The 4% Rule – A Castle in the Air

[The Old Man]

1. You are probably wrong in your initial premise related to economic growth.

We have had slow growth for nearly 20 years. Why should it improve? It is driven by demographics which has high predictive value. Granted, technological progress could accelerate and the third world could improve its living standards to where it is comparable to the developed world thus compensating for the west’s demographic weakness. Lots of things could happen. Are you going to hang your hat on “lots of things happening?” The point is not to make a prediction, but to assess the reasonableness of the underlying assumptions and whether they will still hold in the future. This assessment is necessary for effective contingency planning.

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.

Remember that a statistical analysis (the Trinity study and related studies) is descriptive and not predictive. You are trying to use a description of the past to predict the future. The future will only be the same as the past only if the past conditions carry over into the future. I have previously explained how the underlying conditions will not be the same.

Further, are you saying the 4% rule is independent of economic growth? Remember the 4% Rule Portfolio (stocks & bonds) is highly correlated with economic activity.

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.

I think it is best to have a realistic appraisal of the future, so as to develop reasonable contingency plans. Saying, I have a study and 4% is the answer is not sufficient even if it is accurate.

The world economy is slowly deflating. What is the best path forward? Developing an effective strategy will take more thinking than I have a study and the answer is 4%.

[steveo73]

Are you going to hang your hat on “lots of things happening?”

I know one thing for sure. I'm not hanging my hat on human beings (any specific human being including myself) predictions of the future. I am significantly more comfortable in utilizing the available data and being conservative in my approach. To me a conservative figure is 95% chance of being successful. So I'm pretty cool with the 4% rule.

[daylen]

We all make assumptions about what the future will be like (most unconsciously). The best we can do is be honest with ourselves about what they are.

[Jean]

If having kids is anti ere, then not killing yourself is anti ere as well.

[The Old Man]

To me a conservative figure is 95% chance of being successful. So I'm pretty cool with the 4% rule.

Why is the 4% Rule conservative?

The 5% failures were not random but were driven by the inflationary conditions of the 1960s-70s. The inflation was inadvertently created by the government in its attempt to use monetary policy to smooth out the business cycle. Rather than smoothing out the business cycle the end result was the Great Stagflation. People in real estate and gold (i.e. Harry Brown) did fabulous, but stocks performed poorly and bonds were devastated.

If we disregard inflation, then the next limiting factor would be the Great Depression. Its origins are a mystery, but it is well understood that the Federal Reserve Bank and the government mishandled the crisis in its initial stages; thus, setting the stage for the massive and long-term deterioration of the economy. The economy only recovered due to the massive fiscal stimulus of World War II. It should also be remembered that the bond component of the 4% Rule performs a different function than that of the Permanent Portfolio. In the Permanent Portfolio, bonds (i.e. long-term bonds) were designed to profit in such economic conditions. In the 4% Rule, the bonds were merely supposed to provide a source of funds for expenditures while the portfolio waits for stocks to recover and resume its inevitable upward climb.

Financial Crisis of 2008: This crisis was the worst financial crisis since 1929. I give credit to the Federal Reserve Bank for managing this crisis, so it did not develop into a repeat of the Great Depression. However, we still had the Great Recession.

The safe withdrawal rate of the 4% Rule and its associated 4% Portfolio is a statistical artifact. It is dependent upon government intervention into the economy having no worse effects than in the past. Is this implied assumption a conservative approach to investing?

Consider that demographic trends predict future low growth. Negative Interest Rate Policy and related efforts to remove the zero-lower bound constraint (i.e. Cash) is the government’s answer to this problem. It is not possible to solve an aggregate demand problem in the long term through monetary means alone. Remember that the Great Depression did not have to contend with demographics. Its downturn was temporary, so could be reversed with fiscal and monetary policy. We don’t have that luxury in the current environment. Does the government’s action seem to suggest it will act worse than in the past?

I believe the government knows enough on how to manage a financial crisis, so it does not develop into an economic crisis. However, I don’t believe it has the tools or the knowhow to compensate for a slow growth world.

To understand how this will play out I believe The Debt-Deflation Theory of Great Depressions by Irving Fisher will be instructive. https://ritholtz.com/2016/07/debt-defla ... pressions/

[classical_Liberal]

Interesting. Since we are playing theories...

