Thursday, April 22, 2010

The 4% Saving for Retirement Rule

Source: Journal of Investment Management (via Stanford Graduate School of Business News)

The 4% Rule—At What Price?

Jason S. Scott, William F. Sharpe, and John G. Watson

Saving for retirement is hard enough. It turns out, though, that spending intelligently during retirement is difficult as well. The soon-to-be-retired person has to make a range of decisions about spending that will have real consequences for as long as he or she lives.

Sadly, though, “the 4% rule,” which is the most commonly offered spending advice proffered by investment professionals and the popular press, can ultimately be harmful to the interests of people who heed it, according to recent research by Nobel Laureate William Sharpe, Professor of Finance, Emeritus, at the Stanford Graduate School of Business.

Simply put, the rule suggests that the retiree spend an inflation-adjusted 4% of his or her retirement assets each year, while keeping the balance of those assets in a portfolio that typically includes both stocks and bonds. That might be a reasonable strategy in a world where stocks aren’t risky. But they are, of course. Moreover, there’s more wrong with the rule than simply that it discounts the downside of investing in instruments that have an element of risk.

Read more.

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