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Fire the 4% Rule

Greg Spears, 3:17 am ET

I DID ACHIEVE financial independence and retire early—if you count age 64 as early. My friend Jose, a true believer in FIRE, or financial independence-retire early, celebrated his retirement at 44. That took a steely nerve that I lacked, plus I had big college bills to pay before retiring.

One big challenge of FIRE, of course, is that your savings might need to last 40 or even 50 years. Vanguard Group recently published a research paper to help FIRE followers go the distance. It includes major tinkering with the 4% rule, which was designed with only a 30-year retirement in mind.

Under the 4% rule, you withdraw 4% of your savings in the first year of retirement, then raise that dollar amount by the rate of inflation in the second year and so on thereafter. This approach worked 82% of the time over a 30-year period with a 50% stock-50% bond portfolio. If retirement gets stretched to 50 years, however, the success rate fell to a discouraging 36%, Vanguard’s researchers found.

To improve the odds, they suggest FIRE followers try these four steps:

  • Enter truly big numbers into your retirement planning calculations, by assuming, say, a 50-year retirement. The standard assumptions of a 20- or 30-year retirement could produce false positives for FIRE followers.
  • Slash investment costs. Even relatively modest annual costs of 0.2% cut the odds of 50-year success down to 29%. Index investments can cost one-third of that sum or less at Vanguard and, incredibly, nothing at all at Fidelity Investments.
  • See the world. The 36% success rate was based on an all-American portfolio. The odds of 50-year savings survival jumped to 56% when 40% of the stock allocation and 30% of the bond allocation were invested internationally.
  • Adjust the 4% rule to withdraw less money when account values are down. The chance of savings lasting 50 years leaped to 90% if retirees withdrew 1.5% less when their account balance fell below last year’s. Example: If you withdrew $40,000 in year one, 1.5% less works out to $39,400 in year two. Happily, the model also permits larger withdrawals if account balances are higher, such as $42,000 in year two.

There are no automatic inflation adjustments under this dynamic spending model, so the shoe would pinch if higher inflation turns out not to be “transitory.” Still, the concept follows human nature: Tighten your belt when balances are down and spend a bit more when they’re higher.

Does this mean the 4% rule is repealed? Not really. FIRE followers who adhere to all four steps could start with a 4% withdrawal rate, the researchers found, and have at least an 85% chance that their savings would last a full 50 years. Your results may vary, of course. Good luck, Jose.

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Steve Spinella
Steve Spinella
5 months ago

I think a much better long-term strategy than using a fixed % involves using some version of a “required minimum distribution” which is an actuarially adjusted annual amount. This adjusts for age, life expectancy, and prior returns. It still doesn’t adjust for variability in future returns, but that is unknowable in any case.
To do this, you treat your whole balance under consideration like it was in an IRA, look up the RMD in the actuarial table (which is available for younger ages also) and take that as your target amount.

parkslope
parkslope
5 months ago

I think it is worth noting that the Vanguard analysis used the following assumptions.
We use forecasts from the Vanguard Capital Markets Model® to estimate future returns. The VCMM’s 10-year median return forecasts are 4.02% for U.S. stocks and 1.31% for U.S. bonds—both below the historical averages. Its inflation forecast is 1.58%. Accounting for inflation, the 10-year VCMM median forecasts of real returns are 2.44% for U.S. stocks and –0.27% for U.S. bonds. These forecasts reflect the “initial conditions” (stock market valuations and real interest rate and inflation expectations) that prevailed in December 2020.

Last edited 5 months ago by parkslope
Ormode
Ormode
5 months ago

If I was retiring early, I would want a little more room for unforeseen contingencies. Remember how the world was in 1985? The world today is very different. Who knows what might happen if you are retired for 30 or 40 years.
I did retire at age 61, but I had 25 times my salary in financial assets. Combined with Social Security, this is enough to live on your income and not spend down principal.

Jackie
Jackie
5 months ago
Reply to  Ormode

I am curious how you are covering expenses until social security kicks in – assuming you will start collecting at age 70?

Brent Wilson
Brent Wilson
5 months ago

If Vanguard was going to tinker with asset allocation by adding international, why keep the overall allocation at 50/50 stock/bond? That allocation is dead, and I assume very few FIRE followers would be this conservative. Also, the use of historical returns is framed as a negative by Vanguard, but I trust history more than I trust Vanguard’s ability to predict the next 50 years.

Purple Rain
Purple Rain
5 months ago
Reply to  Brent Wilson

For me, Dividend Growth stocks are the new bonds. For context, I am 50. My portfolio comprises 40% Indices, 40% dividend growth stocks, 20% Cash and I-Bonds.

The growing dividends (2.62% yield with a 10% dividend growth rate in that portion of my portfolio) meet 75% of my current expenses (not counting Social Security).

That mitigates risk on two fronts.

  1. My withdrawal rate is well below 4%. In five years, I estimate it will be zero.
  2. My Sequence of Returns Risk is low because I don’t anticipate having to sell any stocks in the next decade.
Last edited 5 months ago by Purple Rain
steveark
steveark
5 months ago

Can you reference where the 82% success rate comes from? Everything I’ve read on Bengen and Trinity show 95 to 100% success rate for the 4% rule. Bengen has actually revised the rule to over 4% now. While some others have revised it down to 3.3%.

Jim Burrows
Jim Burrows
5 months ago
Reply to  steveark

Figure 4 page 5 of the Vanguard analysis linked in the article.

parkslope
parkslope
5 months ago
Reply to  steveark

The Vanguard analysis that Greg Spears summarized in this article found an 81.9% success rate for a 30-year retirement.
https://personal.vanguard.com/pdf/ISGFIRE.pdf

R Quinn
R Quinn
5 months ago

I’m so glad you wrote this. I get into heated discussions with FIRE folk who seem to have their heads buried in the sand on this issue somehow thinking retiring at 40 is the same as 65 when it comes to using assets to live on the rest of their lives.

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