The 4% Rule - Simplified?

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Aramis
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The 4% Rule - Simplified?

Post by Aramis »

Hi;

New to the Forum.

There is always a lot of talk about the 4% rule (also expressed as the 25 X annual spending needs) and its validity as a retirement planning tool. I believe it is a worthwhile tool but, because of the often unstated assumptions, it might be better explained as a tool that provides a "down and dirty" estimate of the amount of your assets you can withdraw annually, that will leave your estate with original starting amount of assets? It really just presumes an annual return of 4%, after inflation, based on long term investment returns less inflation. Average return is 6-7%? Inflation is 2-4%?

Your net return each year is going to be about 4%, so you can take out that same 4%, every year, and should end up with the same amount of assets you started with no matter when you get off the merry-go-round.

Is it really applicable for someone who is not interested in leaving an estate equivalent to their starting assets? Or someone who is targeting a different rate of return, or inflation rate?

If one starts retirement with $4MM in assets and wants to be sliding into home plate all beat-up, dirty, and smiling when their number is called, why would they want to use a "rule" that is predicated on leaving the original $4MM in the kitty? Why not plan to leave $2MM and enjoy the fruits of that additional $2MM over a lifespan plan that presumes death at 95 or 100?

I realize there are uncertainties, describing the need to consider them does not impact the central concept in my analysis.
Triple digit golfer
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Re: The 4% Rule - Simplified?

Post by Triple digit golfer »

I think you're mistaken. The 4% rule assumes not the same amount each year, but the initial 4% increased for inflation in subsequent years. It also assumes that you can be reasonably certain not to run out of money before 30 years.
Last edited by Triple digit golfer on Thu Apr 15, 2021 4:17 pm, edited 1 time in total.
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Scott S
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Re: The 4% Rule - Simplified?

Post by Scott S »

Welcome to the forum, Aramis.

The 4% rule as generally defined does NOT make any promise that you will still have your original amount left every year, only that you (probably) won't go broke after 30 years.

For a withdrawal rate that does try to maintain your original amount, think about the PWR: https://portfoliocharts.com/2016/12/09/ ... etirement/
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Thesaints
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Re: The 4% Rule - Simplified?

Post by Thesaints »

To be more accurate, it assumes that the chance of running out of funds before 30 years have elapsed is small.

Ending with a zero balance after exactly N>1 years by withdrawing a fixed amount (in real terms) is extremely difficult to achieve. It is also probably not desirable since one has no way to know they won't still be alive on year N+1.
Robot Monster
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Re: The 4% Rule - Simplified?

Post by Robot Monster »

Of possible interest, the Vanguard Retirement Nest Egg Calculator. link
GoneCamping
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Re: The 4% Rule - Simplified?

Post by GoneCamping »

I don't believe it assumes the ending value to be zero; that's not how I understand it. Rather, what I understand is it is the number that safely assumes you will not run out of money at 30 years, i.e. with some degree of certainty. It is less certain at 35 years, 40 years, and so on but I don't believe it to assume an ending value of zero at 30 years. That would merely be the worst-case success scenario in a Monte Carlo simulation.
Last edited by GoneCamping on Thu Apr 15, 2021 4:09 pm, edited 1 time in total.
aristotelian
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Re: The 4% Rule - Simplified?

Post by aristotelian »

The 4% rule is based on the maximum inflation adjusted withdrawal that has been safe with historical returns. It does not make any assumptions about average returns. If your goal is to spend the money there are methods for that. I think it is common sense that if you have a positive sequence of returns you can start spending more.
GrowthSeeker
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Re: The 4% Rule - Simplified?

Post by GrowthSeeker »

My understanding of the 4% 'rule' is as a rule of thumb. If you picked exactly 4% of your pf at retirement, withdrew that amount in year 1, then inflation adjusted that amount to be withdrawn in future years, then you would kinda sorta have a low percentage chance of running out of money 30 years later.
If you go to earlyretirementnow.com, "Big Ern" has a great series on "Safe Withdrawal Rates" that has data analysis for retirement periods from 30 to 60 years, and also with various degrees of portfolio depletion.
I just did a quick look at one of the pages there, and for a 30 year retirement period, under one standard set of assumptions, the difference in withdrawal rate between 100% capital preservation to 50% preservation to 0% preservation (at 30 years) was a jump in withdrawal rate of about 0.87% for each of those two "jumps".

So if a particular withdrawal rate predicts a total wipe out at 30 years, withdraw 0.87% less than that each year to end up with a prediction of 50% portfolio value after 30 years. Or withdraw 2*0.87% = 1.74% less than that each year to end up with 100% portfolio value after 30 years.
Last edited by GrowthSeeker on Thu Apr 15, 2021 4:31 pm, edited 3 times in total.
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Thesaints
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Re: The 4% Rule - Simplified?

