Why the 4% rule is actually (still) a decent rule of thumb

Why the 4% rule is actually (still) a decent rule of thumb

I’m not a huge listener to podcasts but I do enjoy them from time to time – beyond the ever popular Joe Rogan Experience that is.

Recently, I found the BiggerPockets Money Podcast with financial independence enthusiast, financial planner, along with a host of other financial designations Michael Kitces very interesting.

For an hour+ the hosts of that podcast dove deep into the simple math behind the 4% safe withdrawal rate so many investors in the early retirement community rely on, and, why Michael Kitces ultimately believes the 4% rule actually remains a very good rule of thumb to plan by.

If you don’t have an hour and 22 minutes to listen to this episode (not many people do…) then no worries, I’ve captured the essence of the interview from this solid podcast below. Kudos to the folks at BiggerPockets for the deep dive. 

Let me know your thoughts about the 4% rule in the comments section. I look forward to them.

Mark

Background – what is the 4% rule???

In general terms, the “4% rule” says that you can withdraw “safely” 4% of your savings each year (and increase it every year by the rate of inflation) from the time you retire and have a very high probability you’ll never run out of money.

Some things to keep in mind when you read this:

  1. This ‘rule’ originated from a paper written in the mid-1990s by a financial planner in the U.S. who looked at rolling 30-year periods of a 50% equity/50% fixed income asset allocation. His name was Bill Bengen.

4% rule

You can find the details of the report here.

2. This rule was developed almost 30-years ago. A lot has changed since then including real returns from bonds. There are also products on the market now that allow investors to diversify far beyond the mix of large-cap U.S. stocks and treasuries the Bengen study was based on.

3. The study was designed to answer the question: “How much can I safely withdraw from my retirement savings each year and have my nest egg last for the duration of my retirement?” Little else.

4. The study assumed (at the time) most retirees would retire around age 60. Therefore, a “good retirement” would be ~30 years thereafter; what is the safe withdrawal rate to make it through retirement until death.

5. The rule takes none of the following into account:

  • Will you (or your spouse) have a defined benefit pension plan?
  • Do you expect to receive an inheritance?
  • Will you downsize your home?
  • Do you have a shortened life expectancy or health issues that should be considered?
  • Will you continue to earn some form of income in your senior years?
  • And the list of what ifs goes on and on and on…

My 4% rule example:

My wife and I aspire to have a paid off condo AND own a $1 M personal portfolio to start semi-retirement with in the coming years.

If we can grow our portfolio to that value, markets willing, the 4% rule tells us we could expect to withdraw about 4% of that million nest egg (or about $40,000 per year indexed to inflation) and have virtually no concerns we would run out of money for the next 30 years (mid-70s by then).

To the podcast and my takeaways!

On the subject of a 4% withdrawal rate – is that conservative?

Michael: Yes. If your time horizon is 30-years, it probably is. Because, when Bengen looked at his different rolling periods…he found the worst case scenario was a withdrawal rate of about 4.15%. “It was the one rate that worked in the worst historical market sequence…”.

Does recent data say anything different since the 1994 study?

Michael: Not really. Michael and his team replicated the Bengen study and generally arrived at the same number. And that’s not the only good news…50% of the time using the 4% rule you will as Michael puts it “double your wealth”. So, 50% of the time (market returns willing) you will finish with almost X3 wealth on top of a lifetime of spending using the 4% rule.

What if you retire at the worst possible time? Example, on the eve of the 2008-2009 financial crisis?

Michael: Doesn’t matter. 4% worked. Thanks to a massive bull run for the 10 years that followed, as bad as the 2008-2009 financial crisis was, you were still trending far ahead.

What if you want to FIRE (i.e., Financial Independence, Retire Early) – what is the safe withdrawal rate? (I don’t – read why here)

I prefer Financial Independence Work On Own Terms (FIWOOT) versus FIRE

Michael: You’ll need to go down to 3.5% rule. Why? The longer your retirement time horizon, the more you’ll need to pull down your “safe” withdrawal rate.

But, it’s not as much as you might think even if you’re talking 40, 50, or 60-year retirement periods.

Is 3.5% a super safe withdrawal rate?

Michael: Yes, but he wouldn’t advise it. From a purist perspective, 3.5% withdrawals will work if you literally never make an adjustment. You could have retired on the eve of The Great Depression, coming out of the date withdrawing 3.5% and gone for 50 years, and you still had money left over at the end. Sure, there is always a risk that the future could be worse (series of market returns) than the investing past but nothing is a guarantee. The 4% rule is just ratcheting down to the worse case scenarios to be our baseline.

