The Great Mistake

Retirees need income. Accumulators need total return. Mix the two and you make the Great Mistake: the 4% safe withdrawal rate.

The 4% Safe Withdrawal Rate

Total return strategies led to the 4% safe withdrawal rate. No one distinguished between dividend income and price fluctuations. Selling during price declines led to early failure.

Historically, a 4% (plus inflation) withdrawal rate would have survived every 30 year interval in the past. This was claimed to be safe. Further investigation shows that 2% was closer to the truth at the peak of the bubble. And 3% is closer today.

The fallacy remained. Total return strategies ignore the details of the probability distributions. Total return strategies liquidate portfolios during market declines. Liquidation leads to bankruptcy.

Income Strategies

Income strategies focus on dividends and income streams. This portion of the total return is immune from the effect of price fluctuations. Using my techniques, you can withdraw 5% (plus inflation) with ease. You can sleep well at night. With care and accepting a reasonable amount of risk, you can withdraw the full long term “investment return” of stocks: between 6.5% and 7.0% (plus inflation).

You never sell shares as a matter of routine. After your initial purchase, your income depends on business conditions, not on the whim of the market place and its wildly fluctuating prices. You mix high income, slow growth investments with investments with rapidly growing dividends and a lower initial yield. The high income investments fill in the income in the early years. The fast growing dividends provide continuing income in the later years.

I have written many articles related to income allocation and dividend strategies. I have written many articles about intermediate term timing. I have summarized the most important details in two articles: Starting at 5% and Starting at 5% with Risk.

Starting at 5%
Starting at 5% with Risk

Accumulator Strategies

Accumulators should strive for the best total return. Most of the time, they should invest entirely in stocks. At times such as these with sky high valuations, they should preserve capital. The Stock Return Predictor (use the button on the left) tells you what to expect.

Conclusions

The 4% (plus inflation) safe withdrawal rate was a horrible mistake. It leads retirees to make bad investment decisions.

Focusing on income streams solves the problem. It pays off handsomely. Retirees can easily withdraw more than 5% of their original investment (plus inflation). With care, retirees can recover the full long term return of the market.

Have fun.

John Walter Russell
September 18, 2007