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We have all heard of the 4% rule. We know the S&P index has return an average annual return of 10.26% since 1957. Even considering inflation and sequence of returns, how is it possible to run out of retirement funds sticking to the 4% strategy and using cash during downturns. In fact, isn’t more likely assets will grow?
It’s purpose is to help people make sure they don’t run out of money under a worse case scenario, so if you don’t experience a worse case, assets will be higher than otherwise. It isn’t supposed to ensure your assets don’t grow. It’s a conservative approach to withdrawing assets in retirement that will likely result in a large estate at death.
In answer to your exact question: yes, it’s more likely your assets will grow (but you cannot be 100% sure).
I think a better question might be: since the 4% rule was invented 30 years ago, if a person followed it, how would it have worked out.
I’ve searched the internet without finding an answer.
Sorry, I copied the wrong 2nd link. It should be this one.
https://www.bigpicapp.co/bigpicapp/index?v=free
Michael Kitces wrote about newer software that assess safe withdrawal rates.
https://www.kitces.com/blog/safe-withdrawal-rate-calculator-software-big-picture-timeline-app-reviews/
He references the BigPictureAp which calculates historical safe withdrawal rates. I checked this morning and for someone who retired on Jan 1, 1994, the safe withdrawal rate would have been 6.5%.
https://www.kitces.com/blog/safe-withdrawal-rate-calculator-software-big-picture-timeline-app-reviews/
The 4% rule was based on a 60/40 stock/bond portfolio and looked at historical returns. The idea was to find a “safe withdrawal rate” that worked in almost all scenarios for a typical retirement period. In fact, the safe withdrawal rate in many scenarios was significantly higher than 4%. 4% was supposed to be a rule of thumb for safety. Here’s a great explanation to help clear up the confusion. It has a great, simple table that depicts returns since 1907
https://www.kitces.com/blog/what-returns-are-safe-withdrawal-rates-really-based-upon/
So, will a person following all that run out of money if they can use cash to smooth significant market drops?
Bill Bernstein’s second edition of The Four Pillars of Investing makes a convincing case that the returns we’ve seen over the past ~50 years, from large caps like the S&P 500 stocks, will be lower going forward because the steady rise in valuations (higher Price/Earnings ratios) we’ve enjoyed will not continue. If he’s right, and if that concern isn’t simply addressed by an overdue deep bear market, then a lower draw rate of about 3% would give you a higher margin of safety over 30+ years of unpredictable market returns.
Even with the great returns of the past decades, when Bill back-tested 4% draw rates, the worst-case scenario was for someone who retired in 1966. That person’s portfolio drew down to zero in a bit over 20 years.
And I believe the 60/40 portfolio was elected to help smooth out market swings. Since the study used actual historical returns, it shows how things would have behaved in real situations. It doesn’t not guarantee future returns. People have studied a wide varieties of forms of the 4% rule, and you seem to be able to do better, albeit with more complication. I’m not sure anyone has tried to model using the 4% rule with a pile of cash, and foregoing withdrawals after bad years and using available cash. I suspect it would result in a reduced standard of living.
It’s the sequence of return risk that results in the potential to eventually run out of money. It’s just less likely using 4%. Mr. Quinn, what I think is presumed in the 4% rule is that one does NOT have extra cash outside of the nest egg. The 4% rule is presuming that all money is invested.
Right. Any cash should be from the 4% plus inflation withdrawal.
Few thoughts. I don’t know anyone fully invested in the S&P, so their actual results vary. And even though they claim to adhere to 4% they actually dip into the cookie jar when their wants overpower their needs.
I suspect you are right and that’s the key to failure. Seems to me you need two cookie jars to make it all work, one for dipping
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