The 4% rule lives despite what the NY Times says

OK, deep breaths, deep breaths….The drivel the passes for reporting on retirement issues never ceases to amaze me. But this time I found a real howler. The “paper of record”, the venerable NY Times, recently published a piece on the 4% safe withdrawal rule, titled “4% Rule for Retirement Withdrawals Is Golden No More”, that is truly a piece of garbage. I can only hope that it wasn’t really read that much but I cringe at the potential fear caused among many older Americans. I’m going to quote extensively from the piece here to shed light on this whole flawed concept of the 4% rule no longer being valid.

Ok, lets get to it. The premise of the article is that the 4% withdrawal rule in retirement is no longer valid. Due to the widely accepted premise that future returns will be low due to high stock prices and low bond yields retirees can no longer rely on the 4% rule. The first piece of data we get is in the second paragraph;

That percentage was calculated at a time when portfolios were earning about 8 percent. Not so anymore. Today portfolios generally earn much less, about 3.5 percent to 4 percent, and stocks are high-priced, which is linked historically to below-average future performance. Many financial advisers are rejecting the 4 percent rule as out of touch with present realities.

What portfolios earn 3.5% to 4% today? I wanted to give the author the benefit of the doubt so I had to really search for such portfolios. Going with the traditional 60% stocks, 40% bonds portfolio referenced elsewhere in the article and going back to the beginning of the year 2000 you get a compound annual return for the portfolio of 3.16%. Wow, scary right? But that’s the worst I could find. All other periods since 2000 are higher. And if you held a more broadly diversified portfolio like the IVY buy and hold portfolio or the Permanent portfolio your returns over this period would have been 6.5% and 7.9% respectively. Seems like poor returns are more a problem of asset allocation than a poor general return environment. Also, the highest safe withdrawal rates even using only US stocks and gov’t bonds comes from a 70% stock 30% bond allocation, not 60/40. If only we could get some good financial advice….but I digress.

Next, compound returns are only one component of successful retirement withdrawal rates. Inflation, volatility, and the sequence of returns are just as important. For example, lower compound returns at lower volatility lead to higher safe withdrawal rates (see here). A better question is how is the poor year 2000 retiree, who suffered 2 market crashes, doing using the 4% rule doing compared to history? Turns out that he/she is just fine and doing better than the worst times to retire in history. As I discuss in this post, the 4% rule is doing just fine for the year 2000 retiree, better than the worst times in history to retire – 1966, 1965, 1929, and 1973. And the 4% rule worked during those times as well.

But maybe the future will turn out to be different. That’s what some experts say.

Michael Finke, a professor in the department of personal financial planning at Texas Tech University in Lubbock, is a co-author of a paper critical of the rule, “The 4 Percent Rule Is Not Safe in a Low-Yield World.” He says Mr. Bengen’s rule doesn’t acknowledge the new economic reality of prolonged low returns. “There haven’t been any historical periods that look like today,” Mr. Finke said. “We’ve never had an extended period where rates of returns on bonds have been so low and valuation on stocks so high.”

Is this correct? Maybe but lets check the historical record first. The worst time to retire in history was 1966. What were stock prices, bond yields, and inflation back then? In 1966 stock valuations were similar to where they are today, based on the Shiller PE, the 10 year bond yielded 4.8%, and inflation was 2%. In 1929 stock valuations were much higher than today, the 10 yr note yielded 3.4%, and inflation was practically zero. History says we’ve had higher stock valuations before but that real bond yields today are lower than at these two times in history. Lower real bond yields could possibly lower safe withdrawal rates going forward but the data is not conclusive. In the 1929 and 1966 periods bonds went on to suffer massive bear markets in real terms with inflation peaking at 18% in 1947 and 12.2% in 1980. Imagine inflation adjusting your retirement withdrawals back then. Still, what if we have zero real yields going forwards as far as the eye can see? I went back to the historical data and forced real bond yields to zero and re-ran the safe withdrawal rate analysis. Guess what? Yes the SWR went down but  from 4.39% to 4% for a 70% stock 30% bond allocation. Still safe. What studies suggesting that the 4% rule is not safe anymore rely on is a combination of lower stock returns AND low bond returns AND higher inflation. I’m sorry but you’re cooking the books. You’re taking a forecast of low future returns for stocks and bonds and forcing it into a model.  I’d rather rely on history without much flawed human forecasting. By the way, the 100% safe withdrawal rate for a 30 year period that comes out of the study linked above is 1.8%! You could even easily construct a 100% bond portfolio to destroy that.

