LB Thinking Podcast :Factor growth and inflation into 'the 4% rule for retirement savings.

Welcome to Left Brain Thinking, where creative investment ideas meet logical analysis. That's the hallmark of Left Brain Investment Research, where the analysts are looking for growth companies with the potential to double in 2 to 3 years and high-yield bonds with the potential for dramatic price appreciation. Today, we're looking to put a left brain spin on one of the most revered axioms in the entire financial planning world. And we're doing that with Freddy Garcia, Vice President of Investments for Left Brain Wealth Management. You can learn about him and the firm at leftbrainwealthmanagement.com and on Twitter @leftbrainir.com. Make sure you're looking for the Jarvis newsletter and more, which you can find on their websites. Freddie Garcia, welcome back to Left Brain Thinking.

Thanks, Chuck. I'm glad to be on and talk to our listeners about a very, very important planning aspect with everything going on to start the year with rising inflation, high stock valuations, and possible interest rates on the rise. I think it's important to address this very important planning topic.

Freddie, what you're talking about there is what some people call the 4% rule. Other people call it the Bengen rule, named for the guy who came up with it. And it's basically this idea that historically, if you take your retirement savings and you amass enough, a 4% annual withdrawal rate is going to make you set for life. But it's not quite that simple, is it?

It's not, and when we have years and things that we're experiencing now, this is where we find those flaws with this 4% rule. And when we have high inflation, we found that that 4% rule can really, really eat away at a portfolio. For example, if we go by that theory of withdrawal rates where a person has $1 million saved up and if they're safely only taking out 4%, that would be $40,000. Now according to that theory, that person's money should last for the next 30 years. The problem with that is go back and revisit your expenses. If we have inflation going up at its current pace, are your expenses still going to be $40,000 this year? Because if they're not, you're going to have to withdraw more money. So instead of taking out $40,000, you may need to take out $50,000 or $60,000 because your expenses went up. And again, that will change your withdrawal rate and will affect your overall portfolio.

Obviously, timing is everything. Somebody who is entering retirement right now is very different from somebody who has been in retirement for a decade or more is very different from somebody who is 30 or 40 and looking to their future. So how do you account for that kind of variability? Because there have been a variety of other studies that have said things like, hey, you know, you want to make sure you have this asset class or that asset class, but you don't necessarily always want them for long stretches of time. So they're good to have at various points, like say when inflation is rising, but not always. So How much does this vary based on your time horizon and based on the assets you're bringing into it?

It's going to vary differently, right, from person to person. First off, for people who aren't in retirement, that 4% illustration is the tool that's used in all those planning scenarios. So on the illustration, it always assumes that type of withdrawal rate. Now because you're not taking any money out, you're not really going to be as affected. So people who aren't in retirement, who aren't in the withdrawal rate, they're just fine. They shouldn't get freaked out about rising interest rates and possibly their portfolio not doing as well as it has done in previous years because they're not in that withdrawal rate. So they're not affecting their portfolio currently and should keep on going with their plan as expected. But people who are in retirement and are drawing from their portfolio, those are the ones that are really affected. And what I'm telling my clients and also the listeners here today is go back and revisit your expenses because if you were taking out a certain dollar amount, chances are you may need more. So one of the options is you take more out, but then again, you're taking out a higher withdrawal rate, or you can go back and try to adjust your expenses. So those are pretty much the two options that you have. Now, when you are taking money out, one of the other options is that people get tempted to adjust their portfolios because maybe they're not doing as well as they thought they had in previous years, or they get spooked and they realize, all right, now I need to cut my allocation, maybe get more conservative and go into more cash. And that's one of the worst things they can do as well, because at a higher withdrawal rate and you're taking more money out and less earning potential, you're really gonna affect your portfolios in later years because a higher withdrawal rate can eat away at a portfolio much worse than a volatile market can.

You know, one of the things that was discussed about the 4% rule before COVID and all the recent volatility was that as the bull market extended, there were people who were saying, hey, 4% is low. It should really be 4.5%. Are you willing to make any blanket statements like that, or is the real problem with the Bengen rule it's a blanket statement? Let's just not do that.

