The 4% Rule For Retirement Savings Desperately Needs To Be Modernized

Ted

FYI: ( Just a rule of thumb, I'm sure MJG will comment on this subject.)

n 1994, financial adviser William Bengen introduced the concept of the 4% rule, which found that retirees who withdrew 4% of their retirement portfolio balance, and then adjusted that dollar amount for inflation each year thereafter, would create a paycheck that lasted for 30 years.

Now 20 years out from the publication of Bengen’s study, experts recognize that this simple rule of thumb needs some modernization.
Regards,
Ted
https://www.marketwatch.com/story/the-4-rule-desperately-needs-to-be-modernized-2018-07-20/print

msf

"Angie O’Leary is the head of wealth planning at RBC Wealth Management, U.S."

OMG.

O'Leary: "he rule uses a portfolio assumption of 60% stocks and 40% bonds."

Bengen (actual paper): "portfolios consisting of 50-percent intermediate-term Treasury notes and 50-percent common stocks (an arbitrary asset allocation chosen for purposes of illustration)"
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O'Leary: "would create a paycheck that lasted for 30 years"

Bengen: "In no past case has it caused a portfolio to be exhausted before 33 years"
(from this Bengen concluded that if all you needed was 30 years, 4% would work)
---

O'Leary: " modern times require a more dynamic approach to the 4% rule"

Bengen (not so modern times, I guess): "Let us consider first the case where there is a change in the client's goals. ..."
---

O'Leary: "Now ..., experts recognize that this simple rule of thumb needs some modernization. "

Just now? The "rule" has been analyzed, critiqued, modified, qualified, etc. since the day it was published. For solid, substantial yet reasonably readable and moderately short "modernization", from six years ago, here's

Vanguard, Revisiting the ‘4% spending rule’    https://www.vanguard.com/pdf/s325.pdf

O'Leary expresses concern that "Historical [nominal] bond returns for this period were close to 5%, well below what can be expected today." Vanguard somewhat dismisses this concern:

Vanguard believes it’s important for investors to consider real-return expectations when constructing portfolios, since today’s low stock dividend yields and U.S. Treasury bond yields are, in part, associated with lower expected inflation today than 20 or 30 years ago. [Vanguard projects a 50/50 portfolio to be in the 3.0%-4.5% real-return range]. Although this level is moderately below the actual average real return of 5.0% for the same portfolio since 1926, it potentially offers support for the continued feasibility of a 4% inflation-adjusted withdrawal program as a starting point.

While I'm not as confident as Vanguard, their point is well taken - just because nominal returns are not expected to be as high as in the past doesn't mean that real returns won't be in the same ballpark.

O'Leary isn't providing information, just bullet points, points which experts are not "now" recognizing, but have been looking at for decades.

Here's Bengen's original paper, published in the Journal of Financial Planning, not written as piece for Marketwatch:
http://www.retailinvestor.org/pdf/Bengen1.pdf

Ted

@msf: Thanks for filling in the blanks !
Regards,
Ted

Old_Joe

At one time MarketWatch was a pretty decent source for financial information and perspective. It's my feeling that in the last few years it has deteriorated to basically a lot of clickbait crap.

davidrmoran

and just to give further flavor of how much stupider, and fuller of straw, it gets:

"Though the 4% rule has its flaws, it is still a reasonable starting point for retirement planning. So rather than regard it as unassailable truth, ..."

tagline:

"As the 4% rate faces the test of time, it’s clear that retirement readiness is too complex to be codified by a simple rule of thumb"

Dear God. I could never look for guidance or give money to someone as dimwitted as this.

BrianW

@Old_Joe and @davidmoran, on this point we definitely agree. I was not happy when they bought Smartmoney.

Old_Skeet

What has worked well for me and my family as I managed my parents investments while they were in retirement and that was to take no more than one half of what the portfolio's five year total return averaged. Naturally, you have to start with ample principal and live conseratively (but well) through retirement. I grew their principal and their income while they were alive while also at the same taking good care of them making sure they enjoyed life's pleasures. The result was I was indeed blessed and wound up with a nice inhertiance.

