The 4% Rule – A Castle in the Air

[jacob]

I don't think we would be having this discussion if it wasn't for the widespread development of the [false] belief that "the 4% rule" combined with a TSM investment is the equivalent of a magic savings account with a 4% yield ["in the long run"].

Perhaps it makes more sense to understand the 4% rule in its historical context. In the 1990s, retirement planning was very different from the "I need 25x my expenses in investments because of the 4%-rule". Rather it was closer to "I need my retirement investments to cover 80% of my work income. Therefore if my income is 50k, I need 40k from my investments. Since I've saved 500k, my required retirement yield is 8%. How aggressively should I invest to get an 8% yield?" Remember, this was the era of balanced funds and the "100 minus your age in stocks"-rule.

Keep in mind that the late 20th century was a time when 10% average stock market returns was widely presumed to be a law of nature (see e.g. Dave Ramsey who continued this idea way into this century).

Trinity and Bengen used mostly 20th century US data to show that such an 8% plan would have had periods in the past where it would not have survived(*). This study has since been run for many other countries with some countries showing MUCH lower SWRs. Indeed, the US stockmarket was the overall winner in the 20th century. Conversely, Japan---a country which if you read contemporary books from the 1980s was widely believed would eventually come to dominate the economic world---comes in dead last with an SWR of 0.26%

(*) Indeed, there were some ER failures from back then.

How many of you are planning for 0.26% in case your economic powerhouse of a diversfied investment is really a zombie economy?

[Mister Imperceptible]

@GTOO

I know. And the ammo shelves are now emptying out for the last time at Walmart, just as the repo market is blowing up. I fear the worst.

[steveo73]

Neither will the 2020s or 2030s or 2050s because Baby Boomers (like myself or our parents from the greatest or silent generations) living off their investments are not going to be zeroing out their balances. Remember that one of the golden rules is that wealth concentrates, even for early retirees.

This is the problem with all of these broad predictions of the future. Things just turn out differently than what you expect.

There is always an argument for why this time it's different. We don't know this though. We do know that our ability to predict the future is pretty poor.

Maybe a better way to phrase it in the context of this thread is that the 4% rule isn't really a rule. It's just a pretty darn good estimate but your specific situation has to be overlaid on top of the data. If you are 70 well maybe you don't need any assets other than your house to retire. Personally I wouldn't be bothered with the this time it's different argument whatever logic is raised to explain this to you. We don't know how the next 30 years are going to develop. I'd rather have savings invested constructively than be in debt no matter what happens.

[ChickenCoop]

Because I can't know what the future brings, What i'm doing is to prepare for the worst and hope for the best. I understand that this may be a pessimists approach and will bring about a lower return if things turn out more rosy than my expectation. So I will be working longer to be able to reduce my WR.

Its not that dissimilar to someone that has planed on a 4%WR and is just about to retire. maybe with a plan to go back to work if the 4% fails.

The advantage of the second option is that they can retire earlier while only maybe having to go back to work down the track.

The problem with me doing that is, I have a recession proof job, but if I leave it I cant come back to it. It also pays very well compared to other jobs I could get. So for me I feel i'm better off working the extra few years and feel comfortable with a 2%WR.

As Stevo73 said "your specific situation has to be overlaid on top of the data" . But the big question is, What data are people using to overlay their personal situation?? I'm using Ray Dalio's Long term Debt cycle data/info, and it's not pretty!!

[IlliniDave]

How many of you are planning for 0.26% in case your economic powerhouse of a diversfied investment is really a zombie economy?

ETA: whether I can maintain my spending target is not certain, especially if I'm immersed in conditions supportive of much higher withdrawal rates.

[IlliniDave]

I rejected the "4% rule" within a week or two of learning about it. The study, while providing a very narrow snapshot of historic data that is illustrative, IMO; it's not worthy of "rule" status. Although now it's viewed as reckless, at the time it was cautionary. 4% < what people in the US could readily get for "income" (dividends and interest) from a stock/bond portfolio in the general era. (Aside: I get the sense that retirement age people then were much more income-focused than "total return"-focused).

Ultimately I had to test it against the vision I had for my financial future, and my best gut instincts of what I thought future returns might be like. Lower numbers worked better for what I wanted, enough so that continuing to accumulate 2-3 years beyond the first whiff of potential FI won out in the trade study.

