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Not a Law of Nature

Adam M. Grossman

THE 4% RULE IS ONE of the best-known ideas in personal finance. But is it really a rule? And does it apply to you?

Let’s start at the beginning. The father of the 4% rule is a financial planner named William Bengen. Back in the early 1990s, he became frustrated with the prevailing rules of thumb for retirement planning. He found them too informal and set out to develop a more rigorous approach. The question he sought to answer: What percentage of a portfolio could a retiree safely withdraw each year? In Bengen’s definition, “safely” meant that a retiree would not outlive his or her funds over the course of a 30-year retirement. 

The answer Bengen reached: 4%. Specifically, a retiree could build a reliable plan around a portfolio withdrawal of 4% in the first year of retirement and subsequent annual increases in line with inflation. He arrived at this conclusion after testing hundreds of hypothetical historical portfolios—evaluating different starting points and different withdrawal rates.

Since Bengen’s research first appeared in 1994, it has gained in popularity, but it’s also spurred a lot of debate. So how should you think about it?

The first thing to understand about the 4% rule is that Bengen never intended it to be a rule per se. In his paper, he’s clear that 4% is just a recommendation—and only under certain circumstances. In fact, in a recent interview, Bengen—who’s now retired—noted that the figure he used with his own clients was generally 4.5%. Today, with inflation so low, he believes that 5% makes more sense.

Meanwhile, some take the opposite view. Because of today’s very low interest rates, there’s a camp that believes 4% is far too generous and that 3% or 3.5% is a better number.

Bengen’s 4% figure has taken on a life of its own, and he recognizes the irony in that. His intention was to develop a more rigorous approach that improved upon the old rules of thumb. And yet, over time, his work—which also included an entire book on the topic—has itself been oversimplified and reduced to a rule of thumb. That’s why I think it’s worth taking a closer look at the research. As you think about your own retirement plan, and whether 4% would make sense for you, below are six factors to consider:

1. Income. For many people, income varies throughout retirement. You might, for example, retire at age 65 but defer Social Security until 70. If that’s the case, your portfolio withdrawals might be well north of 4% in those first five years. But that wouldn’t be a problem if you expected them to moderate later on. In other words, your withdrawal rate need not be 4% or less every year.

2. Expenses. For simplicity, Bengen’s research assumes that a retiree’s spending will increase linearly each year, in line with inflation. In reality, though, most people’s expenses vary throughout retirement. Retirees are generally more active, and thus spend more, during the earlier years of retirement. For that reason, it wouldn’t be unreasonable if your withdrawal rates were higher in those early years.

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3. Assets. It’s a morbid topic, but—if you have a reasonable expectation of an inheritance later in life—that might also allow you more latitude on your withdrawal rate early on.

4. Age. Bengen’s litmus test for a “safe” withdrawal rate was one that would allow a portfolio to last at least 30 years. But everyone’s retirement timeframe is different. If you retire very early—say, in your 50s—you might want to plan on a more conservative withdrawal rate. In Bengen’s study, a 3% withdrawal rate would have resulted in sustainable withdrawals for at least 50 years in every scenario. On the other hand, if you choose to work until your late 60s or early 70s, you could afford a higher withdrawal rate.

5. Asset allocation. The 4% rule of thumb was based on a portfolio of 50% stocks and 50% bonds. But Bengen also spent quite a bit of time looking at the impact of alternative asset allocations, and he warned investors that 4% wouldn’t necessarily work for all portfolio mixes.

6. Market valuation. In 2008, financial planner Michael Kitces extended Bengen’s work, adding another dimension: market valuation. His finding: If the market is at a relatively high point on the day you retire, a more conservative withdrawal rate would be warranted. Bengen endorses this finding and has built on Kitces’s analysis in more recent work. In today’s bull market, that’s a key point to keep in mind.

In short, the 4% rule is hardly a rule. Like most things in personal finance, the answer that makes sense for someone else will rarely make sense for you. Bengen himself urges investors not to worship at the altar of 4%. In his words, “It’s not a law of nature.”

Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on Twitter @AdamMGrossman and check out his earlier articles.

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David Powell
David Powell
1 month ago

Thanks for this, Adam, very helpful.

Bergen’s piece riffing on Kitces work is interesting though the numbers seem skewed by the need to omit CAPE data from the last 30 years. Even Schiller shrugged when asked why CAPE has stepped up about 1 SD in this period.

Has Bengen or another reflected on impact to safemax of much lower bond returns than the assumptions made in his original paper and book?

ishabaka
ishabaka
1 month ago

These endless articles about the 4% rule seem to never mention variable withdrawals.

Roboticus Aquarius
Roboticus Aquarius
1 month ago

Adam, I have read a lot of articles summarizing Bengen’s 4% calculation.

This is by far the best, both with respect to accurately describing the relevant conditions, results, limitations, & extending to a range of implications as investors assess their own unique situations.

I suspect that very few retirees follow Bengen’s original prescription closely. However almost every alternative process is compared to or measured against the 4% guideline, and the thought process is useful no matter what method you eventually employ.

Ben Rodriguez
Ben Rodriguez
2 months ago

Excellent piece. You quickly hit on all the key considerations. For myself, at 10-15 years before early retirement (Lord willing and the creek don’t rise), I use 4% for planning purposes. I think that will be enough, but not too much, to get us to the time when (hopefully) some social security kicks in to supplement our income (if needed). Generally we plan as if we won’t receive social security, but as we get closer to the time when we’re eligible we’ll revisit that.

I agree that we’ll likely spend more in early retirement while we’re healthy and spry enough to enjoy a lot of travel (and wine). As time goes by, that will probably taper off.

Inheritance, even if 30-40 years off, could provide that buffer to ensuring money never runs out. Ultimately the goal is to leave a financial legacy for at least the next generation.

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