We all know how important your investments are for your retirement. You worked hard for many years to earn your money, invested it properly, and as a result, built this ‘nest egg’ to live from for the next 20 to 30 years. Because of this, we are very careful when taking money out of our retirement funds to make sure that our investments last.  

Many people follow the so-called ‘4% rule’ with regard to their retirement. The concept behind this is if your withdrawal rate is 4% each year, your money will last your lifetime. This seems feasible at first – invest so you receive a 4% rate of return, only withdraw 4% so your capital never decreases, and you always know what your withdrawal amount will be. This is standard practice for most investment companies, but there are some holes in this logic that can result in you taking out too much and going through your money faster than expected.

Let’s look at this 4% rule with a simple example. If you have $100,000 invested and your investment provides a return of 4% in a year, your ‘nest egg’ now equals $104,000 and you can take out $4,000 while leaving your $100,000 capital untouched.

Simple, right?

Here is where things get tricky. What happens if the investment generates less than a 4% return – or even worse, a negative return? If that’s the case and the investment drops to $90,000, what are you to do?

• Take the $4,000 but know that you are taking out more than 4%
• Take a reduction in the amount that you take out (let’s say $3,600) to maintain the 4%

If you maintain the 4% withdrawal rate, regardless of market conditions, you will run out of money in retirement. If you have another year with a return that is less than 4%, the amount of time you have before you run out of money in retirement gets even shorter. You may be thinking ‘well, having a less than 4% return doesn’t happen that often.’ Did you know that this happens every 3.6 years in the stock market? Now, if you take a lower investment rate of 4%, it means that you could end up taking a 10% reduction in your retirement income. While this doesn’t happen in the initial year, any additional reductions in the capital will slowly reduce your retirement lifestyle over time. Who wants either of those situations?

Let me introduce a third option to you, something that I use with my clients. A variable withdrawal strategy where your withdrawal rate is set within a ‘safety zone’ where you have enough money to maintain your lifestyle and your investment assets. Once we decide what your withdrawal amount is, for example, $4,000, we create a ‘safety zone’ around your investments that allows for growth while maintaining your current withdrawal amount. If your investments fall outside of this zone due to poor market returns, we make a minor adjustment to the withdrawal amount that brings you back into the safety zone. As your investment performance improves, we can increase your withdrawal rate back to the original amount or higher, depending on the market conditions and your comfort level. This is an ongoing process that is reviewed monthly or annually to ensure your overall retirement success.  

This is just a single source of income in your overall financial plan. There is also income coming from other sources, such as CPP (Canada Pension Plan), OAS (Old Age Security), and TFSA (Tax-Free Savings Account) that can all help fill in that income gap if we had to decrease your withdrawal amount. In a perfect world, we would never want to decrease our spending in retirement but with the reality of market volatility, there is a need to make these adjustments. Having a plan that can be adjusted based on market conditions and still provide the optimum retirement strategy is the best thing you can have. Don’t rely on the static retirement strategy and assume that things will work out. Work with a financial planner who will actively monitor your investments and make sure that you can live the retirement lifestyle you want.