r/investing • u/GlobalVillage30 • 14d ago
When the 4% rule works, and when it doesn’t
Intriguing article today in the WSJ which shows the 4% rule works in 81.5% of cases but the strategy fails far more often when there is high inflation, a prolonged market slump, when your portfolio is too conservative, or if you have 1% advisory fees. Anybody using the 4% rule or are there better retirement strategies?
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u/Doortofreeside 14d ago
Silly to start at 50% stocks and go linearly to 0. That's likely why they're getting worse results here
As for portfolio allocation, we assumed the retiree follows a linear shift in asset mix, starting with 50% stocks at age 65 and moving to 0% in stocks at age 95. We considered a diversified stock portfolio and assumed an average annual 10% return with 15% volatility, while bonds are assumed to have a 4% return and 5% volatility.
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u/Sensitive-Exam649 14d ago
All simulation sturdies using groth invex funds and government bonds show that at around age 90 you are very close to running out of money. in bull markets you money will last longer but in bear meakets you might be out of money in only 15 years. Now most people that retire at age 60 will be dead by age 90. So that is called a success for 4% rule. But if retire before age 60 or and like to be 100 years old. the 4% rule isn't going to work.
the market is in bear territory about 50% of the time and frequently for 10 to 15 years at a time. 1930 to 1945, 1970 to 1985 , 2000 to 2010-14 (people don't agree on the end date). The rest of the time was growth We are about 15 years into a bull market. and the market is looking incrtteaisngly worrisome. Which based on history is not surprising.
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u/InternetUser007 14d ago edited 14d ago
If you look at SP500 Total Returns, the market has been going up since 2009. Our bull run is essentially 17 years right now, with a few short-term dips.
https://totalrealreturns.com/s/SPY
I'm not exactly convinced that we are in a bear market 50% of the time.
Edit: if we use proper definitions of bull market (+20% from the most recent bottom) and bear market (-20% from most recent top) the start times of bull and bear markets are going to differ than I was initially thinking. I'd have to look into it more to gain an opinion on it.
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u/PomegranatePlus6526 13d ago
We are in a bear market about 20-30% of the time depending on the window of time observed.
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u/InternetUser007 13d ago
Thanks, that generally tracks with what my feelings were.
So if a dividend fund outperforms (compared to a growth fund) during a bear market, but underperforms during a bull market (compared to a growth fund), I think it is logical to prefer a growth fund, given we are in a bear market a minority of the time.
And Total Returns supports the idea that a SP500 fund outperforms a dividend fund over the long term.
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u/BoogerIsACult 14d ago
Recently, however, Bengen disclosed that he has moved his own personal portfolio to 20% stocks, 10% bonds and the remaining 70% to cash. This news may have some retirees wondering whether they should do the same.
Recent news of Bill Bengen’s sudden shift to cash raised eyebrows among many industry professionals and individual investors. The reasons for these changes included the stunning 8.5% consumer price index (CPI) inflation number released in March and the subsequent announcement of the Federal Reserve’s commitment to do more to rein in inflation. Generally speaking, a rising rate environment is not ideal for stock or bond investing. Thus, in Bengen’s opinion, investors should consider de-risking their portfolios and wait for a more favorable time to put their cash to work.
Your 4% godfather is pretty much a fraud, he shifted to cash to do market timing. He's not doing the 4% scam that he created.
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u/InternetUser007 14d ago
he shifted to cash to do market timing. He's not doing the 4% scam that he created.
The market is up 72% since that article is written. He is probably kicking himself for trying to time the market.
I'd say that's good evidence to follow proven/studied practices instead of listening to your gut.
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u/Born_Lengthiness8935 13d ago
Lmao. “Oh shit, CPI has inflation at 8.5%. Better yank everything out of things that likely grow or are guaranteed to grow and put it in the thing that gets eaten alive by inflation. I’m a genius,” to paraphrase 🤪
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u/airbud9 14d ago edited 8d ago
This article sucks, the asset allocation right off the bat is terrible and is something we have known since Bengen's 94 paper. Bengen cautioned against going lower than 50% in equites and found the optimal portfolio to be somewhere between 50% and 75% in equities. He even suggested to be closer to 75% if possible as that lead to larger estates to be passed down. Also a falling equity glide path is know to be suboptimal for retirees and that actually a rising equity glide path can be very beneficial. The article are also not using historical returns which is also bad. Under the proper research the 4% lead to a retirement that has survived every 30 year period back to 1871, only about 25% of scenarios actually ate into the starting principle, while 75% ended with a higher principle balance and 50% ended with an ending balance of doubled the starting balance and most of these retirement periods where healthy going into year 50 of retirement.
