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Question from Mark Lennox, 63, of British Columbia: Can you explain the"4-per-cent rule" for the amount you can remove from your principal? I have read it includes dividends but I cannot believe it. How is the amount really calculated? We are retired with limited pensions and want the nest egg to last.
Nancy Woods is an associate portfolio manager and investment adviser with RBC Dominion Securities Inc.
The “4-per-cent rule” should instead be called the “4-per-cent guideline.” Basically, the rule was used to determine the amount of funds one can withdraw from a retirement account each year to keep most of the original assets intact. It was the “safe” rate as it was expected that the amounts withdrawn consisted primarily of dividends and interest. If you were getting an income of 4 per cent, more or less, then little of the starting capital would be withdrawn.
Since we have been in a very low interest-rate environment for the past few years, this rule has had to be adjusted. There are several factors that will affect the erosion of your nest egg.
If your savings have been invested in mostly fixed-income products or GICs, they probably yielded a lot less than 4 per cent. That would mean your capital is being eroded by the 4-per-cent rule and could deplete the account faster than you would like. The amount of years you need to draw on the account matters as well. Also, if your portfolio suffered a setback due to a market downturn early on in your retirement, withdrawing 4 per cent would only worsen the situation.
My suggestion is that you put your money in investments that pay a secure and steady income. If possible, look for investments that pay over the rate of inflation so you are maintaining the buying power of your dollar. As an adviser, my first goal is to not lose a client’s money. Since the target average inflation rate used by the government is 2 per cent, any investment that pays you less than 2 per cent is effectively losing you money.
Don’t choose investments that pay a rate much higher than the current environment unless you are fully aware of the risks. A higher rate of return implies higher risk. Especially during your retirement years, one should not be a yield hog. If you can get by withdrawing only the amount of income the portfolio generates, then stick to that. It is the only way to ensure your capital doesn’t run out.