Can This Retirement Rule of Thumb Still Guide Your Golden Years?

You've probably heard the golden rule of retirement: "You can safely withdraw 4% of your money every year and never run out." It's a widely quoted guideline, offering a sense of security to those nearing their golden years. But do you know the history behind this famous “rule”? Where did it come from, and more importantly, does it still apply to the unique retirement challenges we face today?

We're going to take a look back in time to uncover the origins of the 4% rule, explore its original findings, and then assess its applicability in today’s financial landscape. You can take a look at my YouTube video on this topic, too.

The Origin Story: Bill Bengen and His Landmark Study

The 4% rule can trace its origins back to 1994, when financial planner Bill Bengen published his seminal paper in the Journal of Financial Planning. Bengen's core question was profound and practical: "How much could I withdraw from my portfolio every year for 30 years and not run out of money, even if I retired at the worst possible time?"

To answer this, he utilized historical market data compiled by Ibbotson and Chen in "Stocks, Bonds, Bills, and Inflation." His methodology involved taking a starting portfolio value, multiplying it by a withdrawal percentage, and then annually increasing that withdrawal amount by inflation for the subsequent 30 years of retirement.

His groundbreaking conclusion? Even if you had retired at what appeared to be the worst possible moment in history – think the eve of the Great Depression or just before the notorious stagflation of the 1960s and 70s – you could, in most scenarios, safely withdraw 4% of your initial portfolio balance and avoid depleting your funds over a 30-year period.

Bengen's Key Findings: What the Data Showed

Bengen's original research explored various withdrawal rates (3%, 4%, and 5%) and asset allocations (from 0% stocks/100% bonds all the way up to 100% stocks/0% bonds). He specifically used data from U.S. large-cap stocks and intermediate government bonds.

Here's a breakdown of what he found:

• 3% Withdrawal Rate: This rate performed exceptionally well. Only in the extreme case of a 0% stock allocation was there any danger of running out of money over 30 years.

• 4% Withdrawal Rate: If your portfolio maintained an allocation between 50% stocks and 75% stocks, Bengen found no instance where the portfolio was exhausted within 30 years.

• 5% Withdrawal Rate: While carrying more risk, Bengen's simulations showed that while depletion was possible, it typically didn't occur before 20 years, even in the worst historical scenarios.

Beyond the Spreadsheet: Criticisms and Real-World Considerations

While the 4% rule remains a valuable starting point for retirement income planning, it's crucial to understand its underlying assumptions and limitations when applying it to real life.

Deterministic vs. Probabilistic Analysis

One key difference between Bengen's original study and modern financial planning is the analytical approach:

• Bengen's Deterministic View: He looked at historical data sequences year by year. Essentially, the "worst thing that ever happened in the past is the worst thing that would happen in the future."

• Probabilistic (Monte Carlo) Analysis: Today, planners commonly use Monte Carlo simulations. This approach runs thousands of different possible market scenarios, many of which can be far worse than anything seen in historical data. This provides a more robust understanding of potential outcomes, including "black swan" events not captured by past returns.

The Messiness of Real Retirement Spending

In practice, real life rarely follows a smooth, inflation-adjusted spending curve like a spreadsheet might assume:

• Early Retirement Expenses: Many retirees experience higher expenses early on, often related to travel, supporting family, home renovations, or purchasing significant assets like a vacation home or a boat. These are not always "consumption" from the portfolio but rather shifts in asset allocation (e.g., investment assets converting to real assets).

• Flexibility Needed: This real-world messiness makes it challenging to adhere rigidly to a precise 4% withdrawal rate. Your actual portfolio value can shift, and so can your needs.

Even Bill Bengen's Own Strategy Differs!

Perhaps one of the most surprising insights comes from Bill Bengen himself in later interviews (such as one with Rob Berger). He has revealed that:

• His Own Allocation: His personal investment allocation is outside the "optimal bands" he identified in his paper.

• Active Investing: He doesn't solely rely on index funds but engages in more active investing approaches, including buying funds that can short the market – strategies not included in the data he analyzed for his original paper.

This simply highlights that real life, with its unique circumstances and personal biases, is often much "messier" than any spreadsheet or academic study.

A Good Rule of Thumb, But Not the Only Tool

The 4% rule remains a useful "rule of thumb" and an excellent starting point for conceptualizing your retirement income goals and the longevity of your portfolio. It provides a baseline understanding of sustainable withdrawal rates. However, its limitations underscore the importance of personalized, dynamic financial planning.

At Barrett FP LLC, we offer expert financial planning on an hourly basis, focused entirely on helping you achieve your goals.

Learn more about how we can help you navigate complex retirement income strategies and see if we're a good fit [BUTTON].