Including Real Estate in a Retirement Portfolio (Part 1)

The 4% Rule

Many investors look to traditional stock and bond portfolios to fund their retirement lifestyles. Following this method, individuals often choose to measure their financial capacity to retire by a simple criterion: the 4% rule. The 4% rule states that once investors have 25 times their annual expenditure saved in a stock and bond portfolio, they are financially able to retire. Much of the logic that formed this rule stands solidly to this day and forms the pillars of modern retirement planning. Still, reducing one’s financial plan to this maxim can leave investors, at best, with unoptimized retirement portfolios and, at worst, risking financial vulnerability in their golden years. 

This rule, first published by William Bengen in 1994, holds that investors may withdraw 4% of their stock/bond retirement portfolio in the first year of retirement and increase that number with inflation annually, without risking depletion of their capital. This is a bold claim to make and Bengen’s data supports it. Bengen studied market data from 1925-1995, with hypothetical retirees in each year from 1925-1966. Over a period encompassing the Great Depression, World War II, Stagflation, Oil Crises, and other course-changing macroeconomic events, retirees using the 4% rule would have enjoyed successful retirements 95% of the time. In other words, they would not have run out of capital during a 30-year retirement. The effectiveness of this rule has legitimized it as a principle that retirees and retirement planners alike can rely upon.

The study assumes a 50/50 portfolio allocation between stocks and bonds, a 30-year retirement horizon and, of course, a 4% withdrawal rate in the first year of retirement. That said, any of the following deviations could adversely impact the success of the model: 

• Retirement exceeding 30 years;
• A portfolio that leans too heavily in either stocks or bonds; or 
• Annual withdrawal rates greater than 4%.

For illustrative purposes only. Source: American Association of Individual Investors, February 1998.

While these assumptions are applicable, or at least adaptable to many retirees today, this 50/50 portfolio of traditional assets exposes investors to avoidable risk, and limits investors in meeting their holistic retirement goals.

Modern real estate investing helps investors avoid pitfalls of the traditional strategy and exploit areas of improvement beyond what the 4% rule can offer. By mitigating risks such as volatility and inflation, investors stand to benefit from the added diversification of real estate in their portfolios.

Real Estate in a Retirement Portfolio