The real value in the Trinity Study I think is that it served as a popular introduction to the notion that more detailed analysis of historic data suggests it is prudent to tax your stash at rates well below historic return averages. That was true through most of the era those historic averages were compiled. For us it translates to a strong likelihood that it would be prudent to systematically tax your stash at rates below the future returns you get. That forces some degree of prediction, which blurs things. I personally plan with pretty low return expectations. Part of that is because I believe for my remaining window returns will be lower than what I've achieved in the past (though I don't retain a religious-caliber belief that its impossible someone with 40-60 years to go could see ~"historic" returns). But it's also just my nature to build in margin.

[Tyler9000]

Trinity and Bengen used mostly 20th century US data to show that such an 8% plan would have had periods in the past where it would not have survived(*). This study has since been run for many other countries with some countries showing MUCH lower SWRs. Indeed, the US stockmarket was the overall winner in the 20th century. Conversely, Japan---a country which if you read contemporary books from the 1980s was widely believed would eventually come to dominate the economic world---comes in dead last with an SWR of 0.26%

Well to be fair, notice that all of the lowest SWRs on the list were in Europe and Japan after the two world wars. If we're planning for that situation, I imagine a comfortable retirement without work is the least of our worries. For reference, even through the severe economic stagnation in Japan beginning in the 1990s, since 1970 the 30-year SWR for a traditional mix of 60% stocks and 40% bonds has yet to dip below 3%. And most of the portfolios I track managed closer to 4%.

That said, I absolutely agree with the observation that SWRs were designed as guiderails for what NOT to do rather than guarantees of success. It seems like a lot of people get into trouble by thinking if them as a rock-solid budget to spend against. IMO the much healthier mindset is to independently maximize your happiness/expense ratio rather than mechanically always spend right up to the limit. Do that with any reasonable portfolio and WR that exceeds your needs, and the odds are that you'll live a very happy life and will fill your later years thinking of ways to help others with your excess funds.

[The Old Man]

I'm maybe missing something very obvious here, but why can't an asset yield 4% unless it experiences a 3% top line growth?

Remember that “The 4% Rule” uses a total return approach to develop a safe withdrawal rate. Namely, that the withdrawals are dividends, interest, and capital gains. Dividends and interest are not sufficient alone, so capital gains make up the shortfall. This approach works so long as the capital is experiencing growth equal to or greater than the sales.

By way of illustration as of 18 Sep 2019, VTSAX (Total Stock Market Index) has an SEC yield of 1.88% and VBTLX (Total Bond Market Index) has an SEC yield of 2.24%. To support a “Safe” withdrawal rate of 4%, then you would need to sell some of your assets to make up the difference. You are in effect assuming there is sufficient growth such that these sales are “safe” and not the long road to bankruptcy.

You can minimize the need for capital gains by choosing stocks with an emphasis on dividends. However, stocks with an above average dividend rate generally have lower than average growth prospects. There is no free lunch here.

Businesses have earnings. Businesses can choose to pay them out to stockholders as dividends or they can retain them (retained earnings) and use them to grow the business either through R&D or expansion. If a business has limited growth options, that is a mature business, then the sensible course of action would be to pay dividends.

The 4% Rule as formulated by the Trinity Study and its successors used a broad market stock index in its stock/bond portfolio. I have not seen a study that replaced the broad market index with high dividend stocks. That approach may be a sensible option.

[unemployable]

For reference, even through the severe economic stagnation in Japan beginning in the 1990s, since 1970 the 30-year SWR for a traditional mix of 60% stocks and 40% bonds has yet to dip below 3%. And most of the portfolios I track managed closer to 4%.

Wait, for Japan? Really? Is that because the most recent 30-year period started in the late 1980s, so that you'd at least enjoy the benefit of bond rates going from 4-5% to negative? I suspect there's a selection bias there, and anyone who retired after 1991 or so is in deep doo-doo.

[Tyler9000]

The worst 30-year retirement period since 1970 for a 60/40 portfolio in Japan was 1989-2018, and it still supported a 3% SWR. And my calculations also account for more recent retirement periods starting less than 30 years ago based on how withdrawal rates predictably decay over time. All of those retirement timeframes are trending a bit higher. You can study it for yourself here (just change the country setting to Japan):

https://portfoliocharts.com/portfolio/withdrawal-rates/

[classical_Liberal]

How many of you are planning for 0.26% in case your economic powerhouse of a diversfied investment is really a zombie economy?

