The 4% Rule Inventor Now Thinks You Can Withdraw More | Bill Bengen on Why 5% Now Works

Key Concepts

• The 4% Rule: An original rule of thumb for retirement withdrawal rates, suggesting that retirees can withdraw 4% of their portfolio in the first year of retirement and adjust for inflation annually thereafter, with a high probability of their portfolio lasting 30 years.
• Worst-Case Scenario: Identifying the historical retirement period with the most challenging market conditions (e.g., high inflation, multiple bear markets) to determine the lowest sustainable withdrawal rate.
• Inflation-Adjusted Withdrawals (COLA): The practice of increasing withdrawal amounts annually by a cost-of-living adjustment, similar to Social Security, as opposed to taking a fixed percentage of the portfolio each year.
• Asset Allocation: The mix of different asset classes (e.g., stocks, bonds, gold) in a portfolio, which significantly impacts its performance and the sustainable withdrawal rate.
• Market Valuation: The assessment of whether stock prices are high or low relative to their underlying value, often using metrics like the CAPE ratio (Cyclically Adjusted Price-to-Earnings ratio).
• Sequence of Returns Risk: The risk that poor investment returns early in retirement can significantly deplete a portfolio, making it difficult to recover even with subsequent good returns.
• U-Shaped Equity Glide Path: A strategy where equity exposure is reduced at the beginning of retirement and then gradually increased over time.
• Bucket Strategy: A retirement income strategy that divides assets into different "buckets" for short-term, medium-term, and long-term needs.
• Front-Loading Spending: A strategy where retirees spend more in the early years of retirement and less in later years.
• Required Minimum Distributions (RMDs): Mandatory withdrawals from retirement accounts that begin at a certain age, dictated by tax laws.

The Evolution of Retirement Withdrawal Rates: Beyond the 4% Rule

This discussion delves into the historical development and modern refinements of retirement withdrawal rate strategies, moving beyond the traditional 4% rule to accommodate current market conditions and individual needs. The core objective is to identify sustainable withdrawal rates that allow retirees to spend more and enjoy their retirement years without jeopardizing their financial security.

1. The Genesis of Retirement Withdrawal Research

Bill Bengen, a financial advisor with over 30 years of experience, initiated his research into retirement withdrawal rates over three decades ago. Driven by client inquiries and a lack of readily available information in financial planning textbooks, Bengen embarked on a personal quest to find a reliable withdrawal strategy. His initial focus was on identifying the "worst-case scenario" – a withdrawal rate that could survive all historical market conditions.

• Methodology: Bengen utilized spreadsheets to analyze historical data, spanning nearly 100 years (back to 1926). He aimed to find a single withdrawal rate that would not deplete a portfolio under any historical circumstances.
• Key Finding: The most challenging historical period identified was for an individual retiring in October 1968. This period was characterized by a combination of significant bear markets and high inflation, which severely impacted portfolio values and forced increased withdrawals.
• Comparison to Other Periods: While the 1929-1932 period (Great Depression) was severe, it was deflationary, allowing retirees to increase their nominal withdrawals to offset losses. The 2008-2009 period, though significant, was less devastating than the 1968 scenario when considering the combined impact of market downturns and inflation.

2. Understanding and Misinterpreting the 4% Rule

Bengen highlights common misunderstandings surrounding the original 4% rule:

• Misconception 1: Taking 4% Annually: Many believe the rule means withdrawing 4% of the initial portfolio value each year.
• Correct Interpretation: The rule implies withdrawing 4% in the first year and then applying a cost-of-living adjustment (COLA) annually thereafter, similar to how Social Security benefits are adjusted.
• Misconception 2: The 4% Rule as a Starting Point: Some treat the 4% rule as the definitive retirement plan. Bengen argues it should be one of the last considerations, as higher withdrawal rates are often achievable today.

3. The Emergence of Higher Sustainable Withdrawal Rates

Bengen's research revealed that in many historical periods, investors could successfully withdraw significantly higher percentages, ranging from 6% to 10%. The challenge was to find a theoretical connection between market data and these higher rates. A breakthrough occurred about three to four years prior to the interview, linking inflation and stock market valuations to access these "juicy higher withdrawal rates."

4. Factors Influencing Sustainable Withdrawal Rates

Several key assumptions and factors underpin the calculation of safe withdrawal rates:

• Planning Horizon: The original 4% rule assumed a 30-year retirement. However, with increased longevity and the FIRE (Financial Independence, Retire Early) movement, longer planning horizons (50-60 years or more) are becoming relevant.
• Asset Allocation: A healthy percentage of equities is crucial for higher withdrawal rates. Bengen's initial recommendation was 55% equities, but he has since updated this to 65% equities for most retirees, as it generally improves outcomes across the board.
• Portfolio Diversification: Increased diversification, including mid-cap, small-cap, and even micro-cap stocks, has consistently led to higher sustainable withdrawal rates. In one instance, diversification increased the rate from 4.5% to 4.7%.
• Market Valuations: High stock market valuations (e.g., high CAPE ratios) suggest a higher probability of future bear markets, which can be damaging to withdrawal rates.
• Inflation: Inflation is a significant factor, as it necessitates increased withdrawals, which are often locked in for the remainder of retirement. Deflationary periods, while challenging, can allow for increased nominal withdrawals.
• Withdrawal Scheme: The method of withdrawal (e.g., fixed percentage, COLA-adjusted, front-loaded) significantly impacts sustainability.

