Dive into the 4% Rule
Summary — the 4% rule is based on conservative worst-case markets and you could take higher distributions¹
The 4% withdrawal rule is based on not running out of money during the worst performing markets in history (1929–1931, 1937–1941, and 1973–1974). Using a 50% stock and 50% bond portfolio you can distribute 4% a year adjusted for inflation and not run out of money for 30 years.²
That original analysis was in 1994. How does that logic hold up today?
From my favorite personal-finance resource kitces.com: “the caveat of the 4% rule is that in reality, the overwhelming majority of historical scenarios do not necessitate a 4% rule, or anything close, and come out with a significant excess of unspent wealth at the end.”
What ends up happening in a majority of cases is the retiree ends up with much more than the principal they started with; again from kitces.com: “The median wealth at the end — on top of the 4% rule with inflation-adjusted spending — is almost 2.8X starting principal.”
Even a retiree starting in 2008 is doing better than any scenario the 4% rule is based on!
The biggest risk to the 4% rule is having a market crash and then not a corresponding rally. 2000 and 2008 scenarios work out for retirees because markets recovered in a timely fashion. Where other historical markets crashes linger at their lows for years and force the 4% distribution to cut into more principal.
Even the creator of the 4% rule, William Bengen, says the original analysis is based on the minimum-safe distribution and it could be higher.³
In my opinion, it is an extremely conservative approach to model your retirement distributions on worst-case scenarios if you don’t have a high priority on sending assets to the next generation. Finding some balance between a safe withdrawal rate and living a good life is probably the most sensible decision.⁴
- Please work with a reputable financial advisor that you trust to stress test distributing more than 4% of a portfolio. There are a plethora of factors to consider; do you have a year of savings, extra income, non-portfolio assets, risk tolerance, risk capacity…etc…etc…
- The distribution percentage drops as the timeline increases.
- https://www.fa-mag.com/news/choosing-the-highest-safe-withdrawal-rate-at-retirement-58132.html?section=47&page=4
- This of course is based on HISTORICAL data; we have never seen how portfolios and distributions handle a low-yield environment from bonds like we are experiencing now. Will be interesting to see how portfolios hold up considering bonds are returning negative real (aka after factoring in inflation) returns. That’s a whole discussion within itself.
Resources:
https://www.retailinvestor.org/pdf/Bengen1.pdf
https://www.kitces.com/blog/what-returns-are-safe-withdrawal-rates-really-based-upon/
Other reading:
https://www.marketwatch.com/story/the-inventor-of-the-4-rule-just-changed-it-11603380557