I think the next recession will be handled differently (ie from gov't/Fed policy makers) in that it's clear interest rates + increased monetary supply have not encouraged inflation due to low velocity. We may actually see some deflation. If we do see deflation, it is possible the zero bound on Intermediate or longer term Treasuries could be tested, but I do not think it will last for long. Reason being, the US economic system is extremely robust, the best in the world. Eventually investors will take their chances with dividends over zero or negative bond yields. Nonzombie companies who can take advantage of very low long term leverage may actually do very well in this environment, particularly if they are dividend focused. So I think over-all market losses in the recessionary bear will not reach anywhere near the level of 1929/2008. Maybe 30% index losses? I think gov't stimulus will come in the form of helicopter money + infrastructure debt spending. As in, each taxpayer will get a large visa gift card because it's easier to spend it than save it. This in combination with massive spending on a mix of rebuilding aging infrastructure (conservative side), and attempts to create a more green society going forward (liberal side). Which gets more money depends on who is in power at the time of action. It will seem like a good plan too, because treasury rates will be so low. The end result of all this, the US will get out of the recessionary cycle. Although, after infrastructure spending is completed, I'm not sure how long it will last.

[Jin+Guice]

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 sincerely did not think of this even though it's my entire shtick.

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

Exactly. It's hard not to see it this way when you come from a money obsessed culture into a movement which at its most superficial is money based. Once the other perspective is revealed it's obvious though, if you're ready for it. The Wheaton level issue is a real stumbling block...

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.

The five years of misery is where the insanity of FIRE lies. My three FIRE heroes (Jacob, MMM, MadFIentist) all had jobs they enjoyed doing, but that they didn't want to do forever. Compare that do a blog like LivingAFI. Reading that shit was fucking painful. Our culture really likes the idea that you have to suffer for a long time to maybe someday get a little bit of something good. What if you didn't?

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.

This is the viewpoint I personally see here the most and what I think when I see it. I don't see a bunch of over-confident McMansion people with 20x savings pulling the plug to live on a beach and thinking they are safe because they have 20X assets and the stock market always goes up. Maybe this is the rest of the FIRE world though?

[jacob]

I don't see a bunch of over-confident McMansion people with 20x savings pulling the plug to live on a beach and thinking they are safe because they have 20X assets and the stock market always goes up. Maybe this is the rest of the FIRE world though?

It is.

Outside the ERE-bubble, typical keywords are: six-figure income, a "badass" budget around 30-50k/year/household, 4%-rule because "internet", slogan-based investing, 1-2M savings goal, flying around the world with a backpack as a goal, starting a FIRE blog to make side-income (there are hundreds now).

As FIRE has gone mainstream and become subsumed by the personal finance sphere, the average Wheaton level of FIRE wannabes has declined to about 3.5.

As I see it, FIRE has returned to what it originally was when it originated on Motley Fool and later "split" into Bogleheads and early-retirement.org. The followers of the modern "FIRE movement" are essentially a Millennial version of the Boomers that made up those groups in the 2000s. In that sense, ERE, MMM, and YMOYL and other early adopters were a bit of an aberration although we did change the language/framework of the discussion. Thus now, high-achievers are now talking about becoming FIRE (or just FI), whereas 10+ years ago the same type of people talked about becoming Millionaires---that being the standard for being rich enough to do whatever.

[Jin+Guice]

It is.

Outside the ERE-bubble, typical keywords are: six-figure income, a "badass" budget around 30-50k/year/household, 4%-rule because "internet", slogan-based investing, 1-2M savings goal, flying around the world with a backpack as a goal, starting a FIRE blog to make side-income (there are hundreds now).

As FIRE has gone mainstream and become subsumed by the personal finance sphere, the average Wheaton level of FIRE wannabes has declined to about 3.5.

I guess I forget this/ haven't encountered it. These are the people I've been trying to escape my whole life and, for me, FIRE (ERE) gave me a full framework for escape that will be workable/ desirable over a lifetime instead of just in my early 20s.

Most of the people I hang out with IRL make <$20,000 a year and have no savings, so it's always kind of amazing to me when I read/ find myself thinking a few hundred thousand dollars isn't enough.

[classical_Liberal]

I guess I forget this/ haven't encountered it. These are the people I've been trying to escape my Most of the people I hang out with IRL make <$20,000 a year and have no savings, so it's always kind of amazing to me when I read/ find myself thinking a few hundred thousand dollars isn't enough.

Right, so when a person is initially exposed to mainstream FIRE, who is not making six figures, they tend to dismiss it. Although these people are the exact types of people who may benefit from ERE. Some of the lifestyle components are already ingrained, but they lack the big picture, systems wise. For many of them FI many years from now is just too much, too far away as a goal. Still, adopting a systems approach to an already frugal lifestyle can release them from the need for half of their income immediately. Save some, and cut back on the crappy job in six months from now, then to learn better ways to generate a lower cashflow. This may be a very appealing concept. This would still generate the positive environmental impacts, and provide for a more resilient lifestyle going forward for any participants.