5. Framework for Estimating Withdrawal Rates

Bengen's updated framework prioritizes inflation first, followed by stock market valuation. This approach acknowledges that inflation is "sticky" and can be more devastating than market downturns, especially when coupled with increased withdrawal needs.

• The "Big Five" Elements for Planning:
  1. Withdrawal Scheme: Fixed percentage, fixed annuity, front-loaded, COLA-adjusted.
  2. Account Type: Taxable vs. tax-deferred accounts, considering tax implications.
  3. Asset Allocation: The mix of stocks, bonds, and other assets.
  4. Legacy Goal: Whether to leave a zero balance or a specific legacy at the end of the planning horizon.
  5. Timing of Withdrawals: When to start taking withdrawals (early, later, or in the middle).
• Additional Factors: Rebalancing frequency (e.g., annually) and the timing of withdrawals.

6. Specific Strategies and Concepts

• U-Shaped Equity Glide Path: This strategy, originating from Michael Kitces and Wade Pfau, involves reducing equity exposure at the start of retirement to mitigate early bear market risks. As the market recovers and time passes, equity exposure is gradually increased. This counterintuitive approach can be beneficial because it limits losses during critical early retirement years, allowing for greater participation in subsequent market upturns.
• Cash Reserves/Bucket Strategy: Bengen's research implicitly incorporates a bucket strategy by including a cash component. While he doesn't see the necessity for complex multi-bucket approaches, a simple two-bucket system (stocks and bonds) is generally effective.
• Front-Loading Spending: This is a viable strategy where retirees spend more in their early retirement years and less later. However, it requires a willingness to accept potentially substantial (25-35%) declines in expenses in later years if market conditions necessitate it.
• Permanent Portfolio: While not rigorously tested by Bengen, the concept of diversifying across cash/short-term bonds, long-term bonds, gold, and stocks is acknowledged for its diversification across economic regimes. However, he expresses caution regarding a 25% allocation to gold due to its historically lower returns compared to stocks.
• Rebalancing: While not always optimal, rebalancing once a year is generally a sound approach for retirees, offering a good balance between simplicity and effectiveness.

7. Personalizing Retirement Planning

Bengen's work emphasizes that personal finance is inherently personal, and a "one-size-fits-all" approach is not ideal.

• Personal Withdrawal Rate: Bengen himself started with a 4.5% withdrawal rate in 2013 and has since increased it to 5% due to favorable market performance. He cautions against letting a few good years dictate permanent increases in distribution rates.
• Social Security's Role: If Social Security covers basic needs, a portfolio can be used for discretionary spending, potentially with lower risk and a more conservative asset allocation (e.g., 40% equities). However, this may limit wealth accumulation for heirs.
• Required Minimum Distributions (RMDs): RMDs are a tax artifact and don't directly dictate withdrawal strategy. Their withdrawal percentages in early years may align with safe withdrawal rates, but they typically don't keep pace with COLA strategies, potentially limiting income in later years.

8. Key Takeaways and Future Considerations

• Updated Withdrawal Rate: Bengen's latest research, detailed in his book "A Richer Retirement," suggests a sustainable withdrawal rate of 4.7% for a diversified portfolio (65% equities).
• Importance of Equities: A minimum of 65% in equities is recommended for most retirees to achieve higher withdrawal rates, though excessive equity exposure (above 70%) can increase vulnerability to bear markets.
• Longevity and Planning: The increasing lifespan of individuals, partly due to advancements in healthcare and AI, necessitates longer retirement planning horizons. Even with extended horizons, withdrawal rates tend to stabilize around 4.1%.
• Central Bank Distortions: Bengen notes that since the turn of the century, central bank policies have led to more significant market swings, making traditional "buy and hold" strategies less reliable. He suggests a potential need for a market reset.
• Personal Philosophy: Bengen emphasizes the importance of family, friends, health, and a passionate interest in life's pursuits for overall well-being and enjoyment.

Conclusion

Bill Bengen's research and insights provide a comprehensive and evolving perspective on retirement withdrawal strategies. Moving beyond the rigid 4% rule, his work highlights the critical role of asset allocation, market valuations, inflation, and individual circumstances in determining sustainable withdrawal rates. The updated recommendation of 4.7% for a 65% equity portfolio, coupled with a focus on inflation-adjusted withdrawals and diversified portfolios, offers retirees a path to enjoy their retirement years with greater financial confidence. The emphasis on personalization and understanding the nuances of withdrawal schemes underscores the deeply personal nature of financial planning.