Post by Thesaints »

GoneCamping wrote: Thu Apr 15, 2021 4:08 pm I don't believe it assumes the ending value to be zero; that's not how I understand it. Rather, what I understand is it is the number that safely assumes you will not run out of money at 30 years, i.e. with some degree of certainty. It is less certain at 35 years, 40 years, and so on but I don't believe it to assume an ending value of zero at 30 years. That would merely be the worst-case success scenario in a Monte Carlo simulation.
The worst-case scenario is actually running out of money on year N<30. The rule does not say that one is 100% sure.
aristotelian wrote: Thu Apr 15, 2021 4:09 pm The 4% rule is based on the maximum inflation adjusted withdrawal that has been safe with historical returns. It does not make any assumptions about average returns.
Since it is based on backtesting, rather than on theoretical arguments, it actually makes the (rather big) assumption that average return and volatility will not be much different in the future.
If your goal is to spend the money there are methods for that. I think it is common sense that if you have a positive sequence of returns you can start spending more.
Consider this case:
You retire on 1 M and plan to withdraw 40k/year, adjusted for inflation.
After the first year of retirement, markets have had a great run and your balance is now 1.1M. Are you authorized to say "Well, I did not really retire last year. I'm really retiring this year, so I can plan on withdrawing 44k/year" ?
What if after the first year markets had a bad run and your capital is 900k ? Do you say "The 4% rule is still valid; I can continue withdrawing 40k/year", or do you say "My colleague is retiring this year on a 900k capital and can count on 36k/year, as per 4% rule. It should be the same for me" ?
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Top99%
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Re: The 4% Rule - Simplified?

Post by Top99% »

While as others have noted, the 4% "rule of thumb" provides no guarantee one won't run out of money after 30 years, I find the real life results for several common portfolios with the 4% "rule" applied here https://retireearlyhomepage.com/reallife21.html somewhat reassuring. Some observations:
1) The data for the 20 year periods 1994-2014 Vs 2000 - 2020 (towards bottom of the page) really highlight how bad sequence of returns can impact things.
2) Year 2000 retirees with the 75% S&P 500 / 25% fixed income portfolio no doubt had some sleepless nights in 2001 and 2009 but it looks like they will pull though.
3) Bonds has a pretty good tail wind throughout the period studied.
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SmileyFace
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Re: The 4% Rule - Simplified?

Post by SmileyFace »

Welcome to the forum.
If you haven't spent time yet in the wiki there is a lot of great reading there.
Relevant to your question:
https://www.bogleheads.org/wiki/Safe_withdrawal_rates
rockstar
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Re: The 4% Rule - Simplified?

Post by rockstar »

Some of your expenses are likely to go up with inflation. If you're going to withdraw 4% and inflation is 2%, you want to earn at least 6% plus whatever you pay in taxes to maintain the same inflation adjusted balance. And some expenses are one time things such as roof replacement, HVAC, and appliance replacements. You will probably want to replace your furniture at least once in retirement. If you buy a car every decade, you'll also want to take that into consideration.

The reality is that your expenses are unlikely to go down, but at some point in the future, you'll collect social security. And you have to withdraw to pay your expenses. And if it's in a tax deferred account, you also have to consider RMDs, where you might have to withdraw more than you need and just end up paying more in taxes.

This stuff isn't simple. Volatility is an additional stressor. I can see why some people just pay up for annuities.
Last edited by rockstar on Thu Apr 15, 2021 4:49 pm, edited 2 times in total.
aristotelian
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Re: The 4% Rule - Simplified?

Post by aristotelian »

Thesaints wrote: Thu Apr 15, 2021 4:30 pm Since it is based on backtesting, rather than on theoretical arguments, it actually makes the (rather big) assumption that average return and volatility will not be much different in the future.
Again, it doesn't say anything about average returns. The 4% withdrawal has been safe for many 30 year periods with below average returns and a variety of sequences of returns.

You are right that the research is backwards looking and there is no guarantee that it will hold up in the future.
MnD
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Re: The 4% Rule - Simplified?

Post by MnD »

I simplified mine to 5% of annual snapshot portfolio balance per signature line below.
Works great if you have other safe income and your true needs are a smallish % of your total income.
Retired in late 2018 and I'm miles ahead on retirement income versus the ultra-low SWR approaches - despite two bear markets since then.
70/30 AA for life, Global market cap equity. Rebalance if fixed income <25% or >35%. Weighted ER< .10%. 5% of annual portfolio balance SWR, Proportional (to AA) withdrawals.
Buddtholomew
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Re: The 4% Rule - Simplified?

Post by Buddtholomew »

MnD wrote: Thu Apr 15, 2021 6:02 pm I simplified mine to 5% of annual snapshot portfolio balance per signature line below.
Works great if you have other safe income and your true needs are a smallish % of your total income.
Retired in late 2018 and I'm miles ahead on retirement income versus the ultra-low SWR approaches - despite two bear markets since then.
I’d say you’re miles ahead “because” of 2 bear markets.
"The first principle is that you must not fool yourself and you are the easiest person to fool" --Feynman.
GoneCamping
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Re: The 4% Rule - Simplified?