On the subject of a cash wedge…

Michael: Lots of cash hurts more than it helps. Why? The hard math answer is at the end of the day, it hurts more than it helps. This is why you have bonds in your portfolio. Cash doesn’t provide the yield or upside that bonds do in a bear market. Mind you, if you can get 2%+ interest on your cash, well, that’s largely a wash these days. 

FYI – here is my cash wedge approach or bucket approach:

My Own Advisor Bucket Approach May 2019

On the subject of a FIRE movement…

Michael: Meh. Kitces believes as I do that the “RE” part of FIRE is rather sensational. Again, nobody in their 30s or 40s really “retires” and does nothing for income for decades on end. They just spend their time differently (and good for them). He cited when he sees clients in practice, when they actually retire, he sees depression increase, isolationism increase, divorce rates increase. There’s actually “all sorts of bad stuff that happen after retirement”. The reason? You need a reason to get up in the morning and be productive. I would argue that just how we are wired. Don’t find it. 

Summary on Kitces on the 4% rule

Overall, I enjoyed the podcast and will be happy to check out their work again in the future.

Kitces’ position on FIRE, having some cash but not too much, being willing to adjust your plans aligns to my DIY thinking and path. I won’t follow a strict 4% withdrawal rate myself. I’m likely to follow some sort of variable percentage withdrawal strategy. Essentially, spend more in good times and cut back during bad. 

Check out this post on that subject here – the benefits of variable percentage withdrawal.

For further reading on the 4% rule including recent articles on my site, check these ones below. Using the 4% rule for your retirement plan might make no sense at all AND there are ways to retire early ignoring this rule altogether.

Let me know your thoughts on this subject.

Mark

Does the 4% safe withdraw rate still make any sense?

The proven path to early retirement ignoring the 4% rule

My name is Mark Seed and I'm the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, we're inching closer to our ultimate goal - owning a 7-figure investment portfolio for semi-retirement. We're almost there! Subscribe and join the journey. Learn how I'm getting there and how you can get there too!

35 Responses to "Why the 4% rule is actually (still) a decent rule of thumb"

  1. Hello Mark, the 4% rule doesn’t make any sense for a dividend investor in my opinion. We are now retired and live mostly on dividends. (I have a small pension but have not started drawing CPP and OAS) The dividends alone cover a very comfortable lifestyle. so there is no need to draw down any amount. For those where dividends alone are not enough you can start withdrawing capital as well. But a solid dividend portfolio will return 3-4% in dividends without touching the principal. So only small amounts would occasionally need to be cashed in. If we had retired in 2009 our income would have dipped by 20%, then right back to the original amount in two years.
    I think it will be much better for retirees to adjust their lifestyle to the income they have from dividends and other sources. This way you never have to worry about a withdrawal rate. Live on what comes in. This does not apply to everyone, I’m talking about investors that follow and profess to invest for dividend income.
    So far still only one dividend cut this year. Could be more to come??????

    Reply
    1. I think there is some truth to that DivInvestor. Although I have a plan to follow some sort of VPW method in retirement (withdraw more $$ in good times and less $$ in bad times) I figure my dividends and distributions from ETFs should deliver ~3-4% returns without touching the capital. I will do that in the “early years” of retirement.

      After the first decade or so, I then have plans to slowly draw down the capital since otherwise I will have more than I can spend. I am also optimistic my pension will kick in, in my 60s and bolster my fixed income.

      “Live on what comes in” is largely how I’m trying to build a portfolio that is income focused. We figure we’re about 5 years away from doing just that now.

      Only one cut? Well done. I have 3 and yes, likely more to come I suspect. Not selling anything!
      Thanks for your detailed comment.
      Mark

      Reply
  2. Great article. I wish that I had the opportunity to have these kind of articles when younger. But the information was not so easily obtained. I agree with the first comment that scale your income on retirement to what you income is and leave the principal alone. What I find hard is trying to get my kids to listen to some of this advice. A lot of that is due I believe not discussing financial planning with them in there younger years. It’s not taught in schools yet is one of the basic fundamentals to living. Enjoy your site and subscribe (and donate once in a while). Cheaper than financial advisors and 5i 😇🇨🇦

    Reply
    1. Great to hear from you Ross. I don’t know what to say about “kids these days…”. I’m not sure I listened well in my 20s either 🙂

      That said, age 30 is when I woke up in a big way financially and I’ve been better since.