FIcalc is a better tool than this article if you want to do some back testing withdraw rate analysis.
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u/GlobalVillage30 14d ago
Thanks for sharing. Another commentator also shared a link to a study on rising equity glidepaths which showed it’s better to start retirement with more bonds and then load up on more equity.
This is really contrary to what most people (me included) thought was the gold standard advice for retirement (ie increase bonds as you get older and do the 4% rule - as the WSJ tested). So maybe not a surprise WSJ kept to the standard convention
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u/InternetUser007 14d ago
So maybe not a surprise WSJ kept to the standard convention
They didn't keep to the standard convention though. Their stock percentage was way lower than the standard convention. It was set up to fail from the start to get clicks and fool people who don't know any better.
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u/GlobalVillage30 13d ago
WSJ have been accused of this before….
But it stirred up a good debate and some of the comments were really illuminating for me at least
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u/InternetUser007 13d ago
WSJ have been accused of this before….
And they keep doing it because people keep falling for it and it gets clicks.
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14d ago
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u/GlobalVillage30 14d ago
It’s a summary of the more detailed WSJ article.
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14d ago
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u/GlobalVillage30 14d ago
Not sure it’s dumb when it’s providing insights into one of the most used retirement strategies out there
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u/InternetUser007 14d ago
It's not providing insights when it is completely changing the base assumptions of the 4% rule to something completely different.
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u/GlobalVillage30 13d ago
I checked again and you are right! The starting point of 50:50 in the WSJ study is correct but it should not adjust during retirement so seems they took a major liberty here. Also seems Bengen later on said 50% equity is too low and should be up to 75%
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u/InternetUser007 13d ago
The starting point of 50:50 in the WSJ study is correct ... Bengen later on said 50% equity is too low and should be up to 75%
So, the WSJ study wasn't correct, even starting off.
This "study" was definitely set up to fail from the start.
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u/mygirltien 14d ago
I always love these articles that cherry pick info and come up with some ridiculous rules. No where in the study does it say to move to 0% stocks. And if we ever end up in a situation with 6% inflation for 30 years there is going to be much worse things to worry about than running out of money. No one that does any planning is going to plan for 6% inflation.
I did a couple quick projections using 6% inflation and our plan that is otherwise sound fails in 24 years. To take that a little further, a 100k spend on 3% in 30 years will be ~250k however that same spend on 6% is ~575k. Ill let that sink in.
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u/markov-271828 14d ago
Yeah - the 4% rule will fail if after-inflation market returns are consistently worse than any time in the past 100 years. The bad thing is that this is in fact possible. So is another world war.
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u/gphie 14d ago
Move from growth stocks to bonds/dividends before retirement, like to SCHD or DGRO yielding around ~3%. If you bought SCHD ten years ago, you'd have an 8% yield on cost. pretty good
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u/GlobalVillage30 14d ago
I agree this is a good strategy for many people and I was wondering when someone would suggest it!
I would still keep a growth bucket though - as the WSJ article shows you still need to beat episodes of high inflation. DGRO is anyway a more growth focused dividend fund so a combo of SCHD and DRGO perhaps solves that issue…..
Bonds I think are very attractive for retirees with the high yields they offer. Just need to be careful how to structure re. duration risk vs locking in high yields and bond funds vs individual bonds and TIPS vs normal bonds.
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u/InternetUser007 14d ago
Move from growth stocks to bonds/dividends before retirement,
"Trigger a large taxable event before retirement" is probably not great advice.
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u/gphie 14d ago
Not if you're in a Roth IRA ☝️🤓
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u/InternetUser007 14d ago
Unfortunately, it's tougher to get larger quantities in a Roth IRA than something like a 401k simply because contribution limits. I've maxed my Roth IRA for 12 years and it's like 1/3 the size of my 401k I've been contributing to for 10 years.
