4% Withdrawal Rule – How’s it Holding Up?
The 4% rule has been a standard one in the industry for years. In case you are not familiar with it the basic premise is you should be able to safely withdraw 4% from your 60/40 portfolio (60% equities and 40% bonds) in a 30-year retirement period without fear of running out of money. Depending on the severity of the market downturn you may end up just getting by on the skin of your teeth though. For example, the 4% rule was created after taking into consideration investment periods such as the Great Depression. Even in this case the 4% strategy over a 30-year period still resulted in not running out of money, but it did have a lower principal at the end than it started with.
There have been many variations of this simple strategy ranging from higher and lower withdrawal rates to different portfolio constructions. However, you know my method is KISS (Keep It Simple, Stupid) and I thought it was worth looking at the old 4% strategy to see how it has done with the two “crashes” most of us remember – the internet bubble bursting and the Great Recession with the mortgage fiasco. The best data I could find on this is from Michael Kitces and it is a couple of years old at this point. Fortunately, the market has pretty much done nothing but go up since then. Let’s dive into it to see how it fared.
First, besides the Great Depression, since the 1870s there were three other periods where the 4% rate resulted in having less money at the end but still not running out. They were 1937, 1965 and 1966. For the person who retired in 2000 right before the tech bubble burst they would be halfway through their 30-year retirement (remember, this data is two years old). At this point, the 2000 retiree is equal to or ahead of the 1929, 1937 and 1966 retirees. This is not even adjusted for inflation which makes the 4% withdrawal rate of 2000 even better due to lower inflation since 2000. The 2008 retiree, while only 7 years into the 30-year period, is well ahead of all these other illustrations at their respective 7 year points.
The next big point is what kind of crash is it? Is it a quick crash with a sudden recovery, such as 1987 which recovered in a year and 2008 which took two years? Or, is it something like the decades from 2000-2010 or 1966 to 1976 where the market was basically crap for ten years? You have probably already figured out it is much better to have a quick rundown followed by a sudden recovery than a long and slow slog back to your starting point. This is a big part of why the 2008 retiree is well ahead of his counterparts as the market spiked right back up.
Finally, not all 30-year periods are as miserable as the ones I have outlined above. In 2/3 of the periods the retiree has significantly more in principal at the end. And when I say significantly I mean nearly three times their starting point (2.8 times to be specific)! This means most retirees have the ability to increase their spending above the 4% number. However, before doubling or tripling your retirement spending make sure you get with your CFP® to make sure the numbers work in your personal situation.
While there are other retirement withdrawal rules out there I thought it was worth the time to understand why the 4% rule was created and how it has done in more recent times. It is good to know it has been holding together. Now it is up to you to figure out how much you want/need to spend in retirement, which is really the most important factor for retirement success.