Let's break the 4% rule

Does the celebrated 4% Rule work anymore?

Is it possible to withdraw 4% of a diversified investment portfolio in your first year of retirement, increase future withdrawals by each year’s inflation rate, and run no risk of running out of money after 30 years of retirement? Apparently, it depends on whom you ask.

The 4% Rule is based on 1994 research by financial advisor Bill Bengen, who studied 30-year withdrawal periods dating back to 1926. It assumed a portfolio mix of 50% stocks and 50% bonds, rebalanced annually.

David Blanchett, head of retirement research for Morningstar Investment Research, thinks today’s historically low interest rates might cause you to run out of money prematurely. In a recent interview with Bottom Line Personal, Blanchett argues the 4% Rule should now be the 3% Rule, and that investors still saving for retirement will need a much larger nest egg than previously thought.¹

But now the creator of the 4% Rule himself says something closer to 5% “is probably going to be OK.” Stocks are expensive now, Mr. Bengen admits, but inflation is very low, which justifies spending more than 4% in the first year of retirement, at least as long as the current investing environment doesn’t change much.

So, should we call it the “3%-to-5%-You-Decide” rule from now on?

Nearly all of the research I read on retirement income these days – including the 4% Rule – focuses on various strategies for “spending-down” assets in retirement, which is a polite way of saying that it’s okay to systematically liquidate your life’s savings over the course of your retirement. It’s all very academic and based on sound investment theory and statistical probability analysis.

And nearly all of it completely misses the point.

As it turns out, most retirees don’t want to spend everything they’ve spent a lifetime accumulating. They don’t like the idea of systematic liquidation, regardless of the academic research that supports it. And they’re not doing it. A recent study conducted by BlackRock and the Employee Benefit Research Institute (EBRI) surprisingly found that “on average across all wealth levels, most current retirees still had 80% of their pre-retirement savings after almost two decades of retirement…. One-third even grew their assets over the course of retirement.”

Most of our retired clients – all of whom reside in the real world – tell us they prefer to live primarily off the income their investments create, preserve as much of their nest egg as possible, and leave a legacy to family or charitable institutions when they depart this world. So to that end, nearly three decades ago we designed an investment strategy aimed at creating portfolio income that is adequate for their spending needs, keeps pace with their rising cost of living over time, and preserves (or grows) capital as much as realistically practical.

Living off investment income might sound a little old-fashioned these days, and many academics dismiss it as theoretically impossible. I suppose I would agree with them if it weren’t for the hundreds of retired investors I know who have been doing it successfully for decades.

¹ “Retirement Rule Drops to 3%”, Bottom Line Personal, February 15, 2021.