      I think the plan to focus on income will eventually be a good decision. I can’t tell you how many retirees I’ve heard from that say because they focus on the income their portfolio generates, and what they can spend from that, they sleep very well at night vs. just thinking about the portfolio value. I’ve taken those words to heart and it is my hope I can be as successful as they are and/or you are!

      Kind words about the site – thanks very much Ross 🙂
      Mark

      Reply
    2. Ross, there is some financial planning–required course–taught in high school in BC. All my 3 kids did it and I saw their work sheets. But it wasn’t retirement focused, that would be too much for 16, 17, 18 year olds. It was more of a budgeting and living within your means focus. Even then, I think at that age many just aren’t thinking that way.

      I was more wired that way–at age 6 apparently I would take all the other kids Sunday school collection money for safekeeping. Ha, that story was told at my wedding during the toast to the bride. So I did always try to discuss finances with my kids. It doesn’t always help, I have two great with money and one who is abysmal, but denies it.

      Reply
  3. Any thing that helps people save towards their retirement is good. Having said that I’ll stick with Divinvestor. Invest to generate an Income and you won’t be watching the market or thinking about how much capital you need to sell to meet expenses.Wonder how those who are relying upon drawing capital feel, wondering how long the markets will stay down and how much more capital they must sell?

    Reply
    1. Yes, not really relying on capital gains here – rather – how much income can my portfolio reasonably generate?

      I figure I’m 50-60% of the way “there” to what I/we need for a comfortable retirement right now based on income from our overall portfolio (less pensions; less government benefits).

      I look forward to the other 40% or so 🙂

      Mark

      Reply
  4. I think the idea of a 4% rule is brilliant. Great place to start your calculations to suit your personal needs. One year you need a new roof so the withdrawal may jump to 8%. How does that affect your nest egg? Recalculate and adjust. As self directed investors we have a huge advantage of having control and in time understanding how it all fits. Whether it is 4% or 6%, understanding the rule of pacing your money to last is what we learn from the 4% rule.

    Reply
    1. I like it as well, as a general rule of thumb but I think you’ve nailed it. Worse case, you recalculate and adjust. That’s life in a nutshell.

      Buying anything these days Paul?
      Mark

      Reply
  5. Our dividends and OAS, CPP cover our day to day expenses but we have to sell equities in order to travel. BONUS: No travel this year so no equities will be sold until next year. If equities are still down then we’ll use our small emergency fund. After all it’s our 50th anniversary this month. Thanks for your posts Mark; always a great read.

    Reply
    1. 50th anniversary! Congratulations!

      That’s still a very, very good position to be in, in that dividends and government benefits cover all the basics.

      All the best Gary.
      Mark

      Reply
        1. Congrats on 50 years Gary.
          We were with my in-laws in Ireland at the time when they were celebrating 61 years and my hubby and I were at 16. They had been through a lot but were still together.
          I am hoping to travel next spring no matter what, it is has been a long time since I have been back to Ireland.

          Reply
          1. Thanks Barbara. We stayed a week in Ireland 2 years ago checking out where my Grandfather was born. We loved every minute of our time there. Happy travels!

            Reply
    1. I think depending upon your retirement timeline with a balanced portfolio of 60/40 (stocks/bonds), I would think 3.5% is rather safe over a 30-year period going forward. You have to factor in taxation, other income sources like CPP, OAS, pensions; inheritance, etc. but by and large if you’re planning only to withdraw 3.5% in the coming 30-40 years, you might just be able to with that 3.5% AND have quite a bit of money leftover.

      I think the key is really to be flexible with spending. That will do more good than the 4% rule 🙂
      Mark

      Reply
      1. +1

        While I agree that the 4% rule is a handy rule of thumb and it’s important to understand the parameters around it (asset allocation, fees, retirement timeframe, etc), there seems to be too much focus on debating the merits and validity of it in isolation. IMO, it should be used as an initial checkpoint point for one’s decumulation analysis but it really needs to be discussed in the context of an overall retirement income strategy like how Kitces discusses course corrections, flexible spending, guardrails, ratcheting, etc. Instead of somewhat blindly following a SWR or whatever starting point one uses, the conversation needs to include How do I check/evaluate the health of my portfolio (both trending to being underfunded and overfunded), What options do I have for making course corrections, and What the scale of those corrections need to be.

        Just my two bits.

        Reply
        1. I would agree it makes very little sense to blindly make 4% withdrawals. The reality is, life will send you course corrections whether you want them or not.

          Every investor would be wise to use a starting point, map out their withdrawal plan, and make some corrections along the way with a combination or spending less or spending more when it makes sense.