Post by GoneCamping »

Thesaints wrote: Thu Apr 15, 2021 4:30 pm
GoneCamping wrote: Thu Apr 15, 2021 4:08 pm I don't believe it assumes the ending value to be zero; that's not how I understand it. Rather, what I understand is it is the number that safely assumes you will not run out of money at 30 years, i.e. with some degree of certainty. It is less certain at 35 years, 40 years, and so on but I don't believe it to assume an ending value of zero at 30 years. That would merely be the worst-case success scenario in a Monte Carlo simulation.
The worst-case scenario is actually running out of money on year N<30. The rule does not say that one is 100% sure.
True, but I didn't say worst case scenario, I said worst case success scenario.
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Re: The 4% Rule - Simplified?

Post by Soon2BXProgrammer »

GoneCamping wrote: Thu Apr 15, 2021 4:08 pm I don't believe it assumes the ending value to be zero; that's not how I understand it. Rather, what I understand is it is the number that safely assumes you will not run out of money at 30 years, i.e. with some degree of certainty. It is less certain at 35 years, 40 years, and so on but I don't believe it to assume an ending value of zero at 30 years. That would merely be the worst-case success scenario in a Monte Carlo simulation.
the 4% rule is benchmarked against the worst sequence of returns we have experienced, and in those two markets, the person runs out of money after 30 years.
Earned 43 (and counting) credit hours of financial planning related education from a regionally accredited university, but I am not your advisor.
lostdog
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Re: The 4% Rule - Simplified?

Post by lostdog »

Scott S wrote: Thu Apr 15, 2021 4:04 pm Welcome to the forum, Aramis.

The 4% rule as generally defined does NOT make any promise that you will still have your original amount left every year, only that you (probably) won't go broke after 30 years.

For a withdrawal rate that does try to maintain your original amount, think about the PWR: https://portfoliocharts.com/2016/12/09/ ... etirement/
I just read this. Thanks for the info. So basically it's saying 3.5% will make sure you'll be around your principal instead of running out of money?
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Re: The 4% Rule - Simplified?

Post by firebirdparts »

lostdog wrote: Thu Apr 15, 2021 7:30 pm
Scott S wrote: Thu Apr 15, 2021 4:04 pm Welcome to the forum, Aramis.

The 4% rule as generally defined does NOT make any promise that you will still have your original amount left every year, only that you (probably) won't go broke after 30 years.

For a withdrawal rate that does try to maintain your original amount, think about the PWR: https://portfoliocharts.com/2016/12/09/ ... etirement/
I just read this. Thanks for the info. So basically it's saying 3.5% will make sure you'll be around your principal instead of running out of money?
Within the dataset that he uses, in the past, that was the result of the worst case. In the past. In the dataset he uses.

It is what it is only.

If you think that is the PWR in the present, that is you thinking that. Not him.

I really only have one concern in that dataset. That is, if you look at 30 year retirements starting in 1970, well obviously that’s a pretty limited picture, and it so happens in that picture gold turns out to be a brilliant investment. Certain events happen that can’t happen again.
This time is the same
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Re: The 4% Rule - Simplified?

Post by Jeepergeo »

Aramis wrote: Thu Apr 15, 2021 3:34 pm Hi;

New to the Forum.

There is always a lot of talk about the 4% rule (also expressed as the 25 X annual spending needs) and its validity as a retirement planning tool. I believe it is a worthwhile tool but, because of the often unstated assumptions, it might be better explained as a tool that provides a "down and dirty" estimate of the amount of your assets you can withdraw annually, that will leave your estate with original starting amount of assets? It really just presumes an annual return of 4%, after inflation, based on long term investment returns less inflation. Average return is 6-7%? Inflation is 2-4%?

Your net return each year is going to be about 4%, so you can take out that same 4%, every year, and should end up with the same amount of assets you started with no matter when you get off the merry-go-round.

Is it really applicable for someone who is not interested in leaving an estate equivalent to their starting assets? Or someone who is targeting a different rate of return, or inflation rate?

If one starts retirement with $4MM in assets and wants to be sliding into home plate all beat-up, dirty, and smiling when their number is called, why would they want to use a "rule" that is predicated on leaving the original $4MM in the kitty? Why not plan to leave $2MM and enjoy the fruits of that additional $2MM over a lifespan plan that presumes death at 95 or 100?

I realize there are uncertainties, describing the need to consider them does not impact the central concept in my analysis.
If you know for sure this year is your last year, take 100% now and enjoy the next twelve months.

On the other hand, if you don't know when the end will come, taking 4% now and the same amount adjusted for inflation in subsequent years has, based on past market performance and assumed portfolio composition, been shown to provide one for 30 years. YMMV.
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