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Managing investment risk in retirement [video]

And what is the '4% rule'?

    Are you dreaming of retirement and the chance to enjoy your wealth?

    The biggest risk in retirement is running out of money...

    Wade Pfau, a Professor of Retirement Income at The American College of Financial Services, explains the logic behind the '4% rule' and the importance of managing investment risk...

    RP: Hello there. Managing investment risk is important at every stage, but especially so in retirement. Of course, you want to enjoy your wealth, but the biggest risk of all is running out of money and having to rely on loved ones or the state. In working out how much you can afford to spend, advisers have for many years used what’s called the "4% Rule". So what is the "4% Rule"? And is it still valid? Wade Pfau is Professor of Retirement Income at The American College.

    WP: The 4% rule was developed by a financial planner in the US using, US historical data in the 1990’s. He was pointing out that there is market volatility, that you can’t just assume an average return and base a retirement plan off of that. So looking at US historical data, he found that the worst-case scenario was that someone could withdraw 4% of their portfolio in retirement to give them a spending amount that they’ll adjust for inflation after that and their money would last exactly 30 years before running out. Also, interest rates are so low today that makes retirement more costly. I do worry about things like the 4% Rule in the context of someone retiring in this low-interest world that we have.

    RP: Another rule of thumb which advisers often use is the "Your Age In Bonds"-Rule. A 50-year-old, say, should have 50% of their portfolio in bonds and 50% in stocks. At 75, the asset allocation should be 75:25, and so on. Of course, everyone’s different, but in most cases, Wade Pfau wouldn't recommend reducing exposure to stocks during retirement.

    WP: I think as a starting point the question should be broadened a little bit so it’s not just asset allocation but also product allocation. To think about things like income annuities, because I think your asset allocation can adjust if you have more income from outside the portfolio to rely on as well, you can be more aggressive. I think Age In Bonds can be reasonable but the research also suggests: Once you retire, don’t keep decreasing your stock allocation as you get older and older. Try to keep it fixed at a level you are comfortable with. And whatever that level is, could vary a lot. 30% stocks up to 80% stocks, just whatever someone is comfortable with. All those different ranges can provide sustainable strategies if it’s incorporated into a good overall plan.

    RP: Again, having a good adviser in retirement is essential. These are important decisions, and there’s no greater wealth than your peace of peace of mind.

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