          I figure if I can “live off dividends” (and distributions) in the early years or retirement I should certainly have enough coupled with part-time work. Markets willing, 5-years or so and counting for me.

          Reply
  6. Just another comment that for me i am investing in equal parts canada, us and eafe. My understanding is the 4% rule only works historically with US and canada returns.

    Reply
    1. Correct. Bengen’s work was based on 50% U.S. large cap stocks + 50% U.S. Treasuries over rolling 30-year periods. I.e., what is the worse case therefore “safe” withdrawal rate not to run out of money in any 30-year period. 4% withdrawal was “safe” and it did not include Canada nor any other international market beyond U.S.

      So, interestingly, take less bonds (e.g., 30%) and add more international (e.g., add 20% Canada or international) and give or take you’re still looking at 4% or so being “safe”.

      Thoughts?
      Mark

      Reply
  7. It sounds like i should try and watch the whole video. Thanks for posting and your article. I’m not sure if you’ve read about variable portfolio withdrawal on the financial wisdom forum which i believe originated with the bogleheads. You calculate each year what your optimum withdrawal is based on returns using a provided spreadsheet. Maybe that is what you are talking about doing.

    Reply
  8. Good review of the 4% rule approach. It’s definitely the known and widely used method and the one to use in quick conversations and quick math. However, I do believe using 3% is better now due to low interest rates for fixed income. A lot of investors confuse fixed income ETFs or Mutual Funds for a real fixed income with a guarantee. One is an “equity” vehicle investing in fixed income, and the other is actually fixed income. The “equity” vehicle moves with the markets whereas the other one doesn’t.

    Just last week, I reviewed plans for a relative and the investment portfolio was not optimal. So many people still have financial advisors selling mutual funds that cripple the portfolio performance. I looked at 2 situations and one portfolio was doing well with a 4% withdrawal rate but it was built from a gold plated pension fund and the other one was managed by a financial planner and is barely making 4% a year.

    I believe that based on the type of portfolio, an appropriate withdrawal rate needs to be derived. That’s my finding.

    Happy investing!

    Reply
    1. Hey my friend!

      Geez, advisors pushing high-priced products still eh? Not going to go away sadly.

      I think with bond yields as low as they are now and likely going to be for the coming decades, folks wishing to leverage the 4% rule as a starting point for their withdrawal strategy are essentially going to have to do one of two things:

      1. Increase their equity holdings beyond 50% (including large cap U.S. stocks that Bengen had in his study) to about 70% or so in retirement, and/or
      2. Potentially lower their withdrawal rate closer to 3.5% for make it more bulletproof for future uncertainty.

      Good on you to help relatives out and help them understand the crippling effects of pricey products 🙂
      Mark

      Reply
  9. How does the 4% rule work in Canada if most of your nest egg was RRSP and now its in a RRIF with ever increasing mandatory withdrawals. TFSA is still relatively new and Boomers are most likely RRSP heavy. Sure I understand that you can re-invest the excess over the 4% in non-registered vehicles, but you are still taking a hit on the income taxes for the entire RRIF withdrawal each year. Is your 4% then including this additional and increasing tax hit each year over 71? If you are including the additional taxes within the 4% total, then your net spending amount available would be increasingly reduced each year of mandatory withdrawals. Something else to think about?

    Reply
    1. Fair question. The 4% rule is really a starting point. Certainly with RRIF rules you’re “forced” to take out more because the government wants their tax-deferred $$$ back.

      Recall the 4% rule is only a guideline and applies to an overall portfolio value, not just one account.

      Personally, if you are using any 4% rule as your starting point for a 30-year retirement horizon, I would tally the total portfolio value; determine 4% of it and see how much your RRIF withdrawals are as a subset of that.

      You are correct Rob that you’ll need to think about inflation, taxation, etc. for your portfolio as well and this is why folks should not look blindly at some constant 4% withdrawal rate.

      All the best,
      Mark

      Reply
      1. Mark!
        You ought to put that caveat right at the beginning. It can apply to the overall portfolio value but withdrawals from a RRIF are mandated (percentage wise) by the government(s).
        You can withdraw whatever percentage you wish to from taxable accounts as well as from a TFSA but RRIF withdrawal rates are mandated.
        Personally I was going to convert my LIRA in to a RRIF this year but CV-19 has reduced my spending to the extent that I am quite able to live off the CPP/QPP, OAS and a small company pension – and still have a little money left over which increases my balance. One of the benefits of this is that when I convert next year the RRSP and LIRA may have decreased in value and therefore I will not have to withdraw as much as I would have if I had converted this year. The stock market may change that from here to the end of the year the way it is going up at present.

