After running multiple scenarios against actual financial market returns and inflation rates between 1926 and 1992, personal finance guru William Bengen articulated the well-known “4% Rule”.
Bengen was surprised to discover that, despite stock market crashes and economic downturns, portfolios with 50% equities and 50% bonds did not typically run out of money for 30 years or more if withdrawals capped at 4%, including annual inflation adjustments. His analysis rippled through retirement and income planning circles until it became codified, accepted, and embraced. (*It’s important to note that, since first calculating the rule in the 1990s, Bengen has revised it to a 4.5% withdrawal rate for the first year’s withdrawal.)
The 4 % Rule is easy for most people to grasp; it says that you can withdraw around 4% of your portfolio the first year you retire, increasing the amount each following year to adjust for inflation, and you won’t run out of money for 30 years. The 4% Rule seems to perfectly answer a fundamental question everyone saving for retirement asks themselves at some point: “When I retire, how much of my savings can I spend without running out of money?” The 4% Rule gives financial advisors an easy rule of thumb to help assuage their clients’ fears about running out of money before they die.
However, in this volatile and unpredictable world, unprecedented market conditions and longer lifespans threaten to upend the 4% Rule, along with the conventional financial planning that supports it.
In today’s world, is a 4% withdrawal rate conservative enough? Will most Americans be unable to withdraw 4% for thirty years without having multi-million dollar nest eggs? Could your portfolio’s yield plus price appreciation mean that your balance might exceed 4%, causing your portfolio to grow?
The 4% Rule, while it has fallen out of favor with some advisors, is staunchly supported by others. Some planners say the rule has been unfairly maligned and maintain that re-allocating your portfolio to include emerging market and flexible strategy bonds or actively managed bond funds may contribute to your safe maximum withdrawal percentage. Other financial advisors continue to adhere to a 60/40 portfolio balance that places their clients savings 60% in equities and 40% in bonds, annuities, and other safe money products.
William Bengen has acknowledged the 4% Rule’s many shortcomings, including the issue of human inability to predict the future. He has also admitted that a baseline assumption for the rule is that a retirement portfolio consists of 50% equities and 50% safe money, including bonds. That allocation may be optimal if your only concern is living too long, but what if you want to enjoy your retirement? For that, you might need a little more growth, and that growth is likely to add a degree of risk to your portfolio.
Other critiques of the 4% Rule in retirement include:
It lacks flexibility. 4% may not meet the changing income needs of modern retirees.
It does not contemplate significant market downturns: One big stock market tumble can disrupt the rule.
Bonds now have lower yields: Historically low interest rates signify bond yields that are much lower than they were in the past.
Life spans are increasing. Your retirement could turn out to be much longer than 30 years.
Summary: The 4% Rule is not written in stone. Retirees considering using it as a guideline for spending in retirement will want to meet with their qualified retirement and income planner first. Your planner can keep an eye on your portfolio, rebalancing as necessary to account for your changing risk tolerance, expenses, and market conditions.
Be sure you consult your advisor before making any changes to your financial plan and exercise due diligence when looking into any safe money product, including annuities and life insurance.
