Does the 4% Rule Still Work in 2021? Here Are 3 Reasons It May Not.
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- čas přidán 7. 08. 2024
- The 4% Rule has become a popular way to determine retirement portfolio withdrawals. Does the 4% Rule still work in 2021? Here are 3 issues.
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4% has worked fine in cycles of high inflation, low bond returns and low equity returns.. it was born from backtesting the worst 30 year cycle... that is the whole purpose of its existing. It isn't a rule from ideal market conditions.
@sbkpilot11 -- you're absolutely right. The 4% rule lacks a bunch of nuance and under-spends during good market conditions.
czcams.com/video/1QxfA1-ApuI/video.html
The problem I have with the 4% rule is it ignores actual spending patterns of retirees, it focuses on what can safely be withdrawn. It assumes your needs are steady in real terms. In fact, other studies have shown that expenses slowly decline then increase for health care costs later in life (the retirement "Smile"). You may not need 4% plus inflation in year 10, so real world you wouldn't withdraw 4%. It also ignores spending adjustments that a retiree would make if their assets decline. If there was a large market decline or say, a pandemic, they would probably tighten their belt. Nice academic study, not a lot of real world application. To my mind the only benefit of the rule is what says about amounts greater than 4%, that is, not a good idea.
I'm with you 100%, Marc. It was a great starting place for retirement research, but we have much better tools now. And you're right -- nobody will robotically spend the same amount, adjusted for inflation, each year. Life changes, so it's good to have a better understanding than the simple 4% rule.
It is not a "rule". It is not a plan. It is just a back of the envelop method for getting an idea of how much income you might be able to withdraw. There are many reasons why someone might not want a constant income stream from their savings. You might retire at 63 and not start SS until 70. You might plan to live in a paid off house until 78 then, sell and move to a retirement community, now both saving and spending change significantly. Even if you did want a constant income stream, it makes no sense to think you could set that income amount and never make adjustments over the course of 30 years.
The important thing is it gives you an approximate baseline. If you have $1M and "need" $70K a year adjusted each year for inflation it lets you know right away you need to fix your spending to bring that down. If you need $40K a year for 5 years then $25K because you will start SS, you are in great shape. If you want $70K a year for 5 years, then $35K, well you are going to need some careful income modeling.
People who poo poo the 4% rule, don't seem to understand what it is and what it is not. It is fine for what it is. It is not fine for what it is not.
@Rodc -- it's just another tool in the toolbox!
Great video
Thank you for the kind words, Basam!
The Trinity study data from 1925 to 1995. Using interest rates from 1935 through the 50s, is pretty much in the ballpark of to where were at today. I don't worry about the interest rates and 4 percent being a safe withdrawal rate
Great point, John! Lots of similarities when it comes to interest rates.
The key to a safe withdrawal rate in my opinion is flexibility. I will probably start at somewhere around 4 or 5 percent. But my discretionary spending is 50% of my budget. Meaning I can live off half my money and simply cut down my withdrawal rate in case of a bear market
@john gill -- you make another fantastic point! These withdrawal rates are a great planning tool, but everyone will adjust as needed in retirement. Some of the follow-on studies show that, if you're willing to temper your withdrawals in a downturn, the overall safe withdrawal rate is something closer to 5.3%. I'll have to do a video on that sometime soon...
When interest rates decrease money flows into equities.. so Wade Pfau isn't correct. Money chases returns in other asset classes propping them up.. as long as you're Diversified low interest rates have little effect on the success of the 4%
@sbkpilot11 -- Sounds like you've studied a lot of this. Remember, the 4% rule for the video is just a back-of-the-napkin tool.
Remember too that there is a lot more to the story than this. Historically bond returns and stock returns are very nearly uncorrelated. That means they are as likely to move together and move in opposite directions. There is zero guarantee that one will do well when the other does not. They can and sometimes do, go down together. For example as bond rate rise, money may flow out of stocks into bonds, but the rising rates drive down bond holdings for existing bond holders. So as their stocks decline, so does the value of their existing bonds.
The 100 year average return of stock market investments is estimated around 10% per year. Why would the 4% rule be in question at all ? And why are you basing it off of bonds in your presentation when anyone I know has through their employer 401k's, 403b's, mutual funds whatever you want to call them with a 100 year average return of 10% Thanks, I'm genuinely curious what I am missing.
Curious about where you got your data from, @JohnsonInc999. As far as what's available through normal retirement plans, there are almost always some stock funds and bond funds. The original study by Bill Bengen looked at a 60/40 stock/bond portfolio.
@@PranaWealth Thanks for the reply, many YTubers do not answer. Naively maybe, I was thinking it was common knowledge of the 100 year ave. / "about 10%". I'll admit I'm going off of Google searches that show charts on many different websites back to the year 1915. I'm absolutely no expert, I'm genuinely questioning everything. But from what all I have read the "about 10%" statement seems to be true. So that why I'm wondering why the 4% rule is in question. Not just here but on many other sources as well. So I really dont know, I'm trying to understand why 4% would be in question when we have a 100 year chunk of time that tells us returns have averaged around 10% which is much more than 4%. Sorry, hope this makes sense as I'm trying to strategize my own retirement moves. Thanks for any info or reply, I know I wont be able to get everything in this type of forum, but thought I would just ask the question. Thanks
Anytime, @JohnsonInc999. I try to answer as many comments as I can, but as my channel has grown, it's hard to get to every one. Remember, CZcams is just a couple of hours per week for me. Depending on how busy I am with clients, I may not have time to answer each one. Ah, the life of a business owner, right?
To answer your question, the 4% rule came out of a 1994 study done by William Bengen. Here's a recent article about it:
www.forbes.com/sites/davidkudla/2022/01/31/understanding-the-4-distribution-rule-for-retirement/?sh=64e7b4a220fb
In the study, Bengen uses a proxy for a diversified retirement portfolio when it comes to returns and standard deviations. Since very few retirees have a 100% stock portfolio, he didn't try to go with straight stock return numbers. Over the years, many, many people have built upon this "safe withdrawal rate" body of knowledge. In that time, people have poked holes in the original study and added nuance to the calculations.
The parts you're missing it's not 4% forever, it's 4% plus inflation adjustments. You're also not considering sequence of returns. Remember in most time periods having 4% plus inflation withdrawal rate would leave you with a big pot of money at the end. It's just historical data and people make it into more than it is. Historically 4% plus inflation is what you can take out safely from a portfolio without worrying about running out of money. You're free to take more risk, for example 5%
Great call, @john gill -- you are supposed to adjust your withdrawals for inflation every year according to the study. Sequence risk is something that I'm concerned about right now. We've had such an incredible run that any mean-reversion might catch folks by surprise. We simply don't know what we don't know. It's also interesting that the safe withdrawal rate would be higher were it not for the stretch starting at the end of the 1960s and ran through the 1970s. For that stretch, 4% really was the max. In the end, there's no really foolproof way to do any of this. The 4% rule is a pretty conservative one, so some people may want to take on more risk.