I hate to even take up the space to define this, I suspect you know the drill as well as I do. Numerous studies (Trinity, Bengen, etc.) determined that if you take the invested assets in a diversified portfolio you can withdraw 4% of the total value your first year of retirement. Each year after that you can withdraw the same amount plus any extra needed to offset inflation. It makes it easy to determine what you need to have invested to pull the trigger on retirement. You need 1/(4%) or 25 times your annual expenses.
Now there have been all kinds of recent reviews of this concept by Vanguard, Fidelity, Schwab and even Bengen himself as to whether 4% is a little too high or a little too low or even way too high. It all depends on your assumptions about the future. What will inflation look like, it’s pretty high right now. What about the performance of stocks, that’s pretty dismal this year so far. And how about that old standby bonds, not looking too great if you ask me. I have that classic diversified portfolio, nearly exactly like the one in the original studies and it’s been quite battered.
Since you are reading this I’m going to make the intuitive leap that you want to know what my opinion is regarding the 4% rule. And I will tell you, but first I need to give you some back story. I’m a chemical engineer and was always on the technical side of my profession. A lot of engineers get into management or sales and don’t do a lot of heavy lifting when it comes to computer modeling of complex processes, but I did exactly that. I was using artificial intelligence software to model chemical plant reactions back when nobody had heard of it. This is like thirty-five years ago, long before iPhones and self driving cars.
My task was to model a complex reactor system that produced a high octane gasoline component that was used for aviation gasoline and high performance car engines. A chemical additive had been created that the manufacturer claimed would improve the yield and quality of our gasoline significantly. If we purchased this chemical for a few thousand dollars a week we’d see a million dollar improvement over the course of a year. But there was a problem. While a million dollars sounds like a big improvement it was actually only a fraction of an octane number and maybe 0.1% of an increase in production. And our product octane varied by a full number every day and production varied by several percent due to constant unpredictable variations in feed stocks amount and quality. In short the very improvements claimed by the additive manufacturer were hidden by the “noise” of the natural variations in our reactors performance.
So what to do? I needed to be able to come up with a model so accurate that it could tell me what the octane and production should be based on feed quality and amount. Then I could look at the actual performance versus the model and any differences would be due to the additive. I tried a whole lot of conventional computer modeling methods, none came close to working. Then I came across something brand new and exotic. It was called artificial intelligence modeling software. I could feed it enormous amounts of past data and it would “learn” what impact things like reactor temperature, feed quality, amount of production and a hundred other data points had on the variables I was trying to predict. And it was great at predicting the past. I could feed it the data from any past date and I’d get results that matched up with what really happened. So problem solved, right? I wish.
There was a huge problem, in that we live in a dynamic changing world. Our facility was constantly being expanded to meet market demand and so each year we ran more feedstock with different components in it than at any time in the past. And my model that was so talented at predicting anything that was within its past experience, lost its mind when it encountered a future that was outside the range of what it had learned from in the past. I suppose it was like a self driving car finding a charging elephant in its path, it’s going to be quite confused and it might not do the right thing, if there even is a right thing.
So what does that have to do with the 4% rule. Everything, in my opinion. The 4% rule applied today is going to base its assumptions on what the next thirty years look like, based on the past. And the past it knows about started in 1925 and ended in 1995 in the original studies. The next thirty years for you and me will be comprised of 2022 through 2052. It’s kind of obvious isn’t it? Does anyone really think that the 2052 economy can be accurately represented by the economy of 1925? We do not have a clue where the next thirty years will take us, but assuming it will be just like some thirty year past set of years is quite a stretch, in my opinion. If we knew, if we could see into the future, we might find the 4% rule should really be the 14% rule, or maybe the 0.4% rule. I’ll let you know in thirty years, if I’m still around.
I hate to attack a sacred cow, because I have used this rule to comfort myself since my withdrawal rate is very low. I tell myself that being well under 4% is surely safe. But then I think back on how poorly my history based artificial intelligence models did when applied to the future and it gives me pause. I realize I do not have any reliable basis for feeling like 4% will mean much of anything heading toward 2052.
