Will the year 2000 retiree destroy the 4% rule?

The 4% rule of thumb for retirement savings is under threat. After 10 years of retirement, through the end of 2009, individuals who retired at the beginning of the year 2000 are potentially on a path to run out of money before the end of their 30 year retirement period. In this post I’ll compare the current path of the year 2000 retiree to the two worst previous times in history to retire and what that could mean to current and up and coming retirees.

The 4% rule is the probably the most popular way of determining how much a person needs to retire. It has worked for every retirement period going back to at least 1926. And in particular the 4% rule has been determined by the worst times to retire in history, 1929 and 1966 as I discussed here. But for the standard 30 year retirement period the last year of data that can be used for these retirement studies is 1980. A 30 year retirement period starting in 1980 would have ended in 2009. Fortunately, there is a way to monitor the progress of retirement portfolios that can signal signs of potential dangers. In this post, I discussed using the current withdrawal rate (CWR) as an indicator of potential retirement danger. Lets take a look at the CWR for the year 2000 retiree after 10 years of retirement and compare it to that of the 1966 retiree, the retiree who experienced the worst retirement results in history.

A recent academic paper compares the retirement experience for the 1966 retiree and the year 2000 retiree. Lets look at the data. First here is the data for the 1966 retiree.

The paper uses some worse assumptions for the 1966 retiree than the traditional retirement studies. The 4% rule worked for the 1966 retiree but the paper uses a 4% rule with 1% fees as the base case. Obviously, this is almost a 5% withdrawal rate in reality so of course it fails the 1966 retiree. This is probably more realistic given that all investors pay investment fees although I think the use of 1% is too high. But no doubt many investors pay this and more. Now for the data for the year 2000 retiree.

Doesn’t look pretty does it. In terms of CWR the year 2000 retiree is better off than the 1966 retiree but the CWR is still at uncomfortably high levels. There is a very real danger that the 4% rule could fail the year 2000 retiree and thus establish a new safe withdrawal rate for all future retirees. In terms of remaining wealth, the year 2000 retiree is worse off than the 1966 retiree! This is due to the higher inflation experienced by the 1966 retiree and the poorer investment returns experienced by the year 2000 retiree. What does the future hold then for the year 2000 retiree? No one knows. It all depends on future investment returns. The data in the study is from 2009 so we at least have one more year of returns to look at. In 2010, a 60/40 portfolio of the S&P500 and the intermediate bond index would have returned 11.8% (15% for the S&P500, 7% of the bond index). With these results the year 2000 retiree’s CWR would have dropped and their total wealth would have increased providing some form of relief to a very stressful situation. We’ll see what the future holds but this retiree cannot tolerate many more bad investment years.

The study of the first 10 years of the year 2000 retiree’s experience is sobering to say the least. What bothers me about these studies is the proposed solutions. Most of the time there are no proposed solutions or there are standard ones of save more, work longer, and use a lower SWR. Gee, thanks for the insight. Easier said than done. Most people have a hard enough time reaching the 4% rule thresholds. I think there are many things a retiree can do to improve their odds of portfolio survival. I’ve discussed many of them on this blog. There are two sides the equation – the revenue side and the expense side. On the expense side, the best thing a retiree can do is stay flexible and have a plant to reduce expenses when returns are low as I discuss here. This alone can increase the SWR significantly. On the revenue or return side there are a ton of ways to trounce the returns of the standard 60/40 S&P500/Bond model. The easiest way is just to index smarter and diversify more.  In this post I describe two ways to significantly increase returns and thus safe withdrawal rates. At the minimum an investor should look into fundamental indexing or equal weight indexing to enhance returns. And of course there is my ultimate preferred method of enhancing retirement security and that is through a core strategy of dividend investing. My model is described here. There are better ways.

In summary, the 4% rule may be at risk. The first 10 years of a year 2000 retiree’s retirement results are worrying. While 2010 returns improved this retiree’s prospects a bit, he/she cannot no tolerate even a few more years of poor investment returns and have their portfolio survive. The good news is that there are ways to enhance retirement security through better investing and staying flexible in retirement no matter what the so called experts may say.