I belong to another category. One that found their way to ERE via mainstream FIRE. Because something just wasn't "right", and I was really getting burnt out in my job. In my case, I had already doubled down on the income--->save---> invest paradigm. Hence I'd reached the sticking point above, also expressed in several other threads here... Why not work an hour at $50/hr to save the 8 hours of labor/learning required for "X"? Stuck on Wheaton 4-5 in many realms. How, beyond cutting off the ability to easily make $50/hr, do I motivate myself to move beyond? Well, there's resilience of lifestyle argument, which is a hard sell in a money based mainstream FIRE, or worse, in general society mindset where people think millions are needed for "safety". There is also the general pleasure in such a lifestyle. Again though, this is a hard sell without anecdotal experience, IMO.

I don't know that pointing out the frailty of WR's is the best way to do this. Because money centered people just think, "man, I need more money!". In speaking about money (what I fully understand) I had to talk to myself in ways like, "hey douchebag c_L, you have enough money to be FI with an ERE lifestyle, why don't you get off your ass and start living that lifestyle instead of wasting more time earning money in a job you don't like". Personally, I lacked the energy to do both, so a decision had to be made. Cut back on the earning and give this ERE thing a real try, or keep moving forward with mainstream FIRE. This community was very supportive. Without it, and a history of having made a similar move once before, I may not have been able to take the leap. As a result, I feel doubly responsible to help others in a similar circumstance make the leap themselves. Especially when responsible opportunities to do so present themselves.

Hell, I may fail, and end up in Wheaton 4-5 land forever. Even in that case, I'm still more resilient than standard FIRE, in my opinion, and at least I made a move to try. The other option I see is just "save more money". Since I don't buy the mainstream FIRE mindset of 4%, and set it and forget it VTI, I would never have felt safe with money alone. The bar would continually rise.

[Jean]

I should start selling some ere coaching boot camp and call them "how to start FIRE in the rain with no dry paper" to finance my purchase of greenland.

[steveo73]

Why is the 4% Rule conservative?

It's been successful 95% of the time with extremely limiting assumptions.

1. No additional income in any form. So no social security, no part time work, no inheritance, nothing.
2. Spending the same amount (including inflationary increases) every year.

It's also handled lots of pretty negative social and economic events. I see no reason to believe the future will be worse than the past. I'm certainly not betting on that. I read the rest of your post but I don't see any need to comment on it. There are always reasons why the future will be worse than the past but typically it's better.

It's going to be subjective but in my opinion the 4% rule is extremely conservative. If I can get to a 90%+ success rate based on my specific situation I'm good with that.

I think a good visualisation to look at is this one:- https://engaging-data.com/will-money-last-retire-early/

I'm much more likely to die that run out of money.

[steveo73]

It is.

Outside the ERE-bubble, typical keywords are: six-figure income, a "badass" budget around 30-50k/year/household, 4%-rule because "internet", slogan-based investing, 1-2M savings goal, flying around the world with a backpack as a goal, starting a FIRE blog to make side-income (there are hundreds now).

As FIRE has gone mainstream and become subsumed by the personal finance sphere, the average Wheaton level of FIRE wannabes has declined to about 3.5.

As I see it, FIRE has returned to what it originally was when it originated on Motley Fool and later "split" into Bogleheads and early-retirement.org. The followers of the modern "FIRE movement" are essentially a Millennial version of the Boomers that made up those groups in the 2000s. In that sense, ERE, MMM, and YMOYL and other early adopters were a bit of an aberration although we did change the language/framework of the discussion. Thus now, high-achievers are now talking about becoming FIRE (or just FI), whereas 10+ years ago the same type of people talked about becoming Millionaires---that being the standard for being rich enough to do whatever.

There are different implementations but the concepts remain the same. To me the core component is saving and investing which leads to financial independence. Different people are going to have different systems in place and therefore be on different levels.

Life is complex too. My FIL still works, he is rich, frugal but also has massive expenses due to supporting other people.

[classical_Liberal]

To me the core component is saving and investing which leads to financial independence.

I no longer believe this is a core component of ERE. This is side-effect, or peripheral action of a core lifestyle design. Metaphorically, it's only one bite into the meat of the apple that feeds you. This is what differentiates ERE from mainstream FIRE. Of course, this is only my opinion and why ERE is so attractive to me.

[steveo73]

I don't know that pointing out the frailty of WR's is the best way to do this. Because money centered people just think, "man, I need more money!". In speaking about money (what I fully understand) I had to talk to myself in ways like, "hey douchebag c_L, you have enough money to be FI with an ERE lifestyle, why don't you get off your ass and start living that lifestyle instead of wasting more time earning money in a job you don't like". Personally, I lacked the energy to do both, so a decision had to be made. Cut back on the earning and give this ERE thing a real try, or keep moving forward with mainstream FIRE. This community was very supportive. Without it, and a history of having made a similar move once before, I may not have been able to take the leap. As a result, I feel doubly responsible to help others in a similar circumstance make the leap themselves. Especially when responsible opportunities to do so present themselves.

