Why the "Rule of 20" no longer works

Dwindling returns, especially on the fixed income side, mean the retirement “Rule of $20” no longer applies, according to Russell Investments.

The strategy – which says a secure retirement is possible if you have $20 in savings for every $1 in annual income you require after leaving the work force – has been the rule of thumb for the past decade if you expect to retire at 60.

However, Shailesh Kshatriya, director, Canadian strategies at Russell Investments, said that changing economic conditions and a low-return environment mean potential retirees will have to work an additional five years to get the same payout or risk running out of money.

Russell Investments’ “Rule of $20” helps estimate the amount of retirement income you can expect to drawdown annually, exclusive of other income sources. It takes into account factors such as inflation, market volatility and longevity risk with the following basic assumptions: the net-of-fee portfolio return is utilized as the interest rate proxy; annual payout is indexed to inflation (assumed at 2.5% a year); portfolio is comprised of 35% equities, 65% fixed; and the investor is married and at least 65 years old (up from 60 years in the old rule).

The previous rule assumed returns of 9% (equities) and 6% (fixed income) but this has been revised to 8% and 3.5%.

Kshatriya said: “Your bond allocation is getting downgraded from a return perspective. What that means is you don’t have the same bang for your buck historically, so that’s one big change. The implication for that is that the money won’t necessarily last you as long.

“In our prior rules, because of a slightly better return environment, the time frame in terms of longevity would have been around 30 years. Now we’re at around 25 years.

“The direct implication of the lower-return imperative is the fact that your funds may not last as long so it depends on how you budget.”

Kshatriya stressed that this is a rule of thumb and the range of drawdown dates will depend on the individual. But he said that if an investor hasn’t had a financial check-up for a while, now is a good time to sit down with your advisor and work out what changes you need to make.

Investors may well need to increase the $20 for $1 guideline to $21 or higher in order to have the retirement income they require.

He said: “Also, from a market and economy perspective, we are extended in this cycle and it’s a good time to have these conversations. Tax implications are a big element of this and this is where you need to have a conversation with an investment professional.”

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