more wealth than the 60/40 portfolio and 39% more than the target-date fund.

There are clear risks. Stocks can swing sharply, and a portfolio made entirely of equities can cause severe emotional stress when markets fall. The authors noted that some investors may give up and sell at the wrong time.

Still, they argued that the other strategies are also volatile, and in some cases even riskier because they increase the chance of outliving savings.

“Our results, as a whole, do not suggest that the all-equity strategy is safe,” they wrote. “They merely suggest that it is safer than common alternatives.”

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