My Four Cents on the 4% Rule

The seemingly never-ending debate over the 4% rule has been refreshed again by a recent Morningstar report. "4%" is dead, they say. My thoughts: what if we availed ourselves of all the techniques that can improve the rule's chances of being viable? Mainly, what if we had better portfolios?

If there is one topic in personal finance that draws out an argument, it would seem to be the debate over the 4% rule, this notion that you can safely draw 4% of your nest egg as living expenses in retirement. It’s too high, some say; it’s fine or even a bit too low, others say. The 4% guideline is important because it can be one of the triggers allowing one to stop working, but if it is overly optimistic, then a retiree could be in a world of hurt as that number can’t sustain them and they are forced to return to work in their 70s or 80s (if that’s even possible).

Without getting too far into the weeds, the rough evolution of the debate is as follows: William Bentgen publishes a classic paper saying that the 4% is a good guideline for what someone can safely withdraw in retirement, also supported by the Trinity study which finds the same thing. This idea is picked up by the nascent FIRE community, especially the influential post about the simple math behind early retirement by Mr. Money Mustache. Then, others start looking at the 4% rule, with some like Wade Pfau saying that 2.8% is the truly safe number. Bengen then comes up again, saying it’s actually 4.5%, and meanwhile you’ve got other top-notch blogs like Early Retirement Now to investigate aspects of the rule. The debate has bubbled for a while, but got re-kindled with a 2021 publication by Morningstar saying the 4% rule is dead and it should be 3.3%. That, in turn, launched rebuttals from Ben Henry-Moreland of the Michael Kitces site, among others, that the Morningstar report was unduly pessimistic.

For the record, I’m on Team Kitces, but the debate has gotten me thinking: what if we’re debating the wrong thing?

Imagine a group of humans, out for a stroll, come upon this big wall that they want to get over. It stretches on forever, so seemingly there is no way around. Also, it is big enough that trying to jump over and failing would be bad. The wall is about 10 feet high, so people gather ‘round, measure their heights, and see that the even tallest are about 6 feet tall. With this figured out, they see how high people can jump, then do the math that it's unrealistic to jump 4 feet in the air to grab the top and pull themselves over. “Well, looks like we’re stuck,” they say. “We ran the numbers and we’ve concluded that we can’t get over.”

But what about finding or building a ladder? How about using shovels to move some dirt to raise the ground and lower the effective height of the wall? Pole vault? Trampoline? Is there any way to increase our chances of making it over? Are we really stuck? Or just not thinking of alternatives?

This is what I see when the naysayers cast doubt on the 4% rule. Not because their return assumptions are unrealistic (I can’t predict the future, either), or their math is wrong, but because so many of the naysayers write off all the ideas of ways to make it a little more likely that the 4% rule is sound. The 60/40 portfolio is taken as a given, for one, and second, there is this strawman argument that once one has left the workforce, their fate is sealed.

In truth, we already have methods for increasing the viability of the 4% rule, and that the metaphorical wall can be scaled. Here are four:

  1. Have guardrails in place, or ways to alter your spending temporarily if absolutely necessary. Yes, the 4% rule works over the long run, but if you do hit a bad patch early in your retirement, you do need to have flexibility. One approach is the use of guardrails; another is to forego the increase for inflation in years with poor returns.
  2. Have an emergency plan in place that involves supplementing income in the case of a true crash in your first years of retirement. When you retire, don’t tell your boss to f* off, don’t burn your address book of contacts, and do take a moment to think about what you could do if worse came to worse. Is there a manageable way you could get some amount of income for a period of time and allow you to follow the 3% guideline, if only briefly?
  3. Relatedly, is there a way you could live on less for a while? Do you have an escape hatch? For me, while I can plan to live on 4% a year where I am, if things really do get tight I know I can live on half of that (easily) in Southeast Asia and have green curry and mango smoothies by the pool for a few years until things improve. Not so bad.
  4. And finally, what improvements could we make to the portfolio to ensure more stable returns over time? The Classic 60/40 is usually the default, but how many of these studies consider alternatives? The Morningstar report, for example, tests a 50/50 portfolio, and of the 50% in fixed income, corporate bonds account for one-fifth of that, and cash another fifth. But…what if we used better portfolios? What if we allocated money to commodities, gold, or direct real estate in order to truly diversify? What if instead of haphazard bond portfolios with high allocations to corporate bonds (which are then liable to the same risk factors as equities), we used long-term treasuries, or even extended duration treasuries? What if being bound by bad portfolios, we had better ones?

To be fair to the Morningstar report, they do mention that having guardrails or a flexible spending plan can make the 4% work, and on page 3, show that using the guardrails can bump the safe withdrawal rate closer to 5%, even with the uninspiring 50/50 portfolio. Yet, despite the evidence within the paper offering great ideas about ways to accomodate a higher withdrawal rate, it all gets buried under the larger point that the “4% rule doesn’t work.”

Maybe it is just an issue of headlines. To be more accurate, how would this sound?: “We tested the 4% rule using assumptions that one of the worst decades for assets we have ever seen would not only be in place for the decade, but then two more decades after that; we assumed that once a path was chosen, there was absolutely nothing anyone could do at any point to respond to conditions; we decided not to avail ourselves of any of the current best practices for withdrawals in the decumulation stage of retirement; and finally, used a 50/50 portfolio subject to a high degree of equity risk, didn’t consider any alternative portfolios, and yet, after all that, we STILL found that you could withdraw 3.3% safely.”

Doesn’t exactly roll off the tongue, I guess, but a whole lot more accurate.