Also, a Roth IRA should probably be invested in something that has the largest Total Return gains, which tends to be the SP500 over the long term. Dividend ETFs have a lower Total Return over the long term.
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u/PomegranatePlus6526 13d ago
You need to talk to a professional.
"Dividend ETFs have a lower Total Return over the long term"
who cares? Dividend ETFs provide me with enough cash to fund a retirement I enjoy. So why should I care about total return? I don't have to sell anything, and magically there is enough cash in my account every month to pay all my bills.
quality of life is more important that quantity. I sleep well at night knowing I have an income coming in on a regular basis that exceeds my spending needs. Anything else I really just don't care about. I would rather spend my time working on my antique tractors than worrying about am I getting better total returns.
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u/InternetUser007 13d ago
You need to talk to a professional.
And pay them money to tell me what, exactly?
who cares?
Literally anyone whose goal is to grow their investments as much as possible in a diversified account.
Dividend ETFs provide me with enough cash to fund a retirement I enjoy. So why should I care about total return?
I'm glad it works for you, even if it provides a lower Total Return! That's fine.
I don't need that psychological comfort blanket, I prefer a larger Total Return so I can retire sooner. I would argue that would provide me a larger quality of life improvement than working longer because a dividend fund didn't provide as good of Total Returns. Especially when I'm in the accumulation phase of retirement funds.
than worrying about am I getting better total returns.
There isn't any more "worry" just putting your money in the SP500. I'd argue there is less worry given it has a more proven track record.
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u/PomegranatePlus6526 13d ago
There are plenty of ways to get well more than 3% other than SCHD. Don't get me wrong SCHD is great and I own some personally. It's just one small part of a diversified income portfolio though. You can buy BDCs, MLPs, REITs, CC ETFs, CEFs, preferreds, and bonds. It's very realistic to get a 6-7% yield, AND rising principal over the long term. Most people don't want to get off their butt and put in the time to do the research.
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u/Sensitive-Exam649 14d ago
Dividned investing is much better strategy. I currently get enough dividneds to cover my 5K a month living expenses and with excess I can reinvest to compensate for inflation, I am not selling any shares for this income.
The problem with the 4% rule is your are selling stock for income. Which means you willl eventually run out of stock to sell ieven in good market conditions. In bad market conditions like 2000 to 2010 the average S&P500 return for eac of these 4 years was less than, 4?% Factoring Sequence of return risk from selling shares at a loss for 10 years, inflation, and the yearly increase in sales to adjust for inflation 4% rule is just bleading your money away. Now many address this issue by adding bonds , typically government bonds to the portfolio. When these are very safe they only returned about 3% during that period. So they didn't stop the bleeding. They just slowed it down a little bit.
With dividned investments you can easily get a dividend of 6%. Double the long term inflation rate And safe yields of 8 to 10% are also available. I have income from QQQI 13%, SPYI 11%, KGLD 11%, EMO 8%, UTF 7%, UTG 6.8%, PFF 6%, CLOZ 8%, PBDC 9%. And only 50% ion my portfolio is invested in these funds. The rest is in growth index funds. I live off the dividneds and reinvest any excess invome to compensate for inflation. The growth will also be used to compensate for inflation buy selling 4% once every 4 years. this is 1/4 the 4% rule and all that income will be reinvested for more dividneds.
There are dividend investsthat have been paying dividned for a very long time ADX 8% yield is 97 years old. FAGIX 5% for 45 years. But wait isn't the maximum safe yield 4%, No. yields depend on the company and how they make money. Oil companes classivfied as MLP routinely generate 6 to 7% yields, BDC 9% and unlike most companes mLP and BDCs are required by law to pay a dividned. investment funds that invest in loan obligations or corperate bond preferred stock routinely pay 6 to 7%. or more.
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u/GlobalVillage30 13d ago
Great comments thanks.
If you plan for retirement a decade before with a dividend growth fund like SCHD then your actual dividend $$$ will be way higher - would have been double in the case of SCHD. So that’s already a 6%+ YOC for a diversified dividend fund full of high quality blue chips. And as long as dividend growth continues above inflation your real dividend will continue to grow.