Everyone actively pursuing ERE, right? What has your actual withdrawal rate from accumulated assets been since 2009?

I don't mean to be an a**, nor start an argument, because I highly respect you (EDIT: and am deeply appreciative of this forum). My point is that on one hand you seem to use scare tactics wrt withdrawal rates. Stating that everyone should be extremely conservative in financial calculations. Telling them they need tons of money (at least 33X current expenses) to make ERE work. Yet, on the other hand you wonder why people are so hyper-focused on "the number", and the save-->invest---> retire portion of ERE, as opposed to the systems living/renaissance man. I realize these are not mutually exclusive, but yet it seems the point needs to be made that the latter makes the former almost irrelevant if done correctly. At least that's how I understand you writings and work, maybe I'm putting words in your mouth, if so I apologize.

In general, I'm not arguing the 4% rule is safe, or even a rule. Just that someone doesn't even need that much to change focus from full time work and accumulation of assets to ERE systems lifestyle. Afterall, humans have limited resources and focus. This is doubly true if someone finds these forums because they are already dissatisfied with their full-time work and feeling overwhelmed. I just think the conversation in these types of threads could be more focused more on systems living approach/wheaton level improvement vs the save more money because life is dangerous. At the very least more towards @draglines "do both", so that overtime folks can see how the money problem solves itself if the lifestyle portion of ERE is addressed more aggressively.

[Jin+Guice]

@c_L: I've noticed this mixed message as well. The other mixed message I've gotten is that only 10% of people possess the skill to be "stock pickers" (independent of the amount of work they'll put in), and everyone else should just index. But then indexing is dumb and no one should do it.

I think what's going on is, on the one hand you have people blinding following a simple set of rules. 4% SWR, 3% SWR, VTSAX is the only god. To criticize this viewpoint it's necessary to give counter examples. But then you've got a lot of people who are very conservative in their finances who see these rules being criticized and they think "fuck! 33x assets isn't even enough!" I think the point is that in any of these cases, it's important to do your homework, remain flexible, and not just listen to simple rules from the internet.

The reaction to the $x isn't enough is why I started running around here yelling about how everyone should both retire immediately and never retire at all.

"To live is to risk it all Morty. Otherwise you're just an inert chunk of randomly assembled molecules drifting wherever the universe blows you." - Rick and Morty. Also.

[The Old Man]

I really appreciate the depth of your post and thoughtfulness of your argument. The thing is, I think it's built on a false assumption. Not all data supports the 4% and 3% figures. In fact, I would argue those numbers are based on an extremely myopic definition of investing steeped in data availability bias.

Concepts like risk parity and modern portfolio theory change the game quite a bit.

So IMO, even though I personally agree that the 4% rule is a bit antiquated I see it very differently from you.

If I understand your post, we are both critical of the 4% Rule, but for different reasons.

The purpose of my post was to make a direct attack on the foundations of “The 4% Rule” as established by the Trinity study and related studies; consequently, I am trying to keep everything the same while only challenging the underlying assumptions of the study itself.

While I like statistical analysis, I see them only as a starting point for understanding complex phenomena. I like to think about why things happen the way they do.

Example: The 4% Rule predicts a 95% success rate over a 30-year retirement period. Sounds good and the way it is presented implies the 5% failures were random. This is not the case as the 5% failures were related to retirements commencing in the 1960s-70s; thus, they were strongly influenced by the inflationary conditions of that era. Since neither bonds nor stocks (The 4% Rule Portfolio) perform well in inflationary environments, then it is unsurprising that the 95% confidence limit for the SWR would be driven by this experience. To make matters worse better withdrawal rates are not the answer because we can neither predict the magnitude nor duration of inflation, so it is not possible to develop a better SWR. In summary, the 4% SWR is a statistical artifact. The answer is better portfolio construction, so I agree with your assertion.

For this post rather than discuss the weaknesses of “The 4% Rule Portfolio” I wanted to discuss the core implied assumption of economic growth. Due to demographics and the interconnected nature of the world economy I posit the growth rate which underpins the SWR will be lower in the future than that experienced in the past; consequently, the SWR will be lower.

[jacob]

The messages are perhaps not mixed if they're seen in the right context.