Today, I practice the same for me and my wife as I did for my parents. Actually, our income (over the past five years in retirement) has increased and now totals more than what we made during our last five years while were working full time. So, it pays to grow principal even in retirement.

I am not saying this will work for everyone. It is simply what I have done and experienced good success with. The key though is to watch what you spend but to also do some things to enjoy life along the way. And, yes we plan to leave some for our son, daughter in law and grand children as was done for us.

Indeed, we believe in passing some of it forward.

MJG

Hi Guys,

Well, Ted was dead-on-target.

I tried, but failed to resist submitting a comment on retirement planning. It's a life changing decision. There is no simple, single number for everyone.

I have been and continue to advocate for Monte Carlo simulations as a useful tool in the retirement planning process. No other tool will allow you to explore future uncertainties so easily and with so much mathematical rigor. Monte Carlo codes generate thousands of cases to define the likely success odds.

The Internet now provides any candidate retiree access to a number of fine Monte Carlo codes. Don't be intimidated by the Monte Carlo title. You need not be an exert in this or any other mathematical field. Inputs are easy and easy to change to permit a ton of parametric studies. You get to customize your inputs for your special circumstances and comfort level.

I like this Link for an excellent Monte Carlo code:

https://www.portfoliovisualizer.com/monte-carlo-simulation#analysisResults

You can explore many scenarios in a very short time. The codes most significant output is a projection of the survival odds for whatever your withdrawal rates or time period are input. I recommend that you test varies assumptions and possibilities. No problems! Enjoy and learn.

Also, good luck.

Best Wishes

Old_Joe

The rest of us were just acting as temporary filler. We all knew that you and Monte Carlo would come along sooner or later.

BrianW

@Old_Skeet: may I ask, how did you handle a one-off event such as the 2008 crisis? I would imagine such an event would dramatically skew the average.

MJG

Hi Old Joe,

Thanks for reading my fully predictable contribution.

It has been some time since I talked Monte Carlo. I'm sure many new MFOers have joined us since I last made a similar recommendation. That code is a powerful tool that will benefit any user who does what-if scenarios. I'm not sure of many things, but I'm absolutely optimistic about the benefits of Monte Carlo analyses.

As always, Best Wishes

Old_Joe

"It has been some time since I talked Monte Carlo."

Hello to you, @MJG- Yes, it has. I was getting worried that perhaps some health misfortune had befallen you. Glad to see that you're still in one predictable piece.

OJ

Old_Skeet

@BrianW,

Thanks for your question as to how I transversed the market swoon during the "Great Recession."

Without going into great detail; but, explaing what I did and why. My parents passed in 2004 so I got step ups on the assets I received from their estates. When 2008 came and the market began to pull back I was at about 70% equity at the time and I sold down when a position developed a 10% loss and continued to do so until I was about 40% equity. Since, a good bit of my investment wealth was in a taxable account this put a sizeable loss on my books. Also, I was at about 40% equity when the S&P 500 turnned upward at the "Devil's Number 666" and sitting on a wad of cash. As the market turned up I began to average back in asset classes that had the faster moving currents. Having a sizeable loss on my books I was able to reposition from time-to-time booking profit and using the losses to cover my gains. I was able to do this for a good number of years and getting my portfolios position pretty much like I wanted them. In time, I started reducing equity and again selling down equities as the markets continued to advance keeping my asset allocation in mind. In addition, I made some nondeductable contributions to mine and my wifes IRAs. Today, these nonductable contributions help as we take RMDs as they are not fully taxable due to the nondeductable contributions made. My accountant deals with this.

Currently, in retirement, my family's portfolios combined bubble at about 15% cash, 35% domestic equity, 15% foreign equity, 25% fixed (bonds) and the rest in other assets such as convertibles, perferreds, commodities, etc. For what it may be worth I consider this to be an all weather asset allocation. In the past several years I have not done the buying and selling (repositioning) that I once did as I have fully used the losses. However, I still do some selling to harvest some of the gains over time but keeping joint income (husband and wife) back of the threshold for higher medicare premium assesments.