So what to do? Are we helplessly adrift with no reliable guides to the future? Should we just make do with 4% because it’s all we have?
Do you have faith in a 4% initial withdrawal rate? If you do, why?
As usual if you’d like to comment and don’t see a place to do so, just click on the title of the post.
As I posted about recently I’m more like a 1% rule and ideally shooting for my business to cover all of my spending. Why not, it’s fun and I don’t really consider it work. Plus I’m too risk averse to even possibly consider using a 4% rule and playing at the edges,
As for AI and predictions, it’s 2022 and the best atmospheric models still can’t get the daily weather correct on a routine basis. Last week here in D.C. we had a day that was supposed to be 74 degrees – based on the forecast the morning of that very day from all weather sites. It never got past 66. There’s much work to be done, our models ain’t shit.
Great observations Dave, yeah our local weather said we’d get flooded out yesterday and it barely rained a drop. One percent or living off income cash flow are pretty stress free. I’m not trying to make money with my hobby job but I made three thousand just last week for a few hours of work and I got another case this morning. But like you, it’s fun, so why not?
I listened to Wad Pfau last week and he is using 2.25% for his personal portfolio modeling. All of my personal models are based on 1% growth annual on average. I didn’t work in a negative 5% year like this one (so far). I need 1.75% growth each year to live on an $85k SOL until I am 100 adjusted 3% annual for inflation. This year I will cut my Standard of Living to $65k because I’ve had no growth.
Lomg story short, I don’t think an average over 40 years means squat. As the Retirement Man says, use an Agile approach to your drawdown strategy. Have enough cash for 8 years, then adjust your other assets for growth every year. You will have to figure it out as you go. Who could have predicted Covid? The model is just too hard for anyone to build 40 years out. With that in mind, he also suggests annuitizing some of your assets, especially for older age band when minds are not so Agile!
Yes Roger Whitney did an entire detailed plan for me since I was a guest on his cast and he did suggest an annuity. Because I feel I have excess assets I did not take that advice but I don’t think it was bad advice, he’s very solid and a very nice person. I do think the only smart path is to keep an eye on how you are doing and to adjust, as you have, if things get a little out of whack. I haven’t done that yet and doubt I’ll have to because I worked longer than I needed to because it was fun, but if things got bad enough I would. You sound like you could do a great podcast yourself, Lisa!
We don’t spend much, so this isn’t some insanely high amount, but we will pull the trigger with a 3% withdrawal that covers double our current spending.
That sounds rock solid Eric. I agree with not spending more than you want to just because you can. We spend maybe half what we could afford but our lives are rich and spending more just wouldn’t add anything, I don’t think. In fact I think it would detract more than likely.
Hi SteveArk,
Great Question and there is really no right answer. As per PersonalCapital, it looks like the average 401K balance at age 65 is $255K and the mean is $82K. I’m using those as a lower bound to exit the 4% guideline if we have a rough next couple of decades. If this bad sequence of returns comes to fruition, entering full retirement age at about what the average American enters full retirement doesn’t seem so dire. Giving up on the 4% guideline after 5 months of bad results seems risky as well. You might trade years of freedom to build your account balances.
I agree there are no right answers and if you put all of life in perspective we don’t know if we will even be around next year to enjoy what we’ve saved and invested. There are far larger uncertainties than finances. I was hitting tennis balls with my wife today and another player came over to talk to us and told us his brother had died the week before. My wife and I knew his brother, but not well, and had not heard. He was very fit and played on two different state championship tennis teams in 2021 yet he developed a wildly aggressive cancer earlier this year and only lasted two or three months. Not to be a downer but the fact is there is no certainty in life or with money. You just try to make reasonable choices but much is not in our control.
For me, the 4% is a stake in the ground where I can monitor my elliptical spending/withdrawal pattern. It’s not absolute but it will work. Having a 23 year spending pattern gives me confidence to stay anywhere between 3.5-4.5% over the course of the next 35 years and still have fluff and avoid the cat food aisle in my 90s.
