Forget the 4% Rule: Here’s What You Should Really Be Looking at During Retirement

When it comes to retirees, total return is better than a high yield.

| More on:
retirees and finances

Image source: Getty Images

The 4% rule has long guided retirees on how much they can safely withdraw from their portfolio without running out of money. It suggests taking out 4% of your savings in the first year of retirement and then adjusting that amount for inflation each year after. This rule aims to make savings last for about 30 years.

But following this rule has led some people to focus too much on finding investments that pay high returns, like certain ETFs or stocks that offer more than 5% in dividends. This approach, known as yield chasing, can be risky. It might seem like a good way to ensure you have enough income, but it can actually lead to bigger problems, like losing money if those high-paying investments don’t perform well.

Chasing after high yields just to stick to the 4% rule isn’t the best idea. It’s better to consider your entire investment’s growth, not just the cash it pays out. I’ll explain why focusing only on high yields can be a mistake and what you should do instead to manage your retirement savings wisely.

A historical example – the assumptions

Let’s get straight to the point: focusing on yield alone can actually set you back in your investment journey, especially when adhering strictly to the 4% rule for retirement withdrawals.

It might seem logical to aim for investments that offer a 5% yield to cover your 4% withdrawal needs comfortably, but this strategy could mean missing out on greater financial growth.

Imagine two investors, both retiring in 2011 with $1 million each. The first investor decides to put their money into the iShares Canadian Financial Monthly Income ETF (TSX:FIE), attracted by its financial sector stocks, preferred shares, and corporate bonds that generate a high 6.95% yield as of February 9.

The second investor opts for a mix, choosing 60% in the iShares MSCI World Index ETF (TSX:XWD) and 40% in the iShares Core Canadian Universe Bond Index ETF (TSX:XBB). The yield from these ETFs doesn’t quite reach 4%, necessitating the occasional sale of shares to fund withdrawals.

A historical example – the results

Fast forward to the present, and let’s assess the results under the assumption of a 4% annual withdrawal:

  • Investor 1, who leaned heavily into the high-yield FIE, would have seen an annualized return of 2.83%, ending up with $1,441,269. This shows that they managed to grow their initial investment while withdrawing 4% yearly.
  • Investor 2, despite having to sell shares periodically due to a lower yield, would have experienced a compound annual growth rate of 3.74%, resulting in a portfolio worth $1,616,561. This outcome surpasses that of Investor 1 by a significant margin.

This example underscores that it’s the total return, combining both price appreciation and dividends, that truly matters in the long run. A high dividend yield might seem appealing as it appears to offer “free money,” but it doesn’t guarantee the best overall financial growth.

Total return should be the focus, ensuring that both the income generated and potential for capital appreciation are considered in your investment strategy.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Tony Dong has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

More on Dividend Stocks

Gas pipelines
Dividend Stocks

Is Enbridge the Best Dividend Stock for You?

Enbridge now offer a dividend yield of 8%.

Read more »

STACKED COINS DEPICTING MONEY GROWTH
Dividend Stocks

How Long Would It Take to Turn $20,000 Into $100,000 With TSX Dividend Stocks?

Here's how a historical investment in TSX dividend stocks would have fared.

Read more »

edit Businessman using calculator next to laptop
Dividend Stocks

Passive Income: How Much Should You Invest to Earn $100 Every Month

Want to earn an extra $100 per month in investment passive income? Here's how much cash you would need to…

Read more »

Canadian Dollars
Dividend Stocks

Buy 1,430 Shares of This Super Dividend Stock for $1,000/Year in Passive Income

Here's how to generate $1,000 in annual passive income with Dream Industrial REIT (TSX:DIR.UN) stock.

Read more »

A worker gives a business presentation.
Dividend Stocks

Ranking Inflation Rates in Canada: How Does Your City Stack Up?

Inflation rates stoked higher for some cities, but dropped for others. So let's look at how your city stacked up,…

Read more »

Doctor talking to a patient in the corridor of a hospital.
Dividend Stocks

Inflation Is Up (Again): What Investors Need to Know

Inflation ticked higher in Canada this month, but core inflation was lower. Here's how investors can take advantage during this…

Read more »

Happy family father of mother and child daughter launch a kite on nature at sunset
Dividend Stocks

Want to Make $10,000 in Passive Income This Year? Invest $103,000 in These 3 Ultra-High-Yield Dividend Stocks

Can you earn $10,000 in passive income in 2024? You can by investing $103,000 in these ultra-high-yielding stocks.

Read more »

Payday ringed on a calendar
Dividend Stocks

1 Under-$50 Dividend Stock to Buy for Monthly Passive Income

First National Financial (TSX:FN) is a high-yield monthly-pay dividend stock.

Read more »