What makes a good rule of thumb? It should be memorable, pithy
and, above all, useful. It also shouldn't overreach; it just
gives good guidance. "Measure twice, cut once" is a great
example. It doesn't try to explain carpentry. It just reminds us
to take our time, be precise and avoid making a mistake that
can't be undone. (Not bad for four words.)
What makes a bad rule of thumb? How about this: it doesn't
work. Or worse, it brings about exactly the opposite of what you
intended. Retirement is full of advice that sound reasonable but
may be bad for your retirement health. Here are three to be wary
Rule of Thumb #1: Save 3% of Salary for
The most frequent auto-deferral rate into a 401(k) is 3% of
pay, probably because it typically maxes out the company match.
Unfortunately, 3% is just not going to get the job done.
Think of it this way: you will likely work for about 40 years
and retirement can last up to 30. That means 40 years of pay
checks need to be spread across 70 years. Common sense suggests
that 3% (even with a company match) is not going to be enough
provide the spending you'd like once you're in retirement.
Our recent research suggests that 10 to 13% is more
reasonable. If that sounds like a lot, think of it this way:
paying your future self 13% of your current pay can buy you 30
years of retirement spending. It may actually be a bargain.
Rule of Thumb #2: The 4% Drawdown
Let's say you retire with one million dollars in savings. One
of the most common rules of thumb is that the first year you
should withdraw 4%, or $40,000. Next year, add a cost of living
adjustment, say 2.5%, and take out $41,000. And so on.
The risk here is that if the market moves against you, the
odds increase that a rigid withdrawal plan will increase the odds
of running out of money. If the market rallies, the opposite can
happen and you will leave behind a large unspent surplus. (Great
for your heirs, of course, but you would have enjoyed retirement
less than you could have.)
So what's a better rule of thumb? Probably one based on a
dynamic amount, a percentage of your portfolio. You may have less
to spend some years, and more others, but the risk of spending
down your assets is substantially reduced. What's more, as
you get older and have a shorter retirement period to fund, you
can increase the percentage.
Rule of Thumb #3: 120 minus Your Age
We know that it makes sense to have a more conservative
portfolio as you get older. This Rule says the equity percentage
in your portfolio should be 120%, minus your current age. So a 60
year old should have 60% equity while a 75 year old should have
45%. We can quibble over the percentage, but this sounds
Well, no. And here's why. Let's say the 60 year old is retired
and the 70 year old is healthy, happy, still working and plans on
working until 75. The 70 year old can actually tolerate more risk
than the 60 year old because she has five years of future wages
to grow her assets and offset market loses. The 60 year old has
no more future wages to offset losses and may feel that 60%
equity is too high.
This idea of factoring future wage potential into the
allocation is actually what some investment strategies do, and
why a 30 year old (with 35 years of wages ahead of him) has more
equity exposure than a 60 year old with only five years of human
Chip Castille, Managing Director, is head of the
BlackRock US Retirement Group. You can find more of his
Investing involves risk including loss of principal.