Francis, I’m certain you’ll never dine on Fancy Feast. I believe you have a solid plan, and studies back up the idea that the best plan is a flexible one that can ratchet up and down with your returns.
As I approach 50, I’m starting to think the best things to do to help hedge your bets is: investing in your health, having a low cost of living, and maintaining the ability to work if you need to.
I live in a much more expensive state than you, but with the house and cars paid off, I could do almost any job and be okay. Our house is also a 2 family and we could rent part of it. Life is about options. Would I want my mom to move from her unit to ours? Probably not, but It’s nice having that as backup plan C or D if the other 3 more preferable options don’t pan out.
I guess that is my other neurosis. It’s not good enough to just have a plan A. Sure, the 4% rule is where you start. Skimming the cream off the top of your nest egg certainly seems like the best option, but in years when it’s not, it’s good to have other levers you can pull to get money in different ways. That’s one of the many reasons I stayed in the workforce when we had kids because we each had a parent that died young. It is not the right decision for everyone but it was right for us given the stats.
Sandy, it’s a curse of being an engineer that you just can’t have a plan A on anything. You need a plan B and usually a desperation plan C if it all goes sideways. Mistakes can be fatal in our line of work and we absolutely spend a lot of our career considering worst case outcomes. You sound totally normal to me, for a chemical engineer.
Hi Steve,
There’s much consternation about the 4% rule in FIRE circles, and I’ve seen some hand-wringing about it for the past few years.
I’m not nearly at the stage yet where I have to worry about such things, but I have looked into it a bit. I think flexibility is key, just as numerous academics have said (such as Bengen, Pfau, and Kitces–especially Kitces).
I fully agree with your point that modeling and simulations are fundamentally based on the past, and are therefore flawed for predicting the future. Even well-designed Monte Carlo simulations fail to account for ‘black swan’ events. As Paul Merriman likes to say, there is no risk in the past!
However, you need *some* basis for planning; it’s better than flying blind. I’ve found it helpful to familiarize myself with existing research, and to play with some data on my own. The results have very much put me at ease, even using a number of very conservative assumptions that are likely to underestimate my financial footing.
Here’s a summary:
Table 1 of the 1998 Trinity study shows that a 3% withdrawal rate was successful across every timeframe and portfolio allocation they studied! 100 percent of the time!!! But in that table, even a 6% withdrawal rate has a success rate over 95% in most conditions. With a 50/50 mix of stocks and bonds, the success rate in that table is at least 90% even at a 7% withdrawal rate!
Granted, conditions have changed since 1998. I’ve seen updated studies from 2004, as well as summaries of even more recent research. The 4% rule is still relatively conservative; 3% gives a person an even greater margin of safety. Bengen himself (author of the initial 1994 study) has even updated his recommendation to a 4.5% withdrawal rate.
One thing I’ve noticed about investing is that investor sentiment is usually the opposite of reality. When everybody seems too scared to put money into stocks, history shows that’s usually the EXACT best time to buy stocks.
So if a lot of people are too scared to use the 4% rule, then it’ll probably hold up fine in the long run. I wouldn’t be worried about that rule unless everybody thinks it’s bulletproof!
Indeed, research by Kitces (I’ll include a link below) shows at a 4% withdrawal rate, there’s an equal chance of a portfolio going down to zero or increasing by 800%.
In fact, Kitces’ work shows a 10% chance of ending up with a lower balance than you had at retirement…but also a 10% chance of ending up with *six times* your balance at retirement! He actually suggests using a dynamic percentage, rather than just mechanically taking out 4% every year. This will help account for both possibilities: a good sequence, or a really bad sequence.
Everybody’s different. Some people plan to leave money to charities or heirs; others want to die with just enough money left to cover funeral expenses. Some are inherently more conservative, while others are more naturally aggressive. Some have more money than they’ll ever need, but others may need Social Security to make sure they can eat during retirement. So a fixed rule like 4%, of course, won’t work for everyone.