There you have it ...

Old_Skeet

BrianW

@Old_Skeet: thanks for the information, it was very helpful.

Old_Skeet

Since, the stock market now sits towards all time highs perhaps some other retail investors that went through the Great Recession will comment on how they tranversed it. I am sure there were more ways than just one to do this with good success. A point of infomation about my above post. I did very little selling in my mine and my wife's IRAs and they recovered just fine although I did go towards a more aggressive equity asset allocation in them as the market began to recover. Note, we were not taking distributions from the IRAs when the Great Recession came upon us; but we were taking from the inheritance account to improve our standard of living. My answer now being in retirement is to hold more cash and take no more than one half of what my five year average total return is in my portfolio and to reduce spending during periods of market declines. In this way my portfolio grows over time so when a good market dip or swoon does come and the portfolio loses value my valuation drop want sting as bad as it otherwise would had I not grown its valuation. I'd sincerely be interested in learning what other retail investors did (within their own portfolio) to navigate their way through the Great Recession. Perhaps, we will hear from some that were taking distributions during this period and some that were within a few years of retirement as I was. With my current asset allocation I figure I can weather a 25% decline in the equity markets pretty well and have a portfolio decline of about eight to twelve percent perhaps no more than fifteen. Interestingly, this seems to be the amount of cash I currently hold (15%). Again, I'd reduce withdrawals along with spending. RMD's could if necessary get reinvested in mine and my wife's joint taxable account. My current withdrawal rate is about 2% of all the portfolios combined investment value. The portfolios generate income at about 3% plus any capital gain income distribution when combined bumps the total income yield upwards toward the 4% to 5% range. Again, an interestingly, I am holding about three to four years of portfolio income generation in cash.

davidrmoran

This has already been posted in some form, I bet:

https://earlyretirementdude.com/summary-tuesdays-reddit-interview-inventor-4-rule/

bee

@davidrmoran,
As for inflation, a well diversified portfolio (especially equities) should inflate with inflation...one would hope. TIPS inflate by external means (posted by the government), but equities over time should inflate as a reflection of "equity inflation"..much like Real Estate inflates over time.

I wonder if inflation adjustments, with regard to retirement withdrawals, should be derived as a reflection of these embedded inflationary elements of one's portfolio rather than a fictitious derived number that may or may not be reflective of one's portfolio. Keeping up with inflation requires a portfolio that at least inflates proportionally with external inflation. If it doesn't, these external inflation adjustments could prematurely wipe out a portfolio.

To me RMD is an interesting alternative to the 4%, 4.5%, etc rule. As you age RMD withdrawal percentages increase (as a result of amortization not inflation). The RMD withdrawal method can be tailored to a starting age other than 70.5.

I believe a retirement portfolio's biggest challenge is adjusting withdrawals for prolonged market downturns that are also accompanied by rising inflation. An RMD withdrawal schedule accommodate this possible scenario, but a fix withdrawal plus additive inflation adjustments may not.

davidrmoran

thanks ... I just ran several rmd scenarios (vanguard calculator) for me and my wife, with a mix of actual and imagined asset totals and returns, and the percents all came in at around 3.65 - 3.8%, which was very interesting.

I mostly want to know when I can start prudently giving small amounts to my kids, even with 25y to live max ...

tnx for your thoughts; I would not have considered it, and it still looks conservative.

VintageFreak

Now I've heard everything "modernize" a "rule".

Reminds me of a ... I met once who didn't understand when I told him I'd set up a "file server" in my house for the past 20 years. His blank stare turned to englightenment when I said I have a "private cloud".

On another note, isn't someone publishing an article on this topic every other week? I really don't understand why anyone has to be obsessing about 4% or 7%. You live in retirement based on how much money you have saved up and you withdraw based on how much you are required to because of RMD.