That was my thought as I read this article from Barron's that has Morningstar suggesting that new retirees only take 3.7% in 2025 instead of the typical 4%. In November we wrote about the guy who created the 4% rule saying 7% is probably ok, Morningstar says 3.7% based on expected stock market returns. Expected equals guess. That guess could very well be right, returns might be less over the next ten years than the previous ten years but the process that created the 4% rule addressed that with testing that started in 1926. Bengen, the guy who derived the 4% rule, said 4% was the worst case scenario so when someone like Morningstar says something lower, as we say at the fire department, slow down and process information. 4% was the worst case. Bengen says that now, with a couple of more decades to add to the study, the worst case, worst case, has inched up closer to 5%.
The annual inflation adjustment also seems like an unnecessary complication. If last year, you took $38,000 and then price inflation was 2.9% you'd lift the $38,000 up to $39,102. Growth in the portfolio takes care of that. A $38,000 withdrawal implies $950,000 in retirement assets. If the investor was up 10%, $950,000, less the $38,000 plus the 10% gain of $91,200 leaves the investor with $1,003,200. Taking 4% of $1,003,200 the next year would equal $40,128.
Making it even simpler, for years I've said just take 1% every three months. Whatever the value of the assets at the end of the quarter, take 1%. Yes, there will be flexibility required every few years if the market is down a lot. Even then though, if you've set aside money toward expenses, that is to avoid an adverse sequence of return, you may not need to reduce what you take or if you have some sort of first responder defensive holding that will go up a lot when stock go down a lot, you can sell that after stocks go down a lot to increase the cash on hand.
In Bengen's study, 4% never failed. I don't believe 5% ever failed. It would take many things going wrong all at once for a quarterly withdrawal 1% or 1.25% to end up failing. For anyone really worried about this, I would suggest figuring out how to create another income stream. I'm not being snarky with that, my wife an I have another income stream, but not because I am concerned about 4-5% failing. Here's why in response to the following comment.
Mr. Hauck, that's not what the 4% is really about. I've never heard Bengen or an anyone else say this but it's a point that I've thought for years is crucial to what the 4% rule is really about. The 4% rule is really about giving yourself the flexibility to pay for very expensive and unexpected things. I don't mean a $1200 vet bill, I mean very expensive things.
Take the scenario above taking $38,000 at 4% of $950,000 or $40,128 the next year. Could something happen with your house that is very expensive and not covered by insurance cost $20,000? Relative to a comfortable $40,000 withdrawal, $20,000 is a lot of money and now you're at 6%. What about a scenario where one of your kids needs help that is expensive? Would you say no? I realize that some people would say no, I am not judging either way but in your life what are some things that could come along that might be very expensive that could throw off your comfortable 4-5% withdrawal rate? Where I live, I've heard stories of wells failing, foundations failing, a little less dramatically something involving roads or driveway access could be expensive too.
Taking only 4-5% most of the time allows for absorbing the occasional financial hit. If we take the $950,000 example at the start of 2020 and following through to now assuming returns 300 basis points lower than the Vanguard Balanced Index Fund in up years, so disregard the 10% gain I mentioned, and taking 4% per year would now have $1,060,000. It's a useful period to study because of the big drop in 2022. Now, at the start of 2025 a $31,000 fixit comes long, plus the $40,000+/- withdrawal. This might not be comfortable but unless VBAIX goes down 40% next year and that's all they're 100% allocated to that fund, this isn't a catastrophic event.
Rewind back to the $950,000 at the start of 2020, everything the same expect the withdrawal rate was 6% all the way through and the current balance would be $954,000. Now comes the $31,000 fixit and the 4% withdrawal. That's about $70,000 out the door.
How many expensive fixits should we expect over the course of a 30 year retirement (use the number of years more applicable to you)? I don't know the answer but not knowing argues for being conservative with withdrawals, taking 1% or maybe 1.25% every three months.
I think the key words here are flexibility, resiliency and optionality. A higher withdrawal rate diminishes our access to all three of those.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
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