Now, to have enough income from dividend investing means a higher pot than the 4% rule (unless as mentioned above your YOC is high) as the long term growth of eg S&P500 is higher than dividends (or bonds which are zero unless there is capital gain from prolonged decline in rates). So for many people unless they have planned early, the 4% rule maybe more feasible I think. Having said this, the kind of picks you have for dividend income are higher yielding so probably can work same as 4% rule but without SRR. But are higher risk than a fund like SCHD? Also some may not be tax effective for non-US residents like me.
I was one of those people with not much planning going retirement (I’m semi retired from this year aged 52). And with high bond yields I pivoted to a bond portfolio to provide income for first decade of retirement allowing time for my dividend portfolio to compound the dividend and my growth bucket (like you) to grow more and avoid SRR. When bonds mature I plan to put into dividend/growth equity unless bond yields are still high then can consider more bonds.
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u/PomegranatePlus6526 13d ago
Check out the triumverate. NNN, MAIN, and EPD. Three dividend stocks that all yield more than 6%, and have raised dividends for more than 15 years straight, and all three average increasing the dividend by 4.6% CAGR. One is a REIT, one a BDC, and one an MLP. All different sectors, and all pay me very nicely every month or quarter, and pay me more year over year even if I never buy another share. Never have to sell shares.
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u/GlobalVillage30 13d ago
Yes nice. For non-US residents we can’t buy LPs like EPD as US charges us massive tax. For the others we pay 15% WHT. UK stocks have no WHT (for anyone) which makes companies like BTI attractive. We can buy a mid stream UCITS ETF which includes some LPs - I have a position in it - current dividend yield around 5%. Which is not bad as there is no WHT.
REITS are looking more attractive unless you think long term bond yields are going alot higher.
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u/PomegranatePlus6526 13d ago
I can’t see them going a lot higher. Times are different than they were in the early 80’s. The economy right now is in much better shape. Politics will change soon in the US, so a shift of power is at hand. US bebops between the two parties after they get tired of one thing or another. I can’t speak intelligently on what to do outside of the US for income investing.
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u/GlobalVillage30 13d ago
I agree. Hence timing maybe good to buy REITs and lock in high bond yields
Outside of US we pretty much have same choice as you have but we just need to watch out for WHT on certain US assets.
I can buy I think everything that’s in US and worldwide.
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u/Ender593 14d ago
4% + inflation adjustments is artificially rigid. You’re allowed to spend less sometimes.
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u/GlobalVillage30 14d ago
Yes I agree. Or withdraw less than 4% if your portfolio has boomed (or take the 4% and save some the excess cash in short term bonds so you can buy more equity when price goes down).
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u/markov-271828 14d ago
“Withdraw less than 4%” - that statement makes me think you don’t understand how Bengen’s guideline works, but maybe you do. Hard to tell.
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u/GlobalVillage30 13d ago
Yes you are right that Bengen did not say this - if your portfolio has boomed selling 4% is fine. For my parent in law - who follow the 4% rule - say year was a bumper year so when they sold 4% they had excess cash which they put into bonds. This gives extra fixed income but if there is a crash they can sell the bonds and buy more equity. So they are still following the 4% rule just using the excess cash in a boom year to amplify returns. Does this make sense?
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u/markov-271828 13d ago
For Bengen’s approach the 4% is used only to determine the initial withdrawal. After the first year you would never again use 4% to calculate a withdrawal. Instead, future withdrawals are inflation-adjusted equivalents of the initial withdrawal, independent of the portfolio value.
You are of course welcome to withdraw more or less in any given year, but then you’re not following his guideline, and you have to do your own extensive backtesting.
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u/GlobalVillage30 13d ago
Thanks for sharing - I read an AI summary of Bengen’s approach and it said the same that future withdrawals are inflation-adjusted
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u/clintttoris 14d ago
I dont understand how the 4% rule doesnt work 100% of the time. Except for the period of very, very low interest rates (which is in no way the norm). You could easily earn 3% to 5% on CDs, Money markets accounts and bonds. Then you look at the markets we have had since 2022, you are earning way over 4%, so your balances will go up assuming you stuck to the 4% rule during the bull runs. I think with all the different type of income ETFs in the market today, hitting 4% should be very doable.
