Don’t Trust the 4% Rule (12:30)

“If you search ‘how much can I withdraw from my portfolio?’ the vast majority reference the 4% rule. The more I’ve been in the industry, the more I’ve realized that is not the best option for the vast majority of people.”

Read More: You Can’t Rely on the 4% Rule

“In financial planning, there is no one size fits all, because everyone’s situation is different.  Everyone has different time horizons, different portfolios, and different goals.  All of those things are going to impact how much you can withdraw from your investment portfolio.”

Origin of the 4% Rule (14:31)

“Bill Bengen tested every 30 year period in the history of the US stock market.  What he found was that even in the worst 30 year period you could have withdrawn 4% of your starting portfolio balance, increased it every year for the rate of inflation, and you wouldn’t have run out of money.  Right off the bat that tells you it is based on a worst case scenario, so it is a super conservative assumption.”

4% Rule Is based on 30 Year Time Horizon (17:25)

“The 4% rule is based on a 30 year time horizon – not every retiree has a 30 year time horizon.  If you retire at 70 maybe you have a 20 year time horizon.  Even if you apply the same methodology, where you try to figure out the most conservative scenario for a 20 year period – it would be significantly higher.  For 10 years it’s even higher!”

“You can’t just blindly follow the 4% rule because it is based on a specific set of assumption and your reality may not match the assumptions that the analysis was based on.”

4% rule is based on a 50% stock 50% bond portfolio (19:30)

“The asset allocation of your portfolio is going to have a big impact on what you are going to withdraw from your portfolio.  A higher allocation to stocks can result in marginally higher spending.”

“If you look at what you can withdraw from a mostly-bond portfolio, it really drops off once you drop below 30 or 40% stocks.  If you are below that, you are potentially setting yourself up to run out of money.”

“You also have to look at what types of stock and what types of bonds you are invested in.  In Bengen’s research, the stock portfolio is based on the S&P500.  If you diversify away from that, you can kind of smooth out some of the ups and downs in the portfolio and actually improve the sustainable withdrawal rate.”

“Bill Bengen actually updated his research with basically the same methodology, but all he did was add small company stocks in the US to the investment portfolio, and he found that 4% safe withdrawal could be increased to 4.5%.  So just adding that one asset class increased the safe withdrawal rate by half a percent.”

The 4% rule is based on the worst case scenario and no adjustments (33:33)

“Most of the scenarios are not going to be anywhere near the worst case scenario.  So if you get even mediocre returns, you will be significantly underspending (with the 4% rule) compared to what you could have spent.  Ideally you have some sort of methodology in place to increase your withdrawals if returns are above average.”

“More than likely you are going to significantly underspend with the 4% rule.  Researchers found that 96% of the time, you would have ended up with more money than you started with.  That sounds like a good thing, but to me that represents money you could have spent or given away while you are alive when you could have seen the impact on the people and institutions you care about instead of leaving a large lump sum when you pass away.”

What should people do instead of the 4% Rule (39:00)

“In an ideal world you come up with a starting withdrawal rate that accounts for your specific time horizon and asset allocation.  And that’s just the starting point.  Equally important, you need some sort of process in place to adjust your portfolio withdrawals based on the returns you actually earn.”

“Instead of just assuming a worst case scenario and never making an adjustment, you need to set a reasonable withdrawal rate and make adjustments based on the returns you receive.”