Revisiting the 4% Rule – Could it Fail?

When William Bengen embarked on his study of safe withdrawal rates from a retiree’s portfolio in 1994, he operated on a couple of key assumptions – 1) that a 30-year time horizon seemed a conservatively long enough period to assume one would live in retirement and 2) past performance of the U.S. financial markets could reflect future probabilities. As a result, Bengen examined the various rolling 30-year period returns of a U.S.-based portfolio invested 50%-75% in the S&P 500 and the balance in intermediate bonds, starting with the year 1926. For a hypothetical retiree beginning retirement at the start of each year, he tested what was the highest sustainable spending rate as a percentage of retirement date assets, adjusted for inflation and meant to last precisely 30 years. He found that the worst case scenario produced a safe withdrawal rate of 4%. Thus the 4% rule was born.

Flash forward to 2015, and one has to ask if today’s retirees can operate on the same assumptions. Which leads me to the article I’m linking at the end of this post. It’s a compelling read as to why the 4% rule, while simplistic and a good way to jump-start the retirement income question, is not something that should be relied upon as the answer. The authors, Wade Dokken and Wade Pfau, present strong evidence that given a current market environment of historically low bond yields, high stock market valuations and increasing longevity, following the 4% rule could actually be to your detriment. Most compelling is seeing how the 4% rule of Bengen’s study would have fared in markets other than the U.S.

The authors put it best.

“It is a fallacy to conclude that just because the 4% rule worked in the U.S. historical data, it can be expected to continue to work just as well for today’s retirees. During the past 145 years, America grew at an unprecedented rate and became the world’s economic superpower. Other developed markets experienced lower growth. The 4% rule has not worked nearly as well in most other developed market countries, for which we have sufficient financial market data to create such a test. While it seems reasonable to focus on U.S. historical data, a century of slower growth will mean lower returns for future retirees.” (from Why 4% Could Fail, originally published in Financial Advisor Magazine, September 2015 edition)

To read the complete article, go here.