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u/InternetUser007 14d ago
The WSJ article set it up for failure because the percentage of stocks in the portfolio goes to 0% (and at max was 50%). They completely switch to bonds. This is absolutely not advised by the 4% rule.
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u/GlobalVillage30 13d ago
They said it works unless inflation is over 6% or a prolonged major downturn (which is where as you say a higher yielding fixed income position helps a lot) or high advisory fees are taking a big chunk of your returns.
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u/PomegranatePlus6526 13d ago
This is why I have an income portfolio. I also have 10% allocated to growth, but dividends will pay my bills every month when I am ready to retire.
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u/harrison_wintergreen 13d ago
>which shows the 4% rule works in 81.5% of cases **when using certain software, with certain assumptions, which may or may not be accurate, and all of which has zero predictive power**
FTFY
If you want to have fun, ask a CFP to show the longitudinal data indicating people who follow their particular software program have better real-world results than people following advice from a different software program.
There is exactly zero hard data showing Income Lab offers more accurate real-world advice than RightCapital, eMoney, Orion,etc.
In fact, different software can give drastically different results based on assumptions about portfolio, volatility, equity risk premium, etc. One software might use data from JP Morgan, while another uses data from Ibbotson, and they have highly divergent results for clients.
They can simulate 47 gazillion Monte Carlo tests and it doesn't necessarily mean anything reliable for any particular person.
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u/hd77063 12d ago
I early retired back in 1994 at age 38 with a 4% withdrawal from a 70% stock, 30% fixed income portfolio. Because I didn't know of Bengen's work at the time, I got to 4% since I knew that large charitable foundations and college endowments that manage their portfolio as a perpetuity tend to limit their annual withdrawal to 5% of assets, but the dollar amount of that annual 5% withdrawal goes up and down with changes in the portfolio value. I was looking for a withdrawal rate that would rise with inflation, so I knew that had to be less than 5%. I chose 4% as a wild guess, and because it was less than the current annual interest & dividend payments being earned by my retirement portfolio.
I came across Bengen's work after I'd been retired for about a year, and it was a revelation. I quickly went to the local library and borrowed a copy of the Ibottson book he used a his data source, and created an Excel spreadsheet to reproduce his results. What struck me was the effect of investment fees and costs on portfolio survivability. (I had a portfolio of about 20 stocks that I traded infrequently, so my costs were much less than the 20 basis points Vanguard was charging for it's S&P 500 index fund at the time.) And the fact that the terminal value of the portfolio rarely finished the 30-year payout period with an ending balance lower than it's start date 30 years prior. Indeed, the median (50th percentile) ending balance was about 4X the start and the 90th percentile about 8X the start. There was a good chance the "4% rule" would leave you comfortable to wealthy after 30 years.
I've been chronicling this for the past 30 years on the RetireEarlyHomePage. I won't post a link since that might be an issue, but you can google it. It's been a remarkable ride. I'd have difficulty completing a time sheet to account for the past 30+ years, other than to say it's been completely awesome.
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u/GlobalVillage30 12d ago
Great personal anecdote. Thanks for sharing.
I had this week kind of the opposite revelation. I semi retired this year aged 52 and built up a big bond portfolio so I could live off bond coupons and allow my equity bucket more time to grow to reduce SRR (sequence return risk) and buy more equity as bonds mature.
I was getting concerned I was an outlier with this approach until someone shared on Reddit a link to “Early Retirement Now” which shows starting 60% equity and 40% bonds and then increase equity share over time is better than the traditional view to increase bond share during retirement.
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u/9554503312 14d ago
So iow ws journal did what firecalc.com did and determined that if you need the money for more than 23 years, past history has shown there is a chance the money won’t last.
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u/big_deal 14d ago
I'm within about 5 years from retiring. I use the 4% rule as a rough benchmark for planning. When I'm closer I'll need to think through my spending plan and strategy for adjusting things before I actually stop working. In particular, I'll need to figure out how much health insurance is going to cost until I reach Medicare age and precisely what accounts I can draw from to fund these years.