On the one hand there's ERE. ERE requires spending a lot of personal resources to develop a level of self-reliance that makes it possible to live a middle-class lifestyle on 4x less than the typical consumer. A high savings rate should naturally follow. ERE also creates an investment horizon of 40-70 years and believing that one can pick the right strategy after spending less time learning about investments than the average person spends on buying a house or an apartment is simply crazy.

One the other hand, there are definitely people following simple rules. Likely an increasing number as FIRE is getting mainstreamed. They seek the quick and easy approach. There's no interest in learning investing or more importantly about investing. Only 10% are capable of learning to invest better than the average, but 100% are definitely capable of learning about investing. But learning is hard and so people tell themselves that since "nobody can beat the market blabla", they don't have to learn anything. Learning skills is also hard and people tell themselves that this is not necessary because it's more pareto-efficient to just earn more money and save a little more or a lot more. It's also crazy to think that an unsafe strategy is rendered safe by doubling down.

It's the distinct difference between "mainstream FIRE" and ERE. It's the difference between financial independence and economic independence.

In ERE, saving money is a side-effect of a resilient lifestyle and investing money is just another skill to be learned. In FIRE, saving money is the primary strategy to get freedom-from work as long as the monies don't run out. It's primarily pursued by people with 80%+ percentile incomes adopting 50% percentile expenses.

What the latter class of people see when they confront ERE on the surface is someone living a cheap-ass lifestyle who at happens to have some kind of astrophysical investment skill and some weird hobbies---because that's what it looks like from the FIRE framework. They can easily convince themselves that this is not for them---that they can't or they won't---when the alternative is just to earn and save about twice as much money.

In between the two, there's this cafeteria-mentality of lifestyle design. "This philosophy is rather extreme, but you can just pick what you like and ignore the rest". Well, no you can't, because there's a reason/framework behind the madness.

[Jean]

It's hard to accept that nothing is safe, when you've been told your whole life that you'll be ok. Whatever capital you accumulate, the risk that something will happen where your existence will be challenged never disapears. Securing it requires regular attention and even work Sometimes.

[steveo73]

For this post rather than discuss the weaknesses of “The 4% Rule Portfolio” I wanted to discuss the core implied assumption of economic growth. Due to demographics and the interconnected nature of the world economy I posit the growth rate which underpins the SWR will be lower in the future than that experienced in the past; consequently, the SWR will be lower.

There are a couple of points that come from this:-

1. You are probably wrong in your initial premise related to economic growth. This is not being super critical of you personally. You are a human being and your ability to predict the future is poor. Economists always get their predictions of economic growth wrong over the short term. You are trying to predict the next 30+ years. There is probably a <.00001% chance that your premise is correct.
2. Your premise could be correct but your rule derivation wrong. The 4% rule has worked during world wars, hyper-inflation, trade wars etc. We may get lower economic growth due to demographics and the interconnected nature of the world economy but the 4% rule may still be valid.

On top of this if you are assuming that now a 4% WR needs to be a 3% or whatever WR you are consigning yourself to working a lot longer than what will probably be required. That is your choice but to me it's not a good trade off. You are trading off years of additional work based upon your bleak prediction of the future which will probably be wrong.

[classical_Liberal]

@Jacob
Thanks for the response. I "grok" the differences between FIRE, ERE, even if I've yet to fully practice the later. This "a la carte" idea is a bit new to me, as from my perspective that is part of what makes ERE great. The ability to pick a lifestyle, then learn the skills needed to manage it with low levels of resource/consumeristic usage. For each person it'd be different. Unless you mean something like partially living off investments, partially off job income, partially off skill where none of them really equal more than the sum of their parts. Would that be Semi-Re-FI-ERE? just kidding.

I can see where your points regarding needing very low WR can potentially impact folks in the direction of choosing instead to place their bets on the lifestyle component of ERE vs financial. I hadn't thought of that. I was instead looking at it from the perspective J+G pointed out, that everyone must keep working to save even more.

