Weekend Reading – Rethinking the 4% rule edition
Welcome to a new Weekend Reading post: my rethinking the 4% rule edition.
It’s nice to be back publishing these posts (I was off last weekend on vacation).
Before this Weekend Reading theme, a reminder about some latest posts on my site and my brother-site Cashflows & Portfolios:
I recently surpassed a new dividend income milestone.
I shared a list of many great retirement case studies here.
I’m giving away another book: The Psychology of Money.
At Cashflows & Portfolios, we’re giving away a copy of Balance by Andrew Hallam.
Rethinking the 4% rule edition
Should we all rethink the 4% rule?
I believe so.
In a few posts on my site, I’ve long since argued that the 4% rule (while a good starting point), is hardly a retirement drawdown plan to trust. There are a few key reasons why:
1. It might be too conservative. Yup. Depending on your time horizon, even if it is 30-years, remember depending on stock returns…the 4% rule was founded on the worst case scenario: a withdrawal rate of about 4.15% and rounded down to 4%. That withdrawal rate worked “in the worst historical market sequence…”. Mapped forward by guru Michael Kitces, even if you retired on the eve of the GFC (Great Financial Crisis 2008-2009), thanks to 10-year+ bull market that followed you’d still be WAY ahead. In fact, Michael and his team have done more work in recent years. They’ve replicated the Bengen study. In a whopping 50% of the time, using the 4% safe withdrawal rate you will finish not just WAY ahead but with almost X3 your wealth on top of a lifetime of spending using the 4% rule.
Reference: Check out the outstanding Michael Kitces study on the 4% withdrawal rule – that shows the extraordinary upside potential in sequence of return risk.
2. Bonds don’t work anymore. Well, that’s not entirely true. Bonds in your portfolio (IMO) can be very useful for the following reasons:
- as a hedge for/to ride out stock market volatility.
- to help rebalance your portfolio (with equities).
- to cash-in when spending is essential since cash is king for near-term spending.
Reference: Why would anyone own bonds right now???
When Bengen published his study in the 1990s, bonds on their own delivered much higher returns. This is hardly going to be the case as we enter a long-term era of a. slowly rising interest rates and b. potentially higher inflation. Owning a large % of bonds in your portfolio is going to get eaten alive…
Also, it’s important to remember that Bengen’s “safe” withdrawal success rate of 4% is based on just U.S. history. I believe it is poor logic to extrapolate both U.S. history going-forward COMBINED with ultra-low rates AND higher inflation today for any prospective retirees including those in Canada.
I guess like potato chips, the 4% rule is tempting and tasty to latch on to but devouring it blindly doesn’t do you any good.
3. Your plan, your future.
Personal finance is of course, personal.
That means your financial plan is yours and yours alone. I can’t tell you what your mix of stocks and bonds should be. I can’t tell you what your desired spending needs in retirement are. I can’t tell you if the stock market with thrive or sink in the coming years. I simply don’t know.
I can say with 100% certainty that depending on your time horizon, spending needs, tolerance for risk, appetite for wealth preservation, gifting, estate planning and more – and I can help you here – your financial drawdown plan must be very personal to you.
That means your 4% rule could be/should be 2.5% or 5.5%, or higher, or variable in between depending on a host of factors including hedging any sequence of returns risk.
Even Bengen, if you read his report, has some words of caution for you!
Bengen noted in his 1994 study:
“Therefore, I counsel my clients to withdraw at no more than a four-percent rate during the early years of retirement, especially if they retire early (age 60 or younger). Assuming they have normal life expectancies, they should live at least 25-30 years. If they wish to leave some wealth to their heirs, their expected “portfolio lives” should be some longer than that. “
Bengen goes on to say:
“If the client expects to live another 30 years, I point out that the chart shows 31 scenario years when he would outlive his assets, and only 20 which would have been adequate for his purposes (as we shall see later, a different asset allocation would improve this, but it would still be uncomfortable, in my opinion). This means he has less than a 40-percent chance to successfully negotiate retirement–not very good odds.”
To paraphrase, Bengen’s study was relevant to 30 years in retirement. Not 35 years. Not 40 years and certainly not 50 years like any early retirees might desire.
Read more here: Why the 4% rule doesn’t work at all for FIRE.
In summary, the 4% rule, while interesting, catchy and likely a nice starting point – becomes barely relevant to you when you actually dig into your own numbers.
Keep that in mind anytime you see an article on this subject!
More Weekend Reading…
A fine post by Fritz Gilbert, from Retirement Manifesto fame, who also questionned the 4% rule recently on Jon Chevreau’s site.
Canadian MoneySaver interviewed author, speaker and former banker Larry Bates (author of Beat the Bank) recently.
You can Beat the Bank like Larry does and invest like he does here.
Andrew Hallam did some fine work in his latest book, Balance, and shared why some FIRE devotees really miss the mark when it comes to their goals in this article.
Nick Maggiulli at Of Dollars and Data told us: you’ve been thinking about inflation all wrong.
I like this thinking which is aligned with mine:
“So what does this mean for you? If you want to protect your finances against inflation you should:
- Have a higher savings rate
- Own income-producing assets that tend to rise with inflation
By having a higher savings rate, you need less of a rise in income to offset future changes in prices (i.e. you have a bigger buffer against future inflation). And by owning income-producing assets such as stocks, farmland, and real estate, your wealth should keep pace with inflation (to some degree) over the long-run.”
Great stuff Nick, these were my thoughts on inflation here.
MoneySense highlighted some budget impacts for all of us.
What’s up with balanced portfolios in 2022? Dale Roberts shares that and more.
Tawcan is flying with his dividend income.
I mean, look at how other investors are doing with their dividend income??? Wow. You go John!
How on earth did John get there?
A combination of this stuff:
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Enjoy your weekend!