The 4% Rule has helped generations of retirees estimate how much they can spend each year in retirement. What many don’t know, however, is the role investment fees played, or didn’t play, in the creation of the rule. For example, does the rule still work if a retiree pays an advisor 1% a year in fees? Does it work if a DIY investor pays mutual fund fees of 1% or more?
In this article, we’ll look at five key things every investor should know about the 4% Rule and investment fees.
1. The 4% Rule Ignores Fees
First, the 4% Rule ignores fees. William Bengen, the father of the 4% rule, published his paper in 1994. In his analysis, he assumed the retiree paid no investment fees. In fact, he didn’t even discuss fees in his paper. Instead, he just assumed returns based on large cap U.S. equities and intermediate term U.S. Treasury bonds.
For those who pay no fees, or virtually no fees, Bengen’s assumption works out just fine. But who pays virtually no investment fees?
2. DIY Index Fund Investors are Safe
If you are a do it yourself investor and invest in low cost index funds, relying on the 4% Rule is consistent with Bengen’s analysis and assumptions. To be clear, a DIY investor doesn’t pay an advisor a percentage of their assets (called Assets Under Management, or AUM) for investment advice.
In addition, these retirees invest in very low cost index funds. For example, firms such as Vanguard, Fidelity and Schwab offer index funds that cost 10 basis points or less. Fidelity even offers some mutual funds that don’t charge any expense ratio. While these funds charge a fee in most cases, the fee is as close to 0% as one can get. As a result, these investors can continue to rely on the 4% Rule as developed by Mr. Bengen.
3. Fees Risk Running Out of Money in Retirement
What about everyone else? For those that pay advisors, invest in expensive mutual funds, or both, what happens if they ignore the fees and continue to rely on the 4% Rule?
In short, ignoring fees increases the risk that one will run out of money in retirement. And the increased risk is significant, particularly for those who spend 1% or more in fees. Bengen’s original 1994 paper gives us some insight into the risk.
In his paper, he considered several initial withdrawal rates beyond four percent. In fact, he considered initial withdrawals ranging from one to eight percent. What he found with withdrawal rates of five and six percent are instructive for our purposes. Why? They give us some idea of how investment fees of one to two percent will affect the longevity of a portfolio in retirement.
To be clear, it’s not a perfect analogy. Unlike spending in retirement, investment fees aren’t adjusted for inflation. Because investment fees are typically calculated as a percentage of a portfolio, the actual fees move higher or lower based on the portfolio’s value. Bengen’s analysis, however, still gives us a rough idea of the effect fees can have on a portfolio. So what did he find?
At an initial 5% withdrawal rate, many retirement years he examined saw portfolios exhausted in just over 20 years. Bump up the initial distribution to 6%, and some years saw portfolios run out of money in about 15 years. There were still years where the money lasted 30 years or more. But the number of years where it didn’t grew substantially. More importantly, there’s no way to know in advance whether a retiree picked a “good” year or a “bad” year to retire. In fact, it may take a decade or more into retirement before one knows. And by then, it’s too late.
4. Fees Reduce What You Can Spend in Retirement
For those not comfortable ignoring fees, and good for you, one option is to reduce spending by the amount of investment fees. For example, let’s assume one pays an advisor 1%, and they in turn invest in mutual funds that cost 1%. That’s 2% that comes out of a retiree’s portfolio every year.
A $1 million portfolio would pay $20,000 a year in investment fees. In year one of retirement, a retiree could spend $40,000 following the 4% rule. In our hypothetical, however, $20,000 of that, or half of the spending allowance, would go to an advisor and mutual funds. In other words, a 2% fee just wiped out 50% of our budget. Even a 1% investment fee would wipe out 25% of what a retiree could spend.
5. Low Cost Options for Investment Help
For those who need investment help, there are low-cost options. Here I’ll list three potential alternatives that would allow a retiree to get some help and still adhere to the 4% Rule.
Low Cost Advisor
The first is a low cost advisor. And by low cost, I mean 30 basis points or less. One example is Vanguard’s Personal Advisory Service. It costs just 30 basis points and they invest in low cost index funds. Vanguard’s PAS is not perfect. I think they’ve had growing pains as Vanguard has seen explosive growth. You also can’t meet in person. It’s still a solid option from the pioneer of index fund investing.
Many advisors today offer their services on a flat fee basis, rather than charge a percentage of AUM. Now here we have to be careful. We are not talking about fee-only advisors. While they have a fiduciary duty to their clients, so do flat-fee advisors. The difference is that fee-only advisors charge based on a percentage of a client’s portfolio. A flat-fee advisor charges a flat fee regardless of the portfolio’s balance.
An example of a flat-fee advisor is Mark Zoril of PlanVision. He is not going to manage investments and make trades for his clients. Instead, he’ll provide a comprehensive financial plan including an investment plan. With a recommended portfolio in hand, a retiree can then allocate their portfolio accordingly.
More and more advisors are offering low-cost AUM services, flat-fee services or both. You can find a list of some of these advisors here.
Digital Advisory Services
A third option is to use a digital advisory service, sometimes referred to as a robo-advisor. These are companies that use technology to help with everything from portfolio construction to rebalancing to retirement spending. Two examples are Vanguard’s Digital Advisor Services and Betterment. Both charge low fees and offer tools to help retirees invest their money and take distributions for spending.
