Woman Placing a Quarter in Her Piggy Bank.

Be a Rule-Breaking Investor

Some of these common rules on saving for retirement are outdated.

 Woman Placing a Quarter in Her Piggy Bank.

Should we retire the "4 percent rule"?

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You may not realize it, but “rules of thumb” play a pretty big role in our financial lives.

From spending three months’ salary on an engagement ring to adjusting your portfolio to the classic "100 minus your age” formula, almost every aspect of our finances can be guided by some sort of rule. Although such rules can be helpful in providing a loose set of guidelines for those who may not have the knowledge, time or interest needed to develop a personalized plan, sometimes following the rules can lead you astray or maybe even leave you short of reaching your goals.

To really succeed in reaching your retirement and investing goals, sometimes you have to make your own rules. Let’s take a look at three popular investing rules, and consider what you should be doing instead:

1. When to retire.
Though 65 remains a popular retirement target (27 percent of workers plan to retire then, according to a 2012 Gallup poll), in the current economic reality, many workers won’t accumulate enough savings to retire comfortably when they want.

The first step to choosing the right retirement date is to determine a savings goal based on your intended retirement lifestyle and the number of years you expect to live in retirement. Use online calculators or talk to an investment advisor for help arriving at a preliminary number based on your current spending levels and estimated expenditures during your retirement years. For example, your transportation costs might decrease, since you’ll no longer be commuting to work, but the cost of utilities might go up as a result of your spending more time at home.

Once you have a retirement savings goal in place, you can work backwards to see how long it might take you to accumulate that level of savings.

2. How much to withdraw in retirement. The traditional rule has been to withdraw no more than 4 percent of your retirement savings per year. When adjusted for inflation, this rule is intended to ensure your savings will last 30 years. But think about this: Our average lifespans have increased, and some of us could spend more than 35 years in retirement. According to projections from the U.S. Census Bureau, approximately 20 percent of Americans will be 65 or older by the year 2050, and of those Americans, about 400,000 will be at least 100 years old. What this means is that your retirement savings may need to last longer than in years past. 

No one should automatically withdraw 4 percent simply because it’s the common rule. When determining the withdrawal rate that’s best for you, or one that will provide for a comfortable retirement and also ensure that you won’t run out of money, you should consider the length of time you have until retirement as well as other sources of retirement income, such as Social Security benefits, pensions or possible part-time work.

3. Your asset allocation. You’ve probably heard that to determine your asset allocation, subtract your age from 100 and use the answer as the percentage that stocks should represent in your portfolio. For example, a 60-year-old investor would have a portfolio of 40-percent stocks and 60-percent bonds, according to this rule. Thus, as you approach retirement, you’ll slowly move away from equities and start investing more in bonds, so as to help lessen your overall risk.

Now that we’re living longer, though, it’s easy to see that this rule may need some tweaking. A more recent recommendation is to subtract your age from 110 or 120, but again, that may not be appropriate for everyone. The bottom line is that if you need to make your money last longer, you’ll need the extra growth potential from continuing to invest in a mix of stocks and bonds. You don’t want to go too conservative as you approach retirement, or you’ll risk outliving your savings.

As you can see, these rules are overly broad and based on average assumptions not unique to your individual circumstances and financial goals. Instead of relying on general guidelines, ask yourself these questions to help you build an investment strategy that is specific to your needs:

1. What are my retirement goals?

2. How long do I have until retirement?

3. How long will I likely live in retirement?

4. What other sources of retirement income do I have?

5. How comfortable am I with risk, especially as I near retirement age?

Based on your answers, an investment advisor can help you develop a customized approach and show you how you’re tracking toward your goals over time.

There may have been a point when retirement planning and investing was almost predictable. However, although there are some tried-and-true investing principles (such as dollar-cost averaging) that have lasted over time, simply following the rules because it’s “what has always been done” means you’re not personalizing your strategy. Remember, what works for your neighbor or brother-in-law won’t necessarily work for you. You don’t want to save for your future based on someone else’s vision, do you?