Fire the 4% Rule

Greg Spears

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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