Forget the 4% Rule -- Here's What You Should Really Be Looking at During Retirement

The 4% rule for withdrawing money from a retirement account makes sense for most people ... even if only as a starting point for planning purposes. According to the rule, by withdrawing 4% of your retirement account's balance in your first year of retirement and then only increasing your annual withdrawal by the previous year's rate of inflation, your money should last at least three decades. That's more than enough time for the typical retiree.

This popular strategy, however, isn't the only detail regarding a retirement portfolio that retirees should be thinking about. It's not even the most important one. Here are four other considerations that will help you get a better handle on fully funding your golden years.

1. Your actual spending needs

The 4% rule presumes any withdrawals from the retirement fund will be necessary to cover your expenses, but that's not always the case. You may only need to withdraw 3% of your retirement account's value in your first year of retirement to live on. If that's the case, the smart-money move is to leave that last 1% invested and allowing it to continue producing growth.

On the other hand, you may actually need to withdraw 5% or even 6% of your retirement savings to pay all your bills. If this is the case, your retirement fund isn't apt to last the 4% rule's projected minimum of 33 years.

Don't panic if that's you! Maybe reducing your budget the following two years will be enough to cover the difference. Or perhaps you tweak your portfolio's allocation from half stocks and half Treasury bonds (as prescribed by the 4% rule) to something closer to 60% stocks and 40% bonds, and prepare for additional volatility. Every problem has a solution.

Before applying any solutions, though, you must know the extent of any problem. A careful calculation of your actual spending needs in retirement is the obvious place to start.

2. The volatility of your account's balance

A 50/50 mix of stocks and bonds should mean a less volatile portfolio than one made up of nothing but equities. But not all stocks are built the same -- some are considerably more volatile than others. Even if only half your portfolio consists of stocks, it's still possible for that portfolio to change dramatically in value from one year to the next. It depends on the tickers in question.

Here's where the 4% rule's fixed-number recommendations can really become problematic: Removing 4% of a $1 million retirement fund in the first year of retirement is a withdrawal of $40,000. Should a bear market begin thereafter and reduce your portfolio's value to only $800,000, however, taking out an inflation-adjusted $41,000 the following year is actually a withdrawal of more than 5% of the fund's value.

You might be able to safely get away with this for a few years. Sometimes, volatility can even work in your favor! But the lost nickels and dimes linked to unfortunate timing and missed opportunities can add up to quarters and dollars over time. You'll want to be sure your portfolio's value is reliably consistent from one year to the next if you're withdrawing a set percentage of it every year. That's especially true in light of the high inflation in recent years.

3. Your cash production (and cash optimization)

Just because your retirement portfolio's value is stable doesn't necessarily mean it's easy or convenient to apply the 4% rule to it. If it remains 100% invested in stocks and bonds, you'll need to sell something when the time comes to make a withdrawal.

And there's the rub -- you don't want to be forced to sell anything at a pre-determined date on the calendar. Your portfolio may be down quite a bit at the time. You generally want to exit trades on your terms, like when a stock is overvalued or even when bond prices are inflated.

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This point prompts some discussion regarding dividends.

Although many investors tend to reinvest their dividends, they usually do so because they don't need the income at the time. They're likely earning income from a job, but that's not the case in retirement. This might be the right time to stop reinvesting dividends and instead let these cash payments remain liquid until you're ready to withdraw this money.

That being said, investors are currently enjoying a cash-like option they've not seen in several decades. That's money market funds that pay on the order of an annualized 5%. Most of these funds require you to stick with them for at least a few weeks or pay a small early exit penalty, so plan accordingly. But it's certainly worth the trouble of shifting any idle cash into these short-term funds.

4. The true growth potential of your "growth" bucket

Finally, while your biggest concern in retirement is reliable income, the 4% rule is rooted in the premise that half of your portfolio will remain invested in stocks (as opposed to fixed-income investments). This is so your retirement fund will continue to grow meaningfully in value, even while you're gradually cashing it out to meet your retirement spending needs. These stocks will still need to at least match the broad market's long-term average gains.

How this happens is up to you. Quality growth stocks are capable of doing the job, but these tickers tend to be volatile from one year to the next, which can be less than ideal for a retiree. On the other hand, it's not unheard of for investors to underinvest in growth during retirement only to end up outliving their money. The key -- as always -- is finding a reasonable balance of reliable, risk-adjusted growth.

This might help: For the 4% rule to work as intended, you'll need to earn a yearly average of between 2% and 3% on your bonds and between 7% and 9% on your stocks to achieve an overall average annual return of 6% to 7% on your retirement fund. That's easier said than done, but it's certainly possible. A portfolio with a healthy number of high-quality dividend stocks could readily lead the charge.

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