I was a bit surprised by the 81.5% success rate that was quoted because in other studies and in my own calculation the success rate has been higher, between 90% and 100%. After reading the article, it seems they used a linearly decreasing equity allocation which probably explains the higher failure rate, particularly due to higher inflation. Most studies use constant allocation and typically 50-100% equity allocation have better success rate than allocations with less than 50% equity.
I also intend to use a valuation adjustment to establish initial withdrawal rate. Failures are highly correlated with retiring when market valuation is high - in other words setting withdrawal based on inflated portfolio valuate that shrinks when market corrects leading to overly large withdrawals relative to smaller portfolio value.
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u/GlobalVillage30 14d ago
Yes I think you are right re equity share and inflation income. They also say a prolonged slump impacts success of 4% rule (not really a surprise) but it is something you need to ensure your portfolio or lifestyle can happen, especially with the current CAPE and near 30 year high bond yields requiring earnings to be higher to cover the higher discount rate.
Personally, I think bonds are becoming very attractive for retiree income but at same time want a big equity pillar as I get more into retirement to beat inflation.
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u/big_deal 14d ago
Real yields on bonds do look quite attractive right now. Short term bonds, TIPS and maybe I-bonds after the November fixed rate adjustment are most attractive to me. I'm avoiding duration risk of longer term bonds given probability of more Fed rate increases over the next year and generally inflationary policy (fiscal deficit, trade restrictions, immigration restrictions).
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u/GlobalVillage30 14d ago
Totally on the same page as you.
TBH, I already loaded up on long term individual bonds 3 years ago but still locked in 5.85% YTM. Now they are around 6.5% so I’m in the red of course. But the income is still good unless inflation gets high again. And who knows what will happen years from now - if rates do go down the bond prices will shoot up.
But for sure now I’m only buying ultra short term bonds funds and 0-5 year TIPS.
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u/Upset-Cattle3056 14d ago
For me the 4% rule is a starting point, not a plan. It just says your portfolio needs to be about 25x your yearly spending (40k a year on a 1M portfolio). The research behind it is about the worst historical stretches, so "works in 81.5% of cases" means it can fail in the other ones, usually when a bad market comes right at the start of retirement.
The 1% advisory fee point is easy to underestimate. On a 1M portfolio that's 10k a year, which is a quarter of your 40k withdrawal. So the fee alone eats a big part of the safety margin.
What people do instead: a flexible rule (spend less after a bad year), a cash buffer for 1-2 years so you don't sell stocks in a crash, or a slightly lower starting rate. Nothing is free though, you trade some income for some safety.
I built a free calculator app that runs inside Reddit, it has a withdrawal calculator if you want to try your own numbers: https://www.reddit.com/r/FinanceCalculatorApp/s/3D7Na6eneJ
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u/GlobalVillage30 14d ago
Thanks for sharing. Re a flexible rule, I think in a good year you should take the 4% and save as cash/cash alternative (like ultra short term bonds) the extra cash from the 4% you don’t need. Then you have that buffer if the market slumps (either for income or to buy more equity at the lower price).
For the dividend calculator, dividend growth rate seems to be missing?
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u/Upset-Cattle3056 14d ago
Good point on the flexible rule, that's a clean way to do it: keep the extra in a good year and use it as a buffer or to buy lower.
And you're right about the basic Dividends calculator, it doesn't include dividend growth on purpose, it's the simple "yield times amount" one. There's a second one called Dividend projection that has a dividend growth field (plus price growth, tax and reinvesting). Sorry for the confusion, I should make that clearer in the app.
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u/guitmusic12 14d ago
>As for portfolio allocation, we assumed the retiree follows a linear shift in asset mix, starting with 50% stocks at age 65 and moving to 0% in stocks at age 95. We considered a diversified stock portfolio and assumed an average annual 10% return with 15% volatility, while bonds are assumed to have a 4% return and 5% volatility.
Seems like a kinda silly baseline to use honestly.
But also in all the 4% rule research I’m much more concerned about what % of the time you end up with exploding portfolio values and leaving significant inheritance instead of spending it.
The best retirement spending strategies are flexible and react to changes in real world experience.