I also get that the ERE lifestyle component will create ERE FI component, even at very low wages. The problem seems to be, how to get someone (like me and others here) past the pareto optimization thoughts of earning more money, and move forward to learning more skills. If the Wheaton levels flow in this direction, it's an easy sticking point if income is rather high. Also, I believe there may be an audience ripe for moving very quickly to the lifestyle component, who may not want to stick around long enough for the FI component. People who don’t earn 80% incomes and are willing to do almost anything to get out of what they view as a dead-end lifestyle. Asking for extreme change in lifestyle is hard, but asking for that PLUS five or more years devoted to continuing in the same miserable situation makes anyone who follows an outlier. I couldn’t quite do either (complete lifestyle change or five years, although I purposely "doubled down" on FI by making my situation even less desirable to earn more income), and I consider myself above average in tenacity and open-mindedness. However, cut out a big chunk of the five years and I believe the audience expands significantly (see all the arguments about humans discounting the future).

My anecdotal viewpoint is one of someone who wishes he had focused less time maximizing income/pareto optimization/investing, and more time ERE lifestyle designing over the past two years. Both for the resilience and pleasure of that lifestyle. I am very much a person who had limited life energy resources and found "do both" very difficult. So I did half of each, a la carte I guess. However, once I drew a line in the sand wrt to accumulation, my attitude and energy level towards the ERE lifestyle ideas started shifting dramatically. I can't help but wonder, am I the only one in this boat? and if a decision to stop accumulating money at maximum rate is a lever for that change, then continuing to encourage more accumulation could prevent transitions to higher wheaton levels. So, that's where I'm coming from, as opposed to someone who liked their work, lived ERE, became FI before work related issues creeped into life.

[steveo73]

ERE also creates an investment horizon of 40-70 years and believing that one can pick the right strategy after spending less time learning about investments than the average person spends on buying a house or an apartment is simply crazy.

There's no interest in learning investing or more importantly about investing. Only 10% are capable of learning to invest better than the average, but 100% are definitely capable of learning about investing. But learning is hard and so people tell themselves that since "nobody can beat the market blabla", they don't have to learn anything.

This is part of the message that I have problems with. I consider myself well educated when it comes to investing and based on this education I think the idea that more work = more knowledge = better returns is false. I think and the data agrees with me that a poor investment strategy is more likely to come about via thinking that better knowledge = better returns. Investing doesn't work like that.

It's also crazy to think that an unsafe strategy is rendered safe by doubling down.

I agree with this point but I get the impression that on this forum the general idea is to double down. The 3% rule is a way of doubling down. Another reason to double down is via the scare mongering ala this thread. If you have a customised investment strategy you may need a 3% WR (or lower) compared to a simple investment strategy that will cater to a 4% WR. That though shouldn't be why you go lower than a 4% WR. If you need to go lower for instance to have your money last 50-70 years that makes sense.

In ERE, saving money is a side-effect of a resilient lifestyle and investing money is just another skill to be learned. In FIRE, saving money is the primary strategy to get freedom-from work as long as the monies don't run out. It's primarily pursued by people with 80%+ percentile incomes adopting 50% percentile expenses.

I view ERE as systems based approach to lifestyle design. I like this approach. It's similar but broader to MMM stating riding a bike leads to financial freedom. It doesn't but changing your behaviour makes saving easier.

I also think that Jacob would state that each of us needs to design our own approach to ERE. I am comfortable with my investing approach but my decision to have 3 kids is completely anti-ERE. I have to accept that I'm working now because I have 3 kids to take care of. Myself and my wife could retire today if we didn't have to support the kids. I think kids and an ERE lifestyle just don't go together.

[classical_Liberal]

Myself and my wife could retire today if we didn't have to support the kids. I think kids and an ERE lifestyle just don't go together.

Is literally this:

What the latter class of people see when they confront ERE on the surface is someone living a cheap-ass lifestyle who at happens to have some kind of astrophysical investment skill and some weird hobbies---because that's what it looks like from the FIRE framework. They can easily convince themselves that this is not for them---that they can't or they won't---when the alternative is just to earn and save about twice as much money.

Like, it's part of the statement you've been quoting from.

[steveo73]

Is literally this:
Like, it's part of the statement you've been quoting from.

I could get rid of the kids but I'm not ready to do that just yet. My daughter is 18 though and finishing her last year at school. The problem is my youngest is about to turn 9.

I think having kids and especially a couple of kids is going to be a poor decision for any form of FIRE. In my situation for instance our investments are probably large enough to last us for life if we had no kids. We are also probably fine post the kids being financially independent from us. We would go bust if we retired now though because the kids are expensive. So we will end up saving more but we will probably save too much because our expenses should drop a fair bit.