Millions of investors have heard the same two pieces of retirement advice: your portfolio should be split 60/40 between stocks and bonds, and you should plan on withdrawing no more than 4% of your savings annually after leaving work.
Following those rules may have been wise in the past, but experts say they don’t hold up in today’s world of staggeringly low interest rates. And with the Federal Reserve’s March 3 announcement that it was cutting rates even further amid fears of the coronavirus outbreak’s economic impact, it’s clear that the situation isn’t likely to change anytime soon. It’s time, then, to rethink these old guidelines.
First, there’s the 60/40 rule, which is meant to balance the long-term growth of stocks with the relative safety of bonds. But analysts warn that at low or even negative rates, bonds can’t offer steady interest income that can offset stock declines during bear markets. Furthermore, this guideline came about when stocks and bonds were negatively correlated–returns from stocks went up as those from bonds went down, and vice versa. But lately they tend to move in tandem, so it makes less sense to pair them. Morgan Stanley recently gave a “sobering” outlook for 60/40 portfolios, predicting annual returns of 4.1% over the next decade, only half the rule’s average performance. A Bank of America report said this asset mix “may have thrived in the 2000s and 2010s but won’t survive the 2020s.”
Ditching the 60/40 rule doesn’t have to mean shifting money into today’s volatile stock market. Alternatives include investment-grade U.S. corporate bonds or emerging market bonds, both of which can offer higher yields than U.S. Treasuries. “You can generate a greater level of yield if you diversify your fixed-income investments,” says Tracie McMillion, head of global asset allocation strategy at the Wells Fargo Investment Institute. However, some experts say the 60/40 rule can still hold up for investors with a decade or more before retirement.
Meanwhile, the 4% rule is meant to give investors a sense of how much they need to save for retirement. A person following it who has put away $1 million, for example, should anticipate withdrawing no more than $40,000 a year, adjusting for inflation. A landmark study found investors following this rule had a 95% chance that their savings would last for 30 years.
But the 10-year U.S. Treasury yield, considered the global benchmark, was much higher when the study was conducted in the 1990s, at around 5% to 6%. Following the Fed’s rate cuts, it dropped below 1% for the first time ever. Rates that low, plus lengthening U.S. life expectancies, mean that modern investors following the 4% rule have a 1-in-3 chance of running out of money. “It’s really tough right now,” says Wade Pfau, a professor at the American College of Financial Services. He says today’s investors should expect to withdraw no more than 3% a year in retirement. With inflation running near 2.5%, that leaves very little in real returns.
Some experts say it’s wise to avoid catchall retirement advice in the first place. “These rules are simple and therefore popular, but perhaps overly simplistic,” says Anil Suri, a managing director at Bank of America’s investment solutions group. Instead, investors should create a personalized financial plan and keep it updated as market forces change.
For investors who find they are falling behind, there are several ways to catch up, though none are easy. They can choose to work longer, which adds to earnings and shortens retirement. They can spend less. Or they can seek out higher returns through riskier assets. The last option may seem appealing, but it carries the risk of losing even more should global stock markets plummet.
To guard against a potential downturn, McMillion says investors should keep 12 to 18 months’ worth of expenses in cash. Pfau also suggests supplementing underperforming bonds with investments in annuities, which can guarantee steady lifetime income but can involve complex structures and fees.
The shocking effect that years of low interest rates are having on retirement portfolios may wind up being just the wake-up call investors need. After a decade of economic growth, many have lapsed into a complacent “set it and forget it” mentality. But while on the road to retirement, it’s never a good idea to fall asleep at the wheel.
FAQs
According to the 4% rule, if you retire with $500,000 in assets, you should be able to withdraw $20,000 per year for 30 years or more. Moreover, investing this money in an annuity could provide a guaranteed annual income of $24,688 for those retiring at 55.
What type of retirement plan is affected by changing interest rates? ›
One of the most obvious ways a change in interest rates affects your 401(k) is the rate of interest you earn on money market investments that pay either a guaranteed or a floating interest rate.
