Per usual, Tyler makes great points about AA. If someone is so very concerned about the 4% rule (I am not), there are ways to mitigate this risk through portfolio management. Changing passive AA during different times in drawdown is not market timing, itís like hedging your bets or buying insurance.
Think of it this way: You purchase a house in a flood plain. History tells us that in the last 150 years your neighborhood has flooded 5 times. Rightfully, you are concerned and get a quote for flood insurance at a rate of $100 a month. However, detailed investigation shows that every time your neighborhood has flooded it has happened in March and April, your insurer is willing to offer you a policy that only covers March and April for $400 annually (letís forget about climate change here as that is a known variable, pretend all things are equal). Which insurance is the best buy?
There are only two historical scenarios that have cause a failure of 4% rule in the US:
- Significant drop is asset value soon after drawdown initiation which lasts multiple years (sequence risk)
- Long term low growth coupled with high inflation (stagflation)
Why not insure against these two risks? For example, a portfolio 100% VTI is a high risk portfolio for scenario #1 (If you call single digit percents high). In the first decade or so of drawdown, a simple modification to 25 to 40 percent treasuries significantly reduces this risk. If a bad sequence never materializes (most scenarios) and the retiree sees average or above average gains, this risk disappears. Yes, being less invested in equities means a smaller stash after the decade of average returns, BUT (big but) itís meaningless! A 60% equity allocation would have been more than enough to reduce withdrawal rate to a point in which historically, the retirement never fails. 100% equities would have reduced WR more, but for what purpose? After the sequence risk has been eliminated (historically speaking, since thatís all weíve got), then reallocate to defend against the next issue, inflation. Obviously having a percentage of liquid assets tax deferred allows for easier (quicker) AA changes, but over periods of time it can be adjusted in taxable accounts rather efficiently as well (or one could glidepath).