The next 3 paragraphs in the article are pure drivel.”Strict application of the rule also does not factor in how important returns are in the early years of retirement, something known as the sequence of returns.” Uh, yes it does. That’s how safe withdrawal rates are calculated. Next, we get “High inflation early in retirement can have a similar impact, especially if earnings are also low. Taking out more money just to keep up with the rising cost of living will accelerate the depletion of savings, Mr. Finke said” Duh. Again, safe withdrawal rates take this into account by adjusting withdrawals for inflation. Like some old commercial used to say…its in there! Next, “Many advisers recommend maximizing earnings by moving away from the 60 /40 portfolio allocation on which the 4 percent rule is based, says Jay Wertz, director of wealth advisory services at Johnson Investment Counsel Wait we may actually get some advice here…..nope, sorry, see link so you can pay fees.

Now comes the worst part of the article. “Retirees wanting more certainty in the future might consider investing in a deferred income annuity”…..”The annual income usually ranges from 5 to 6 percent of the amount paid for the annuity…” OK, wait. We are supposedly living in this new low return world right? How are the supposed professional investment managers at insurance companies supposed to generate 5-6% payouts in a world of low returns that you just told me I can’t even safely withdraw 4% from. These people buy the same asset classes at the same prices that we do. In a low yield world annuities tend to be a raw deal. Not to mention the fees, and the risk you take on by going with an insurance company. That’s the advice we get, buy annuities? Stunning is all I can say.

Finally, at the end of the article we get some common sense from the founder of the 4% rule, “Mr. Bengen still feels his rule is a good benchmark, but advises clients to spend more conservatively. When he first came up with the 4 percent rule, “people said, ‘How can anyone live on so little?’ Now they are saying it’s too high. I think it’s a lot to ask people who have saved their whole lives to live on 3 percent.” Exactly. After all this drivel your best advice for retirees is sorry you need to live on 3% or less, you better keep working. No other solutions to be offered? Better asset allocation models which maybe give you exposure to market beating assets like value and small cap stocks or lower valued equities like international or dividend payers? How about strategies to reduce volatility like the IVY timing model? How about starting with 4% but having an early warning indicator to tell us if/when we’re in trouble? Nothing. Just live on less and maybe buy an annuity.

In summary, the demise of the 4% rule is greatly exaggerated. It hasn’t failed yet. Even that year 2000 retiree is doing just fine. But yes the future is uncertain, there are no guarantees. The 4% rule may fail in the future. But before we go telling soon to be retirees or worse current retirees, sorry, your only option is to spend less or keep on working to save more, many other options should be considered. When other options are considered, like better asset allocations, volatility/drawdown reduction strategies, early warning indicators, and smarter withdrawal methods retirees can still enjoy 4% and even higher withdrawal rates. Articles like the NYT piece don’t help at all.


Full Disclaimer - Nothing on this site should ever be considered advice, research or the invitation to buy or sell securities. These are my personal opinions only.

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7 thoughts on “The 4% rule lives despite what the NY Times says

  1. Paul. That was a good insightfull analysis. Seeking alpha said 2.5% was the new rate 2 yrs ago, time will tell but 4% is holding up. Tune out the incessant noise of those with an agenda such as annuity sales.

  2. Excellent article and great perspective.

    I think the lesson to be had in this low-yield environment is to be more proactive in rebalancing. When the Fed keeps rates low, rebalance into dividend-yielding equities; when the rates go up, rebalance into bonds. Or just focus on dividend-yielding large-caps and invest for future dividend increases.

    Maybe the 4% rule isn’t dead–passive investing is dead.

    1. Maybe but not yet. With a broadly diversified portfolio the 4% rule is still fine.

  3. Paul – could you elaborate your statement “in a low yield world, annuities tend to be a raw deal”.
    ed bottrell

    1. Sure Ed. Insurance companies invest in the same things we do at the same price. Pretty much anyway. They also try and match their assets with their liabilities in terms of time. So, in general they tend to be big long term bond investors. In a world where long term gov’t bonds yield just over 3%, the guaranteed payouts the companies offer cannot be very high. They can do things like increasing allocations to REITs, stocks, etc.. but the fact that they need to guarantee payouts keep most of their assets in bonds. They are also bound by regulations as to how much risk they can take.

      As an example, probably the best value fixed annuity out there is the one you can get through Vanguard. It offers a guaranteed payout of 4% with payments not adjusted for inflation.


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