- Generally accepted financial rules can provide a foundation for clients as they invest for retirement.
- Different rates of return can impact the time it takes for investments to grow.
- Many clients aren’t sure what percentage of their investments to dedicate to stocks and bonds.
For many people, surviving math class was a day-to-day proposition. Square roots, algebraic equations, and geometry proofs can be an acquired taste.
In financial services, numbers and formulas are essential to our business. Growth rates, withdrawal rates, total investment return, life expectancy, asset allocations, sequence of returns, and yield curves are among the mathematical tools that help us provide better service to our clients and customers.
Personally, I wouldn’t label myself as a “Rule Follower”. I of course respect right and wrong, and have a strong moral compass…but some rules, are meant to be broken. Recently, watching a rerun episode of Southpark, where Cartman is faced with breaking the rules, it reminded me of several financial rules that are worth living by. These “rules of thumb” are helpful for all levels of financial literacy.
The Rule of 72
This personally is my favorite financial rule. The Rule of 72 will tell you how long it will take an investment to double in value based on the annual interest rate. Simply divide 72 by the annual rate of return.
Or divide the number of years you want to double your money into 72 to determine the necessary rate of return.
That means a $10,000 investment earning 12% per year will double in six years (72 ÷ 12 = 6). The same investment would take 18 years to double at a 4% annual return (72 ÷ 4 = 18). That’s not a prediction. It’s a mathematical certainty if the rate of return doesn’t change.
The Rule of 72 can be powerful for clients interested in creating guaranteed income in retirement. Have a client 10 years from retirement? Think about how great it would be to recommend a strategy that offers a 7.2% annual return. After all … 72 ÷ 7.2 = 10.*
Rule of 100
To help clients diversify their investments at different stages of life, financial professionals used to use the Rule of 100. For a 35-year-old client, that meant subtracting 35 from 100 to determine a 65% exposure to equities (stocks, mutual funds, etc.) and 35% to fixed income investments (bonds, money market, etc).
As people live longer, I think the Rule of 100 should change to the Rule of 115. In this case, that same 35-year-old client would have an equity-to-fixed income ratio of 80% to 20%. With more time until retirement, it offers a better opportunity to take advantage of investment growth over a 25- or 30-year period.
This rule can apply up to and through retirement.
The 4% Rule
In October 1994, MIT grad-turned-financial-planner William P. Bengen published “Determining Withdrawal Rates Using Historical Data”. Though widely debated, it remains the foundation for drawing income in retirement.
“Assuming a minimum requirement of 30 years of portfolio longevity, a first-year withdrawal of 4 percent, followed by inflation-adjusted withdrawals in subsequent years, should be safe,” Bengen wrote.
Whether you agree or disagree, give Bengen credit for using 30 years as his model. Increased longevity has changed how we create retirement strategies, and three decades is no longer a far-fetched premise for many people.
Taking it a step farther, rather than hoping that 4% is appropriate to “be safe,” why not look for ways to guarantee income for life at an even higher withdrawal rate? It is possible. And millions of Americans are taking advantage of that guarantee today.
Serving your clients
What do each of these rules have in common? They might not be a perfect match for everyone, but they can help financial professionals create tailored options for each individual client.
Whether we’re good at math or not, that’s something we can all appreciate.
Things to Consider:
- Share some of your tried and true financial rules with your clients.
- Since each client has different investment goals, no one rule will fit everyone.
- Show clients how a set rate of return can help them simplify their financial strategy.
The presentation is hypothetical and does not represent any specific investment. It does not take into account any fees, expenses or taxes associated with investing and that if it did, the result shown would be lower. Both the return and principal value of investments fluctuate over time. It is unlikely that any one rate of return will be sustained over time.
Transamerica Resources, Inc. is an Aegon company and is affiliated with various companies which include, but are not limited to, insurance companies and broker dealers. Transamerica Resources, Inc. does not offer insurance products or securities. The information provided is for educational purposes only and should not be construed as insurance, securities, ERISA, tax, legal or financial advice or guidance. Please consult your personal independent advisors for answers to your specific questions.