It’s Not Just Getting the Safe Withdrawal Rate Studies Corrected, We Need to Come to Terms With Why It Took So Long to Do So

Published on

Retired Financial Planner Bill Bengen, who did more than anyone else to popularize the infamous 4 percent rule (the idea that retirees can safely plan to take 4 percent withdrawals from their retirement portfolio), recently backtracked a bit on that claim (“Cut Your Retirement Spending Now, Says Creator of the 4 Percent Rule”). I could have used that article back about 20 years ago!

Bengen’s reasons for doubting the 4 percent rule are not entirely the same as the ones that got me into such trouble on the internet when I argued back in 2002 that it is not possible to calculate the safe withdrawal rate accurately without taking valuations into consideration. But I am of course happy to hear anyone express doubts about a rule that was cited by many investors as a dogmatic truth not that long a time ago.

Or maybe I am not!

Get The Full Ray Dalio Series in PDF

Get the entire 10-part series on Ray Dalio in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues

Q1 2022 hedge fund letters, conferences and more

The 4 Percent Rule

I certainly don’t view the 4 percent rule as an ironclad rule. So I am glad to see it questioned. There was a time when friends of mine were handing in resignations from high-paying jobs because they had read on an internet discussion board on early retirement that a plan calling for 4 percent withdrawals was “100 percent safe.” That horrified me given that the valuation levels that applied at the time showed that any withdrawal of greater than 1.6 percent from a high-stock portfolio was not entirely safe.

Bengen’s concern is that “there’s no precedent for today’s conditions.” I don’t quite agree. I of course agree that today’s valuations are scary high. But they are not unprecedented. Valuations were worse in January 2000. And they were almost as bad in 1929, which is one of the years examined in the studies that are cited as supporting the 4 percent rule. The analytical failure that is at the root of the analysis that produced the rule is that, if a retirement using that withdrawal rate survived even though it began at a time when valuations were off the charts, that withdrawal rate is retroactively rendered “safe.” That makes no sense to me.

Yes, a retirement calling for a 4 percent withdrawal that was initiated in 1929 survived for 30 years. But it was a close call. What that tells us is that a 4 percent withdrawal was a high-risk proposition at that time. That retirement survived because it was lucky, not because it was safe. There are many valuation levels at which a 4 percent withdrawal is super safe. But there are others at which it is risky and the fact that such a withdrawal has survived on a small number of occasions does not change that. The fact that such retirements have come close to failing on every occasion on which they started from super high valuation levels underscores the point – aspiring retirees simply MUST take valuations into consideration when planning their retirements.

Changes In Safe Withdrawal Rate

I am more concerned that people come to understand why the 4 percent rule is so wrongheaded than that they get about the business of correcting the studies that have popularized it. Yes, those studies are in error and need to be corrected. But what we really need to come to terms with is why those mistakes were made by many smart people and then tolerated by many other smart people. Anyone who understands that valuations affect long-term returns (Shiller showed this in peer-reviewed research) should understand that it is impossible that there could ever be a single withdrawal rate that would be safe at all valuation levels. Stock investment risk is not stable, it is variable. The safe withdrawal rate changes with changes in valuation levels.

The general point is far more important than the specific application of it to retirement planning. When we come to accept that stock investment risk is variable, we will see why market timing must always work and indeed is always required for all investors seeking to maintain a constant risk profile (that is, to Stay the Course in a meaningful way). Once we achieve that breakthrough, there will be no further bull markets (because investors will lower their stock allocations when prices get too high, causing prices to return to reasonable levels). The end of bull markets will mean the end of bear markets because it is out-of-control prices that cause price crashes. And the end of price crashes and the contraction in consumer spending associated with them will mean far fewer economic crises.

There’s a lot more on the table with the questioning of the 4 percent rule than better retirement planning. Coming to terms with why as a society we messed up re this one opens the door to lots of exciting economic advances not too much farther down the road. Yes, the 4 percent rule is out of date. But the learning experiences that we can enjoy as a result of our unfortunate embrace of that rule are only beginning on the day we toss it into the ashcan of history.

Rob’s bio is here.