Hell, I may fail, and end up in Wheaton 4-5 land forever. Even in that case, I'm still more resilient than standard FIRE, in my opinion, and at least I made a move to try. The other option I see is just "save more money". Since I don't buy the mainstream FIRE mindset of 4%, and set it and forget it VTI, I would never have felt safe with money alone. The bar would continually rise.

Good post. I think focusing on the frailty of WR's is fraught with danger as well

Danger no 1:- Thinking that you can beat the market. If we look at the data these people will probably (highly likely) under perform.
Danger no 2:- Working for too long. I understand some form of being conservative but if you are at a 95% success rate for your specific situation then you are in a really good situation.

I'd add one other point. More money invested wisely is often going to be the best way to manage your downside risk. If you read the stuff on ERN this is pretty clear. I just think that you can take this too far.

[steveo73]

I no longer believe this is a core component of ERE. This is side-effect, or peripheral action of a core lifestyle design. Metaphorically, it's only one bite into the meat of the apple that feeds you. This is what differentiates ERE from mainstream FIRE. Of course, this is only my opinion and why ERE is so attractive to me.

I get this as well. If you design your lifestyle well then you save money. The problem with this concept is I see Tim Ferris as a big proponent of lifestyle design but his approach is very different. I also think that most bloggers on FIRE out there are talking about lifestyle design as well.

I also like the idea though of setting your lifestyle up and then retiring (or working less) if you want too when you want too.

[classical_Liberal]

I'd add one other point. More money invested wisely is often going to be the best way to manage your downside risk.

I tend to disagree with this. Basically what this means is you are using a bigger sledgehammer.

So, let's assume 4% rule has a 95% historical chance of success for your, or my, particular situation. In order to mitigate that historical risk, and potentially mitigate other, new risks discussed in this thread, I decide to save to a 3%WR. That means I have to save another eight years or of expenses or increase my total savings by a full one third to gain a "guarantee" for that last 5%! Even in a Wheaton level 5, "pareto optimize" mindset it makes no sense to save 33% more to offset a 5% risk. Additionally, the correlation between an event(s) that leads to one of the 5% failures and one that leads to near complete failure of financial assets, is probably rather high. Hard to know exactly because the latter would probably be a black swan. So, isn't it better to rely on something other than the money-sledgehammer to cover you in both the 5% failure cases AND a potential black swan? Particularly if whatever that "thing" is, happens to be easier to procure than 8 years of expenses.

[steveo73]

I think we are basically on the same page but with a key difference.

If we assume that getting to a 95% success rate based on historical data isn't good enough then how do you increase your chances of success. There is one approach (the sledgehammer) which entails savings more money. There are other approaches such as trying to beat the market (a very very silly approach but one I think that is commonly used), going back to work etc. The point that I'd make is that the save more money approach is the most robust way of mitigating against that risk. If you read some of Big ERN's stuff you can see how this makes sense.

As you state though additional money will not lead to 100% chance of success because there can always be black swan events and the future will be different to the past.

My take is to accept that no retirement plan will be fool proof. Getting to a 95% chance of success is good enough for me (I'm probably okay with 90%+). If you aren't comfortable with a figure like that then you will have to do something different. This is where I think we disagree. I think you believe that by following an ERE lifestyle you can increase your chances of success. I think you can't do that much to increase your chances of success without working longer plus I think the assumptions underlying a success rate of 90%+ are pretty unrealistic.

We both don't believe in working another 8 years to increase your chances of success which in reality cannot ever equal 100% because unforeseen events can occur.

[Bankai]

I think a good visualisation to look at is this one:- https://engaging-data.com/will-money-last-retire-early/

I'm much more likely to die that run out of money.

Is it as simple as adding some 'spending flexibility' for a portfolio to 'never fail' (at least looking back)?

Spending flexibility thresholds for some popular asset allocations 'guaranteeing' 100% success rate (historically):

70/30 - 14%
60/40 - 17%
50/50 - 19%

This looks almost too simple - is cutting travel or eating out or clothing for a few years really enough?

[2Birds1Stone]

A big risk we are ignoring here is the desire/ability to keep your expenses as low as they are when you stop accumulating/pull the plug to ERE on assets alone.

Take myself for example. I've demonstrated that I can live on $16-18k/yr, and the FIRE calculators show a 90% success rate for a 60 year period any way I slice the data. A change in circumstances such as health issues, family needs, or simply a desire to increase consumption could wipe me out very quickly with such a low baseline spending. Sometimes returning to FT work is not an option. My situation already relies on geographical arbitrage, healthcare subsidies, and the current favorable tax code for low income individuals.

Additionally, accumulating 8 years of additional expenses does not equal to working an additional 8 years when you have a 75% savings rate, it's more like 2 years with average market returns. Not the worst tradeoff

Playing devils advocate here, as I'm pulling the plug this month.