There's always adjustments to that Bengen rule. Even he, when he was doing his own adjustments, it was 4.1% if it was an after-tax account. If it was a retirement account, then it would be higher than that. It would be 4.5%, 4.7%, because you had to account for taxes. Because in a retirement account, you you withdraw money, but you also have an additional tax expense on top of that. So your withdrawal rate would need to be a little bit higher. So there are different adjustments based on that, but the reality is it is going to be individual for everybody because everyone's expenses are different, everyone's health is a little bit different, and that's why one of the things I'm asking again everyone is to go back and revisit your expenses and find out what you really need to make adjustments on. And then also don't give up on growth. That's key. If you felt you haven't, because the way the market has been as volatile, haven't done as well as you would like to, doesn't mean you give up on market growth. Go back and make sure you still have market growth exposure because even the Bengen Rule has, you know, when they did that study, it has somebody at least at 50% equity. Now, depends on what your risk tolerance is and what your growth rate assumptions need to be, but that's going to be different for everyone, but it still needs to have some equity exposure in order to combat inflation or to combat years like this year where if you need higher amounts, perhaps you're making it up in different different years. When there's bullish years, again, your portfolio grows more, your withdrawal rate can be less. In bearish years like we just are having this year, your withdrawal rate possibly has to go up, but you're allowing for the fact that you're making up for previous years. And that's one of the key things, is that capture growth when there's growth in the market, because there's going to be years like now where if we are bearish, your portfolio may not do as well, and that'll make up for the fact that you may have to take a little bit more out.

I wouldn't be having a discussion about the Bengen rule, the 4% rule, without at least bringing up one of my pet peeves. One of the things that I dislike about this is that, hey, if it works to perfection, well, obviously you get to live out the rest of your days with a nice portfolio, but it also leaves that portfolio for your heirs, which is great for the financial planning world. And hey, it's great for your heirs, but the problem with it is that there are a lot of people who are younger in the planning stages, and they get with a financial advisor, and the financial advisor says, well, hey, to meet this 4% withdrawal thing, look at how much you're going to have to amass. And they think, oh my God, I'm never going to do that. And it becomes daunting. And yeah, you don't want to run out of money before you die, but you wouldn't necessarily mind dying and being broke at that time and not being a burden to anyone. So, how do you deal with that when you've got somebody who comes into you and you're doing financial planning and you're talking about the need to keep growth and etc., and they look at you and they say, "Okay, but whatever rule you put me on, Freddie, I'm never getting that much money." You have to manage expectations, right?

And what is feasible, what isn't feasible. According to the Bengen rule, again, for every million dollars, you basically be able to pull out about $40,000. Now $40,000 is not a lot of money to live off of. So a person would need— if say they were making an average salary of about $200,000 or $250,000, you'd have to have over $5 to $6 million saved up just to be able to achieve that amount. For some people that may not be possible. So you have to live in a set of expectations. If leaving money behind is important to a person but it's not financially possible, then you have to set the expectation as The first step is to make sure you can take care of yourself. You can cover your light bill. You can feed yourself. You can stay in your home. So those expectations have to be met. And then everything else is a wish list. So you have to prioritize yourself first because the worst thing you can do isn't so much not leaving money behind to a child, but making sure that child is supporting you. You don't want to be that. So set those expectations up appropriately. Not everyone will be able to save up to where they're leaving tons of money behind. But we can save to where at least we're covering our own. And then part of that too is, you know, invest appropriately too. Make sure you're getting the type of growth that's needed so you can get the nest egg that you need to save up for yourself. Too many people go too conservative, too quick, not realizing that you're going to need money for quite a while.

Yeah. And if any year is going to teach folks that lesson, it might be this one. Freddie, thanks so much for sharing that with us. Talk to you again soon.

Thanks much for having me.

This has been Left Brain Thinking, a joint production of Left Brain Investment Research and Money Life with Chuck Jaffe. Our conversations are not personalized investment recommendations but are designed to engage your brain. Please do your diligence before making any financial transaction. I'm your host, Chuck Jaffe, and you can learn more about my weekday podcast at moneylifeshow.com. Thanks to my guest, Freddy Garcia, Vice President of Investments for Left Brain Wealth Management. Learn about the firm and its services at leftbrainwealthmanagement.com. But learn about the firm's picks on stocks and bonds, learn about the Jarvis newsletter and much more at leftbrainir.com. And Left Brain's on Twitter @leftbrainir. Left Brain Thinking is available every other Wednesday. Follow us on your favorite podcast app to make sure you don't miss a single chance to wear your Left Brain Thinking cap. And until next time, happy investing, everybody.