'Four percent rule' may not fit your retirement spending needs

If you believe that an apple a day keeps the doctor away, then you may also be convinced of the rule of thumb that spending 4 percent of your portfolio is a safe spending amount in retirement. Apples have worms and the "4 Percent Rule" can also be full of holes. There are a number of factors that will determine what you can spend in retirement, so here are the most important things to consider.

The 4 percent rule posits that if you have your assets allocated properly, your money will last for 30 years using a 4 percent withdrawal rate and by increasing your withdrawals with inflation. This analysis is an interesting rule of thumb, but it is simplistic.

The single biggest factor of how much you can withdraw from your portfolio is how long you need the money to last. If you are a recently retired 90-year old, you can obviously draw more than 4 percent a year; if you retired at 50, that number could be a stretch. Each year that you work and can delay pulling from your investments, the higher the percentage that you can withdraw when you are living off your portfolio. The simple way of thinking about this is that every year you live brings you a year closer to dying and your spending typically stops when your breath does.

An important consideration is whether you intend to do any work for money. Using that 4 percent yardstick, every dollar you earn is equivalent to having $25 of investments. Five thousand dollars of paid earnings match what you could withdraw from a $125,000 investment portfolio using the 4 percent rule. While this is only the case for the year you earn it, it can still reduce the pressure on how much you need to pull out of the portfolio, thereby allowing more of it to work longer for you.

Another critical factor is how much you wish to leave to your heirs or charity. The more money you want to leave, the less you can spend on yourself. If you happen to be in a position where you are able to make current gifts to charities or to your children, then you can leave less to them when you die. We have found many clients get great satisfaction from having a better understanding of their potential spending so they can direct money sooner to the people and causes that matter to them.

Managing the investment portfolio properly is slightly less important than the first two considerations. Unless you have far more money than you will ever need, you will have to have some money invested in three categories: stocks, bonds and cash. Stocks are what you need in order to have your portfolio keep pace with inflation; bonds give you income and protection, and cash is your safety net.

With bond yields so low, it would be difficult to spend 4 percent growing with inflation when your bonds are paying far less than that.

This creates two problems — it either forces them primarily into dividend paying stocks, which means their growth investments won't be properly diversified, or they buy too many bonds to try to create an income stream resulting in lower long-term returns. For many, money needs to last several decades after retiring. It is much better to spend a certain percentage of the portfolio each year rather than simply the income that the portfolio produces. This allows you to build an investment plan that will last as long as you do.

The fourth consideration is how you want to view inflation. The 4 percent concept expects you to need to increase your spending each year as inflation kicks in. But while inflation is real, your personal inflation rate may be much different from the stated one. Your total housing costs may rise less dramatically than inflation. Your health care costs may move in directions distinct from inflation. You may not be spending much money any more on goods or services influenced by inflation. Dynamic retirement spending models adjust for portfolio valuations rather than inflation and reset withdrawal amounts every few years as you age, often allowing you to spend a higher percentage earlier (when you are most active).

Managing your cash flow doesn't change the amount that you can withdraw from the portfolio but it reduces the pressure on those withdrawals. Using the same numbers from above, a $5,000 reduction in spending means that you would need $125,000 less in assets. As people near retirement, ideally they can drive down their fixed costs. If your investment portfolio takes a hit, you can delay such things as travel or a car purchase, but you still need to pay your rent or mortgage. Lowering fixed costs increases both your overall flexibility and your comfort level.

While 4 percent is a starting point, you can go up or down from there. If you properly prepare for retirement, you will be financially healthy.