Most Retirees Follow This One Simple Spending Rule — but Experts Don’t Think They Should
Written by
Gabrielle Olya
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Molly Sullivan
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Deciding how to most efficiently spend your money in retirement can be tricky. Many experts have long touted the effectiveness of the “4% rule,” which suggests that retirees withdraw 4% of their savings in the first year of retirement, then adjust that amount for inflation annually.
However, many retirees are eschewing this approach. According to a report from the Investments & Wealth Institute, only 1 in 7 retirees (14%) ever touch their investment principal during retirement. The majority live on just their income — or less than their income — during their golden years.
While this might be the simplest approach to retirement spending, it may not be the best one — here’s why.
You Could Be Depriving Yourself of a More Fulfilling Retirement
While the idea of living solely off income generated by retirement assets, without ever touching the principal, is often seen as the holy grail of retirement, it’s not always the most efficient or beneficial retirement strategy, said Nikhil Agharkar, wealth advisor and managing member at Crowne Point Tax.
“This strategy can lead to the underutilization of savings,” he said. “If you have saved diligently, lived frugally and have entered retirement with a strong portfolio, why not derive more fulfillment from those funds?
“Rigidly avoiding principal could mean denying yourself meaningful experiences, such as travel, family support or home improvements,” Agharkar continued. “Plus, as you get older, you will be less physically able to do things. Spend the money when you’re able to enjoy it the most!”
Aaron Brask, principal at Aaron Brask Capital, has seen firsthand how this can play out.
“In my experience, many retirees have taken this mentality too far — that is, they do not spend and enjoy the bulk of their hard-earned savings,” he said.
It Can Drive You To Make Riskier Investments
If you are reliant on income from investments only, you may make riskier investments than is necessary.
“It may place undue pressure on your portfolio to generate high income, potentially pushing you into riskier investments, like high-yield bonds or dividend stocks, that might not align with your risk tolerance or tax strategy,” Agharkar said.
It Can Be Difficult To Sustain
The broader economic climate can also affect how useful this strategy is.
“In a low-interest environment, income-only strategies can become increasingly difficult to sustain without reducing your standard of living,” Agharkar said.
There Are Still Risks With This Strategy
Some retirees who choose to live solely off income may see this as the safest strategy, but this isn’t necessarily the case.
“When retiring on investment income alone, it is important to address all the risks,” said Asher Rogovy, chief investment officer of Magnifina, an SEC registered investment advisor firm.
“Most people are concerned with stock market risk, and might allocate to bonds in order to secure their retirement income. However, bonds are exposed to inflation risk, which can decrease real spending during retirement. Finally, there is longevity risk, but retiring purely from anticipated income should help minimize this risk. An investment advisor can help design a portfolio to balance these risks.”
What’s a Better Spending Strategy?
Agharkar believes that following strategies like the 4% rule do ultimately provide better outcomes.
“The 4% rule, derived from historical modeling, offers a more balanced approach,” he said. “This approach assumes both income and principal will be used strategically.
“Rather than trying to live exclusively off interest and dividends, retirees should think in terms of a total return strategy, balancing income and growth and drawing down principal in a disciplined manner,” Agharkar continued. “This allows for more diversified investments, improved flexibility and better alignment with personal goals.”
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