In Singapore, when the word “retirement” is discussed, it usually revolves around our CPF savings. However, our CPF savings is only one component of our retirement funds, especially since CPF LIFE monthly payouts only start from 65 years old.
Ideally, we should build up a complementary retirement pot outside of our CPF funds. This can help supplement our retirement income when we do eventually decide to stop working. We also have the flexibility to start drawing down from it first if we intend to retire before we turn 65.
Of course, there will always be retirement “hacks” out there to help individuals optimise our retirement plans. One of the best-known ones is the “4% withdrawal rule” – which is widely cited as a foundational strategy to build a successful retirement plan.
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The Origin: How The 4% Withdrawal Rule Works
Conceptualised by a California-based financial advisor, William Bengen, the 4% withdrawal rule hinges on financing your retirement lifestyle by drawing down 4% of your investment portfolio’s value in your first year. For example, if you need $2,000 per month or $24,000 per year for your retirement, you should have an investment portfolio value of $600,000.
You can continue to withdraw this same amount – worth 4% of your investment portfolio in the first year that you retired – each year for the next 30 years. You should be able to safely withdraw this amount with little to no chance of running out of money over the next three decades.
As simple math would tell you, 4% a year for 30 years means that you would be withdrawing 120% of your initial portfolio value. This withdrawal strategy was created based on retirees continuing to earn an average return from global markets, evenly split into a portfolio of both in stocks and bonds.
William Bengen’s 4% rule was based off looking at 50 years of market data, from 1926 to 1976, on returns from both stocks and bonds.
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Limitations To The 4% Withdrawal Rule – And Why You Should Consider Adjusting
Despite its popularity and simplicity, there are naturally some notable limitations to basing your entire retirement plan off the 4% withdrawal rule.
One of the biggest drawbacks to it is the strict parameters that are applied to an individual’s portfolio, both from the asset allocation perspective but also the time horizon that allows for safe withdrawal.
Many individuals’ asset mix (the percentage of stocks and bonds that make up your retirement portfolio) will differ. Obviously, you can rebalance your retirement portfolio before you actually retire. However, this may depend on the state of the economy when you actually want to retire. For example, if there is a market downturn, you may need to significantly pare down your bonds allocation to level out your stocks allocation evenly. This may not necessarily be wise when you are heading into retirement.
With Singaporeans potentially living longer and healthier lives, your risk appetite may continue to evolve over three decades. A strict 50-50 asset allocation to stocks and bonds may not be for everyone.
Furthermore, the 30-year withdrawal period may also be cutting it very close. This horizon was envisioned in the mid-1990s and may need to be stretched out with rising life expectancy. While Singaporeans today have an average life expectancy of 83 years, 1 in 2 Singaporeans aged 65 will live beyond 85, and 1 in 3 will live beyond 90.
For those who wish to retire earlier, the 30-year withdrawal period may have already become obsolete.
Longevity should always be a blessing, but not planning well may lead to adverse outcomes. The last thing you want is to find out that your retirement income will dry up in your lifetime, because you will live longer than you planned for.
Finally, the 4% withdrawal rule relies on historical market returns. Not only that, it relies on market returns between the years 1926 and 1976 specifically. Since 1976, there may need to be new assumptions and numbers to be crunched to land on a safe withdrawal rate. Just one example is the current sustained inflation rate, that has come after a decade of near-zero interest rates.
It’s difficult to rely on the 4% withdrawal rule unconditionally for our entire retirement plan.
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Regional And Psychological Differences Not Considered With The 4% Withdrawal Rule
There is also an issue related to consistent spending. The 4% rule assumes you will need exactly the same amount each year (adjusted for inflation) but the reality of retirement – or just general living – is that expenses can be lumpy.
In some years, you may have unexpected expenses crop up, like medical/healthcare costs. You may need extensive home renovation works in one year, and not again for the next 20 years. You may also plan for annual holidays, and prefer to take one longer vacation every few years.
As with any rule that is created in the US, we should also account for the differences that could apply to us in Singapore, or indeed anyone outside the US.
William Bengen’s 50/50 portfolio was built with the US investor in mind – with the 50% equity allocation in the S&P 500 Index and the 50% fixed income allocation in intermediate-term Treasuries.
Of course, while US stock and bond markets are the world’s biggest, Singapore investors may have a much more global mix of assets and even be skewed to the Singapore market. This will clearly have an impact on the projected returns profile of such a portfolio.
Especially in Singapore, many of us may also have majority of our assets tied in our homes. This requires a separate strategy to unlock for our retirement needs. We also have a mandatory retirement nest egg in our CPF – which will pay us a lifelong income and reduces the risks of longevity.
Read Also: Complete Guide To Understanding The “Benefit Illustration” Of CPF LIFE Payouts
Planning Beyond The 4% Withdrawal Rule
There are many other “alternative” strategies to the 4% rule that are provided but one of the best ways to plan for it is to have multiple streams of income by the time we retire.
Being in Singapore, we are lucky to have one such stream in the form of our CPF LIFE payouts, and the flexibility of various retirement sums, that can provide differing levels of monthly payouts once we reach 65.
We can also take into account our monthly CPF LIFE payouts to reduce our reliance on a separate retirement pot.
Of course, this can also help us to be more conservative with our withdrawal rate (say, withdrawing 3% annually instead of 4%) and could also ease some of the fears surrounding not having enough money in retirement. Naturally, this buffer will either increase the retirement pot we need to build or deflate our retirement lifestyle.
Many of the other ways to plan beyond it is to take into account everything the 4% rule does not; primarily time horizon, asset allocation mix, and unexpected expenses. We should try to personalise these decisions for our situation.
The post What Is The 4% Retirement Withdrawal Rule, And Why You Should Plan Beyond It appeared first on DollarsAndSense.sg.
