An ETF Proposal for the 4% Rule

An ETF Proposal for the 4% Rule

Traditional wisdom regarding withdrawing funds has competition.

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Reviewed by: Lisa Barr
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Edited by: Sean Allocca

The biggest unknown in retirement planning is how much can one safely withdraw, increasing for inflation each year to maintain one’s lifestyle.  

The 4% rule means one can withdraw $4,000 annually for every $100,000 in the portfolio, increasing each year with inflation. This equates to estimating a 90% chance it would last for at least 30 years.  

But if inflation (which is very uncertain) averages 5% annually, $4,000 increases to $10,613 in 20 years and $17,288 in 30 years. And who knows how markets will perform? Perhaps that’s why some think the safe withdrawal rate is now 1.9%

Several months ago, I implemented and wrote about how I solved this issue for my own portfolio: The 4% Rule Just Became a Whole Lot Easier. 

I built and purchased a 30-year TIPS ladder with roughly $1 million of my own money. TIPS are Treasury inflation-protected securities that are bonds indexed to inflation. By buying as close as possible to bonds maturing each year, I was able to create a 30-year cash flow paying me an inflation-adjusted average of $43,800, or 4.38% annually.  

So between Social Security and the TIPS ladder, I was guaranteed a six-figure inflation-adjusted cash flow for the next 30 years irrespective of market performance.  

That cash flow comes from a combination of interest being paid out plus bonds maturing with the original principal plus the accumulated interest from past inflation. Knowing that this cash flow is (virtually) guaranteed makes stock market plunges far less painful. This link describes TIPS in more detail.  

An example of such a portfolio today can be found in TIPSladder.com. As of the time of this writing, a 30-year TIPS ladder could produce a 4.27% real annual cash flow.  

An ETF like the iShares TIPS Bond ETF (TIP) is also a laddered TIPS portfolio but is subject to market swings such as its 12.24% decline in 2022. The only way to guarantee a specific real return is to hold until maturity.  

But there were a few issues building my TIPS ladder myself (and with clients) that could be solved by an ETF such as the SWR ETF I’m proposing: 

  1. It was complex and took hours to buy each of these bonds, with many of the trades not going through the first time. 
  2. The bid/ask spreads from buying a very small number of bonds were large and therefore took from returns. 
  3. While the cash flows average 4.38%, from buying a small number of bonds, the annual payouts varied a bit from that average. You can’t buy fractional amounts of TIPS as you can in a fund. 

The Proposed ETF Solution 

An ETF could easily solve all three of these problems.  

Here’s how it could work: The prospective consumer clicks on the SWR website to see its current real yield and annualized real cash flow. As of the time of this writing, it would show 1.70% and 4.27%, respectively.  

With a few simple clicks, one buys SWR with the intent never to sell. Let’s use $100,000 in this example. The authorized participant aggregates this purchase with many others to buy large volumes of TIPS to build the ladder similar to that shown earlier by TIPSladder.com.   

Then all the consumer or the ETF issuer has to do is nothing other than hold it forever. As the underlying TIPS mature, SWR would distribute the annual amount, $4,270 in this case, plus accumulated inflation.  

The value of SWR would decline over time as the TIPS mature and eventually reach zero in 30 years. In other words, SWR would be a self-liquidating ETF. The goal would be that the authorized participant’s only role is in the creation of SWR shares and there would be no redemptions.  

Of course, someone in their 70s may not need 30 years of cash flow, so perhaps there could be a few other versions such as an SWR-20 with a 20-year TIPS ladder.  

Problems With Existing Solutions 

The closest ETFs to what I’m proposing are those nominal bond ETFs with specific maturity dates such as Invesco BulletShares. But those do nothing to protect against inflation. And there are insurance annuities that act as pensions.  

While such annuities also provide longevity insurance, buying them is playing Russian roulette with inflation. While counterintuitive, an annuity with a fixed COLA (annual increase) actually exposes the purchaser further to higher-than-expected inflation. 

My Challenge to the ETF Industry 

Creating and maintaining such an ETF would be child’s play for the ETF issuer, and the expense ratio should be very low—perhaps 0.05%. Are you reading this, iShares, Invesco, State Street and Vanguard?  

As with all current TIPS ETFs, there is the issue of phantom income tax, though that too could be solved by making distributions, or the purchaser could buy within tax-deferred or tax-free accounts.  

I’ve never actually launched an ETF. Perhaps there is a reason this wouldn’t work within an ETF structure and, if so, I’d like to hear it.  

Its possible liquidity could be an issue if the fund attracted hundreds of billions of dollars. If it does work, I’d recommend this when real interest rates are attractive, and real interest rates have surged in the last 18 months.  

My Advice to the Consumer 

With the current debt and deficit, inflation is very uncertain.  

Though you too could build such a TIPS ladder, never put all of your eggs in any one basket, even in such an attractive basket such as this TIPS ladder.  

Allan Roth is founder of Wealth Logic, an hourly based financial planning and investment advisory firm. He also benchmarks portfolio performance for foundations and other business concerns. Roth's website is www.DareToBeDull.com. You can reach him at [email protected] or follow him on Twitter at Allan Roth (@Dull_Investing) · Twitter