When The 4% Rule Works

Jul 3, 2020

This week I’m talking about the 4% rule. 

The 4% Rule is a short-hand rule of thumb that helps you calculate how much of your portfolio you can safely withdraw in retirement without running out of money.

This week I've been mostly critical of the 4% rule, but today I want to talk about when the 4% rule does actually work. 

Because even though it has some significant limitations and you shouldn’t rely on the 4% rule for retirement, you can rely more on the 4% rule if you check a few important boxes. 

First, I think some background on where the 4% rule came from will be helpful to understanding whether or not the rule actually works. The 4% rule came out of research by financial planner William Bengen in the early 1990s. Bengen tested a variety of withdrawal rates on several different investment portfolios using inflation data and investment returns going back to 1926. 

After crunching the numbers, he concluded: "Assuming a minimum requirement of 30 years of portfolio longevity, a first-year withdrawal of 4%, followed by inflation-adjusted withdrawals in subsequent years, should be safe."

So what are the scenarios where the 4% rule is more likely to work: 

• If you have a balanced portfolio - a portfolio that has 40, 50, or 60% stocks in retirement is more likely to work with the 4% rule. The good news is that most retirees portfolios fall somewhere between 40-60% in stocks
• If you’re willing to adjust - As I’ve mentioned in earlier episodes this week, if you can be flexible to cut your withdrawals when your portfolio drops in value, you’re more likely to make the 4% rule work for you in the more normal years
• If you have the ability to accurately track and adjust your spending for inflation. A key component of the 4% rule is an adjustment to your spending for inflation. So you do have to do some legwork each year to recalibrate your spending to account for inflation.

If you maintain a balanced portfolio, are willing to make adjustments to your withdrawals, and track inflation, you’re more likely to be able to make the 4% rule work for you in retirement. 

That’s it for today. Thanks for listening. My name is Ashley Micciche and this is the One Minute Retirement Tip.

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