Whatever approach one takes, the key is to understand how investment fees affect the 4% Rule. Arguably the best approach is to use low-cost index funds that one manages on their own. For those that need some help, seek out one of many low-cost advisory services.
More China coal investments overseas cancelled than commissioned since 2017
More China-invested overseas coal-fired power capacity was cancelled than commissioned since 2017, research showed on Wednesday, highlighting the obstacles facing the industry as countries work to reduce carbon emissions.
The Centre for Research on Energy and Clean Air (CREA) said that the amount of capacity shelved or cancelled since 2017 was 4.5 times higher than the amount that went into construction over the period.
Coal-fired power is one of the biggest sources of climate-warming carbon dioxide emissions, and the wave of cancellations also reflects rising concerns about the sector’s long-term economic competitiveness.
Since 2016, the top 10 banks involved in global coal financing were all Chinese, and around 12% of all coal plants operating outside of China can be linked to Chinese banks, utilities, equipment manufacturers and construction firms, CREA said.
But although 80 gigawatts of China-backed capacity is still in the pipeline, many of the projects could face further setbacks as public opposition rises and financing becomes more difficult, it added.
China is currently drawing up policies that it says will allow it to bring greenhouse gas emissions to a peak by 2030 and to become carbon-neutral by 2060.
But it was responsible for more than half the world’s coal-fired power generation last year, and it will not start to cut coal consumption until 2026, President Xi Jinping said in April.
Environmental groups have called on China to stop financing coal-fired power entirely and to use the funds to invest in cleaner forms of energy, and there are already signs that it is cutting back on coal investments both at home and abroad.
Following rule changes implemented by the central bank earlier this year, “clean coal” is no longer eligible for green financing.
Industrial and Commercial Bank of China, the world’s biggest bank by assets and a major source of global coal financing, is also drawing up a “road map” to pull out of the sector, its chief economist Zhou Yueqiu said at the end of May.
(Reporting by David Stanway; Editing by Kenneth Maxwell)
Bank of Montreal CEO sees growth in U.S. share of earnings
Bank of Montreal expects its earnings contribution from the U.S. to keep growing, even without any mergers and acquisitions, driven by a much smaller market share than at home and nearly C$1 trillion ($823.38 billion) of assets, Chief Executive Officer Darryl White said on Monday.
“We do think we have plenty of scale,” and the ability to compete with both banks of similar as well as smaller size, White said at a Morgan Stanley conference, adding that the bank’s U.S. market share is between 1% and 5% based on the business line, versus 10% to 35% in Canada. “And we do it off the scale of our global balance sheet of C$950 billion.”
($1 = 1.2145 Canadian dollars)
(Reporting by Nichola Saminather; Editing by Leslie Adler)
GameStop falls 27% on potential share sale
Shares of GameStop Corp lost more than a quarter of their value on Thursday and other so-called meme stocks also declined in a sell-off that hit a broad range of names favored by retail investors.
The video game retailer’s shares closed down 27.16% at $220.39, their biggest one-day percentage loss in 11 weeks. The drop came a day after GameStop said in a quarterly report that it may sell up to 5 million new shares, sparking concerns of potential dilution for existing shareholders.
“The threat of dilution from the five million-share sale is the dagger in the hearts of GameStop shareholders,” said Jake Dollarhide, chief executive officer of Longbow Asset Management. “The meme trade is not working today, so logic for at least one day has returned.”
Soaring rallies in the shares of GameStop and AMC Entertainment Holdings over the past month have helped reinvigorate the meme stock frenzy that began earlier this year and fueled big moves in a fresh crop of names popular with investors on forums such as Reddit’s WallStreetBets.
Many of those names traded lower on Thursday, with shares of Clover Health Investments Corp down 15.2%, burger chain Wendy’s falling 3.1% and prison operator Geo Group Inc, one of the more recently minted meme stocks, down nearly 20% after surging more than 38% on Wednesday. AMC shares were off more than 13%.
Worries that other companies could leverage recent stock price gains by announcing share sales may be rippling out to the broader meme stock universe, said Jack Ablin, chief investment officer at Cresset Capital.
AMC last week took advantage of a 400% surge in its share price since mid-May to announce a pair of stock offerings.
“It appears that other companies, like GameStop, are hoping to follow AMC’s lead by issuing shares and otherwise profit from the meme stocks run-up,” Ablin said. “Investors are taking a dim view of that strategy.”
Wedbush Securities on Thursday raised its price target on GameStop to $50, from $39. GameStop will likely sell all 5 million new shares but that amount only represents a “modest” dilution of 7%, Wedbush analysts wrote.
GameStop on Wednesday reported stronger-than-expected earnings, and named the former head of Amazon.com Inc’s Australian business as its chief executive officer.
GameStop’s shares rallied more than 1,600% in January when a surge of buying forced bearish investors to unwind their bets in a phenomenon known as a short squeeze.
The company on Wednesday said the U.S. Securities and Exchange Commission had requested documents and information related to an investigation into that trading.
In the past two weeks, the so-called “meme stocks” have received $1.27 billion of retail inflows, Vanda Research said on Wednesday, matching their January peak.
(Reporting by Aaron Saldanha and Sagarika Jaisinghani in Bengaluru and Sinead Carew in New York; Additional reporting by Ira Iosebashvili; Editing by Sriraj Kalluvila, Shounak Dasgupta, Jonathan Oatis and Nick Zieminski)