How long will $200,000 last in retirement? ›
Assuming you'll live to be 85 and won't want to work after retiring, you can anticipate a need for 20 years of income. If you're able to retire with $200,000 at 65, that will equate to $10,000 a year, or approximately $833 a month.
How long will $400,000 last in retirement? ›
Safe Withdrawal Rate
Using our portfolio of $400,000 and the 4% withdrawal rate, you could withdraw $16,000 annually from your retirement accounts and expect your money to last for at least 30 years. If, say, your Social Security checks are $2,000 monthly, you'd have a combined annual income in retirement of $40,000.
Can I retire at 62 with $400,000 in 401k? ›
If you have $400,000 in the bank you can retire early at age 62, but it will be tight. The good news is that if you can keep working for just five more years, you are on track for a potentially quite comfortable retirement by full retirement age.
What is the average 401k balance for a 65 year old? ›
Is it better to retire when interest rates are high? ›
“Having a higher interest rate is helpful because you'll receive more interest income with CDs and cash equivalents for emergency savings and a portion of your overall retirement asset allocation,” said Daniel Soo, an executive wealth management adviser at TIAA. “Especially if you're more conservative by nature.”
Why does my pension go down when interest rates go up? ›
When interest rates rise, the present value of future pension payments decreases, resulting in a lower lump sum value. Conversely, when interest rates decline, the present value of future pension payments increases, leading to a higher lump sum value.
Why is my lump sum pension going down? ›
These rates are issued on a monthly basis. There is an inverse relationship between these interest rates and the pension lump sum amount a participant would receive. That is, when these interest rates increase, the value of the pension lump sum decreases, and vice versa.
What is a good monthly retirement income? ›
Average Monthly Retirement Income
According to data from the BLS, average 2022 incomes after taxes were as follows for older households: 65-74 years: $63,187 per year or $5,266 per month. 75 and older: $47,928 per year or $3,994 per month.
In fact, statistically, around 10% of retirees have $1 million or more in savings. The majority of retirees, however, have far less saved.
Can I retire at 55 with 300k? ›
On average for a comfortable retirement, an individual will spend £43,100 a year, whilst the average couple in retirement spends £59,000 a year. This means if you retire at 55 with £300k, an individual will run out of funds in approximately 7 years, and a couple in 5 years. So, on paper, it doesn't look like enough.
What is the average Social Security check? ›
Social Security offers a monthly benefit check to many kinds of recipients. As of December 2023, the average check is $1,767.03, according to the Social Security Administration – but that amount can differ drastically depending on the type of recipient. In fact, retirees typically make more than the overall average.
Can I retire at 62 with 300k in my 401k? ›
If you earned around $50,000 per year before retirement, the odds are good that a $300,000 retirement account and Social Security benefits will allow you to continue enjoying your same lifestyle. By age 55 the median American household has about $120,000 saved for retirement, and about $212,500 in net worth.
Can I retire on $500k plus social security? ›
The short answer is yes, $500,000 is enough for many retirees. The question is how that will work out for you. With an income source like Social Security, modes spending, and a bit of good luck, this is feasible. And when two people in your household get Social Security or pension income, it's even easier.
Can you retire comfortably with 500k? ›
The short answer is yes, $500,000 is enough for many retirees. The question is how that will work out for you. With an income source like Social Security, modes spending, and a bit of good luck, this is feasible. And when two people in your household get Social Security or pension income, it's even easier.
What percentage of retirees have $500,000 in savings? ›
How much do people save for retirement? In 2022, about 46% of households reported any savings in retirement accounts. Twenty-six percent had saved more than $100,000, and 9% had more than $500,000. These percentages were only somewhat higher for older people.
Can I live off interest of 500k? ›
Key Takeaways
It may be possible to retire at 45 years of age, but it depends on a variety of factors. If you have $500,000 in savings, then according to the 4% rule, you will have access to roughly $20,000 per year for 30 years.
How much monthly income will $500,000 generate? ›
Depending on how you manage your money, you can probably expect an annual income between $48,000 (at roughly $4,000 per month) and $63,000 (at roughly $5,300 per month). More is possible if you invest for more aggressive returns, but that will mean taking on more risk.
