Including Real Estate in a Retirement Portfolio (Part 1)

September 28, 2021
By EQUITYMULTIPLE Staff
Posted In: Investing Strategy

The 4% Rule

Many investors look to traditional stock and bond portfolios to fund their retirement lifestyles. Following this method, individuals often choose to measure their financial capacity to retire by a simple criterion: the 4% rule. The 4% rule states that once investors have 25 times their annual expenditure saved in a stock and bond portfolio, they are financially able to retire. Much of the logic that formed this rule stands solidly to this day and forms the pillars of modern retirement planning. Still, reducing one’s financial plan to this maxim can leave investors, at best, with unoptimized retirement portfolios and, at worst, risking financial vulnerability in their golden years. 

This rule, first published by William Bengen in 1994, holds that investors may withdraw 4% of their stock/bond retirement portfolio in the first year of retirement and increase that number with inflation annually, without risking depletion of their capital. This is a bold claim to make and Bengen’s data supports it. Bengen studied market data from 1925-1995, with hypothetical retirees in each year from 1925-1966. Over a period encompassing the Great Depression, World War II, Stagflation, Oil Crises, and other course-changing macroeconomic events, retirees using the 4% rule would have enjoyed successful retirements 95% of the time. In other words, they would not have run out of capital during a 30-year retirement. The effectiveness of this rule has legitimized it as a principle that retirees and retirement planners alike can rely upon.

The study assumes a 50/50 portfolio allocation between stocks and bonds, a 30-year retirement horizon and, of course, a 4% withdrawal rate in the first year of retirement. That said, any of the following deviations could adversely impact the success of the model: 

  • Retirement exceeding 30 years;
  • A portfolio that leans too heavily in either stocks or bonds; or 
  • Annual withdrawal rates greater than 4%.
Inflation-adjusted retirement portfolio success rates
For illustrative purposes only. Source: American Association of Individual Investors, February 1998.

While these assumptions are applicable, or at least adaptable to many retirees today, this 50/50 portfolio of traditional assets exposes investors to avoidable risk, and limits investors in meeting their holistic retirement goals.

NOTE: There can be no assurance that any investment will achieve its objectives or avoid substantial losses.

Modern real estate investing helps investors avoid pitfalls of the traditional strategy and exploit areas of improvement beyond what the 4% rule can offer. By mitigating risks such as volatility and inflation, investors stand to benefit from the added diversification of real estate in their portfolios.

Real Estate in a Retirement Portfolio

Real estate has proven to have more consistent returns than equity investments and higher historical returns than bonds.¹

Additionally, commercial real estate has generally been able to outpace inflation. Inflation represents price appreciation in the broader economy, as measured by the Consumer Price Index (CPI). Residential and commercial real estate are not immune to inflation, but both values (appreciation) and rent prices (cash flow) have historically increased in correlation with the CPI. Real estate generally remains an inelastic good, with demand strong despite pricing changes, driving values up in inflationary periods. Additionally, this gives landlords leverage to increase rental rates alongside the market. During the most acute period of inflation, in the late ‘70’s, it was even standard for landlords to build programmatic rent increases into leases, indexing rent growth to price (CPI). 

Inflation and Rent Growth for Retirement Portfolio
Source: Multi-Housing News, October 2020.

While one cannot perfectly predict bear markets, inflationary periods, or recessions, it is important to strengthen one’s portfolio to weather adverse economic events while still taking advantage of bull markets.

Real estate investments do exactly that. Taking a look at historical examples, supplementing a stock/bond portfolio with real estate produces less volatility, cushioning downfalls in bear markets and providing stock-like returns in bull markets. This is especially true in low-interest rate environments; it protects retirees even in worst-case scenarios. 

Specifically, multifamily has historically shown more stability in down markets due to intrinsic worth and essential value. Other niche CRE asset classes, such as last-mile industrial, data centers, senior housing, or self-storage offer recession-resistant investment theses. As such, they are well-positioned to capitalize on demand trends for years to come. Generally, private-market, illiquid securities offer opportunities to realize cash flow and appreciation regardless of events affecting the public markets.

Modern real estate investing may offer uncorrelated returns to the stock market, inflation-protected assets, and more predictable cash flows during retirement. This allows investors the opportunity to find the delicate balance between managing risk and creating the potential for a financially safer and healthier retirement.

Putting it all Together

The 4% rule is a cornerstone of financial planning, which serves as a key benchmark for individual investors. That said, there are common pitfalls to avoid. An allocation to private real estate may help smooth returns in volatile periods (especially in the crucial early years of retirement). It may also hedge inflation risk, and potentially increase withdrawal rates throughout one’s retirement. In sum, real estate can help investors elevate a traditional stock/ bond portfolio, and create the opportunity for a more prosperous retirement lifestyle.

Download the whitepaper below to learn more.

Whitepaper: Optimizing Your Retirement Portfolio through Real Estate Investing

Equity Multiple Document
Optimizing Your Retirement Portfolio through Real Estate Investing.

¹Past performance is not indicative of future results. There can be no assurance that any EquityMultiple investment will achieve its objectives or avoid substantial losses.

*Harvard University Department of Economics: https://economics.harvard.edu/files/economics/files/ms28533.pdf

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