        RICARDO

        Reply
        1. Hope you don’t mind me jumping in here, Mark.

          Hi Ricardo,
          Just a small point of fact here. A LIRA needs to be converted to a LIF, not a RRIF. The difference is that a LIF has both a minimum and a maximum that has to be/can be withdrawn each year, whereas a RRIF only has minimums.

          I find LIFs to be somewhat of a tricky account as they can take a long time to withdraw. Depending on your province and circumstances, you may be able to unlock 50% of the LIRA to ‘free up’ that money by putting it into your RRSP.

          Here in BC, unlocking is not possible, so we try and drawdown that money as soon as possible as the remaining balance will be taxable as income at death.

          Steve

          Reply
          1. Thanks Steve. Yes, interesting that some provinces like Ontario (but BC does not) allow for LIRA unlocking. I hope to unlock 50% of my LIRA before it must be a LIF in the coming decade.

            Mark

            Reply
          2. Thanks for the info Steve.
            Yes, I was aware that it was a LIF just the abbreviation slipped my mind so I just put in “RIF”
            I have discussed the possibility of transferring 50% to my RRSP but that might screw things up a bit as it boosts the RRSP value significantly. The LIF gives some leeway to min/max withdrawals. At any rate I am not quite there as my 71 years of wisdom is next year.
            Prior to CV-19 the idea had been to make a large withdrawal from the LIF to lower it before I am obliged to take money out of the RIF. I might do that and delay the RIF until 2022 which is allowed. The whole idea is to try and keep me below the next tax level.
            CV-19 has twisted the thinking a bit so I will have to book another review with the bank financial guy to see which way will keep the tax man at bay.

            https://www.youtube.com/watch?time_continue=4&v=l0zaebtU-CA&feature=emb_logo

            RICARDO

            Reply
        2. Yes, there are RRIF and LIF minimums. The government wants their tax-deferred $$ back!

          I think it’s VERY good if retirees can live off government benefits and their small pension (should they have one), leaving personal invested assets for “extras”. I hope to be in that lucky position in the coming decades!

          I have a small LIRA and I’m hoping to unlock 50% of that here in Ontario in the coming decade before I have to move the rest into a LIF.

          Mark

          Reply
  10. Mark, I just saw your article posted in another newsletter so I’m late in commenting. I agree, when you are relatively young, with using 4% as a guideline for planning withdrawals and thus your required capital to retire but as you approach your retirement, the first thing is to determine how much you will need, ie what will be your cost of living in retirement. Later, you can also use 4% guideline to monitor annual withdrawals funding your life’s expenses. Remember to use it as an average, as for example, in the next 12 months, we’re going to replace my wife’s 16 year old car with a new one.
    But first, before you retire, you should track your living expenses and project your expenses when you retire as the typical big bank ‘advisor’ or broker will tell you use 70% or more of pre retirement income. BS and lazy thinking to get you to save more with them so that get their 2% of your assets. So for 20+ years I’ve been doing it myself and have done OK, being fortunate to work for companies that had matching RRSP plans with mutual funds, which I put into 100% equity or as close as possible. Spreadsheets are your friends. I determined when I was 64 that I had enough and was not really happy in my job, so I retired. I / we haven’t had to withdraw 4% as our lifestyle has been relatively economical but over the last couple of years, we’ve taken longer and more expensive holidays as we age, monitoring withdrawals against the benchmark 4% and spreadsheet projections. COVID-19 and the drop in equity markets are offset by closure of borders and difficulties getting safe flights means no expensive holidays this fall. So things balance out.
    It is good to have some rules-of-thumb but don’t let them control your life.

    Reply
    1. I like your thinking Hugh. As I approach some form of semi-retirement myself (likely ~5 years away) I am starting to run more math to see how much we can spend from our portfolio using far more than the 4% rule of thumb.

      We are tracking our living expenses now and if we continue on this trend, excluding any major high-class vacations or trips we need about $4,500 per month after tax to live the lifestyle we want. We will need to draw down our portfolio if we want that income since I’ll be too young to get CPP and OAS in any semi-retirement.

      We figure $1 M invested will allow us to draw down that portfolio in our 50s and 60s, leaving CPP + OAS + TFSA assets and any pension funds “until the end”. That should be enough. I’ll be posting much more detailed articles on this thesis this year.

      If you’ve been managing to withdraw less than 4% then that is excellent during these times for your portfolio longevity. Kudos.

      Mark

      Reply

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