Personally, I tend to be on the conservative side when it comes to my planning. So my current plan involves two main factors:
a) When I get closer to retirement, I’ll adopt an allocation of about 40% stocks and 60% bonds. This should (in theory) result in a more stable portfolio. Note that Bengen himself counsels no less than a 50% allocation to stocks.
b) I expect to live fairly frugally, relying on dividends of ~2% to pay the bills. Essentially, something like a 0% withdrawal rate [but with occasional larger withdrawals as needed, especially during good market periods].
If I’m spending $120k per year in retirement, I’d need a portfolio of $6M to sustain this plan. But if I’m spending $35k per year, I’d need a much smaller portfolio of $1.75M.
For anybody who’s concerned whether the classic 4% rule will hold up in the future, I think it would be helpful to:
a) read the 1998 Trinity study in its entirety (and maybe Bengen’s original 1994 study, if you’re so inclined)
b) read follow-up studies
c) run the numbers for yourself for a couple different scenarios, and
d) most importantly, maintain some flexibility in your plans.
If you’ve got a bunch of money in the stock market while a recession is barreling in like a runaway freight train, maybe that’s not the best time to take that cross-country trip you’ve been planning…
Helpful resources:
-The 1998 Trinity study: https://www.aaii.com/files/pdf/6794_retirement-savings-choosing-a-withdrawal-rate-that-is-sustainable.pdf
-A scanned copy of Bengen’s original 1994 paper: https://www.optimizedportfolio.com/wp-content/uploads/2021/04/Bengen.pdf
-One of my favorite analyses on the topic (from 2019): https://www.kitces.com/blog/url-upside-potential-sequence-of-return-risk-in-retirement-median-final-wealth/
-An analysis of various studies from over the years: https://www.optimizedportfolio.com/4-percent-rule/
Retirement calculators. I’d encourage you to play around and change the assumptions and see how much your changes affect the outcome:
-FIREcalc: https://firecalc.com/
-Or the alternative that I prefer, cFIREsim: https://cfiresim.com/
Great advice Froogal, and in fact I’ve read all of those studies and played with a bunch of simulators. I don’t use any kind of withdrawal rules, we just spend what we want and the result over the long run will be about 1% because in our case Social Security will pay us $72,000 in today’s dollars when we start to draw it in the near future. Plus I’m still earning from my hobby job. When you are looking at only one percent withdrawal then the only scenarios that it won’t work in are ones where the country falls apart, and then we’ve all got more than finances to worry about. I would quibble on one thing you said. If you are living off dividends of 2% some future time that is still a 2% withdrawal rate even if you don’t touch principle. In a growth only portfolio most of the time the principle continues to grow even when withdrawals are taken, it’s no different with dividend stocks. Total market return is all that really matters and whether it’s in the form of dividends, bond interest or selling shares the math is the same. The amount you spend divided by the total value of the portfolio as a percentage is your withdrawal rate.
Hi Steve,
Whew, that comment was way too long!!! I figured my advice and links could, perhaps, help some future readers who stumble across this post. Maybe I should turn it into a post of my own…
Very nice – a 1% withdrawal rate is definitely sustainable, probably forever!
Based on what I’ve read here in the past, Steve, it sounds like you are set up very well! I’m not nearly as far along as you are, but I’m in a similar position in that I’d be among the last people to suffer in a downturn.
I wouldn’t argue with your position that my plan would be a 2% withdrawal rate. My reasoning was that, in the future when I retire, I will no longer be reinvesting dividends; I’ll be spending them! I could see the argument either way.
It’s all based on something I read a long time ago, about people with generational wealth: they said “never spend the corpus” [that is, the main part of your money]. So, assume the “corpus” is $100M – 2% of that would be $2M. So, under that plan, you could spend 2 million dollars per year and still maintain the corpus of $100M (plus or minus whatever movement you get from the markets).
I thought that was a pretty wise approach, though it obviously isn’t possible for most of us.
I expect it’ll take me most of a working lifetime to reach the point where a 2% WR is even possible.
That is the way my parents did it and I suspect my wife and I will hand down our corpus to our kids eventually. You have things figured out for a great future, Froogal!