The 4% Rule – A Castle in the Air

[The Old Man]

I think you are overstating the matter a bit.

I am not.

The 4% Rule was back-tested upon the 4% Rule Portfolio.

The 4% Rule Portfolio is composed of stocks and bonds. This portfolio was selected because these are “investable assets” so much beloved of the investment industry. It is not intended to represent an optimum selection of investment assets, just the most convenient assets for the investment industry. There are mutual funds to be sold and financial advisors to be paid.

The Great Stagnation: Stocks perform poorly in an inflationary environment and bonds are devasted in such an environment. The magnitude and duration of inflation cannot be predicted; thus, a SWR cannot be predicted.

The Great Depression: Stocks are devastated in such an environment and bonds are spent down to buy time until the economy recovers such that stocks can resume their upward trend and replenish the depleted bond component. What surprised contemporaries was that the economy did not recover on its own as Classical Economics said it would; the downturn could have continued for much longer. The massive fiscal stimulus of World War II was necessary for the economy to recover. Is it possible to predict a World War will arise just when you need one or that politicians will agree to approve massive fiscal measures? The origins of the Great Depression are a mystery, but it began with a financial crisis and financial crises appear to be a feature of modern economies. Can you predict that the Federal Reserve can successfully prevent a financial crisis from escalating into an economic crisis? If you can’t do any of this or even develop probabilities of success, then a SWR cannot be calculated.

I attacked the 4% Rule on its core implied assumption that economic growth of the past will continue into the future. Since due to demographics it won’t, the 4% Rule and its 95% confidence level will not hold. I attacked it because people treat it like it’s a rule of law.

The answer is not to develop a better SWR, because you can’t. The answer is to develop contingency plans for overcoming the shortfall if it should arise. In theory, the entirety of ERE - as I understand it - is to reduce the dependency of people on the money economy and replace it with other forms of capital so as to create a resilient person capable of prospering in any economic environment. Instead people seem to want to create a better SWR (or have religious faith in the 4% Rule) and forgo other capital developments.

[George the original one]

Interestingly, initially, ERE was 'save extremely (75%+) for 5 years', while current consensus appears to be '3% or better 2.5% SWR'... meaning 11 or 13.3 years at 75% SR... am I the only one this sounds rather unappealing to? Are people industrious enough to retire very early also not smart enough to reduce spending or generate some income when they see portfolio dwindling?

No, you are not. And that's why the observation of when to change course in retirement is needed. Research has shown the "point of no return" is when your spending is around 12% of investments, but it has not been particularly publicized and is thus a rather unknown fact (unlike SWR 4%).

[daylen]

.. is a statistical analysis and thus descriptive only. It is NOT a model and thus lacks predictive capability.

That is a blurry line. Any analysis assumes a model (however crude) of the whole it is reducing, and any prediction is based on past description even if that information is encoded into a "state".

Analysis or calculus differentiates over a space then integrates the parts into a coherent whole again. Statistical analysis adds noise to the signal. The boundaries of the space and of the components being differentiated is the ontology. The epistemology is the coupling of these ''things" into propositions.

Let's say my garage is the spatial boundary and 4:30-4:35pm is my time boundary (relative to me the stationary observer in the corner ). An ant in my reference frame starts at <x(0),y(0),z(0),t(4:30),v(30cm/min,towards me in opposing corner)>. That is a description of the situation using a "model" of what things are and what state they are in that can be used to predict the ant will be 150cm closer to me at 4:35.

A statistical addition could be that my estimation of his velocity follows a normal distribution with some variance centered at 30cm/min.

[George the original one]

What are your plans for world domination when your stash hits stinkin'?

I probably won't make stinkin' because I'll start spending on services when there's "more than plenty".

[daylen]

In relation to the 4% rule: the time interval, stocks, bonds, portfolios, and so forth are all things being coupled together to form a statistical description. If the assumptions are maintained, then the time boundary can be expanded for predictive power. This does nothing to say if the model is accurate or not.

[George the original one]

My take on when people state they need to get to a lower than 4% rule is that they want a >95% success rate in their situation.

They forget that unknown unknowns will preempt anything above say 96% success rate (disasters natural and manmade, of which manmade are more numerous IMHO).

[daylen]

I guess you could argue that adding in a probability model to the ant situation above is inferential instead of descriptive. Though, I could just say that during the first few centimeters I sampled the velocity and inferred a distribution. So, an inference still needs to be made, but precisely what is and is not an inference is up for debate.

Also relates to parsing issues with logic. Not everyone interprets language the same way because parsing is a complex task even when ignoring semantics.

[steveo73]

They forget that unknown unknowns will preempt anything above say 96% success rate (disasters natural and manmade, of which manmade are more numerous IMHO).

This is correct. It's just probabilities. Lot's of really bad shit has happened in the past plus you die. Once you get to a reasonable comfort level I think it's okay to quit work but I'm still working and looking forward to retirement.

[Jin+Guice]

Put another way, it is a lack of confidence in the resilience of our current situation, coupled with the concern we may just decide ERE lifestyle is for the birds later in life.

I'm surprised to hear this because, to me, ERE is such an obviously superior strategy that I can't imagine wanting to turn back. Put another way, I always suspected that extreme frugality was possible and probably desirable but I didn't understand why. Once I found ERE I understood why. At the higher levels, I don't think ERE separates you from money, except that it separates you from the desire to have (very much) money.

Interestingly, initially, ERE was 'save extremely (75%+) for 5 years', while current consensus appears to be '3% or better 2.5% SWR'... meaning 11 or 13.3 years at 75% SR... am I the only one this sounds rather unappealing to?

This is what I'm angling at with my ranting about semi-ERE and investment returns. 5 years consecutively with enough effort to earn 4x(==75% SR) the amount you spend is passed the border of worth it to me, unless I REALLY enjoy my work. The fact that this approaches an extreme ideal for many members of this forum, and the recent discussion of the integrity of even a 3% SWR is why I started advocating examining alternative paths.

"Never kid yourself that you can go passive!!!"

Advice I needed to hear.

[7Wannabe5]

The answer is not to develop a better SWR, because you can’t. The answer is to develop contingency plans for overcoming the shortfall if it should arise. In theory, the entirety of ERE - as I understand it - is to reduce the dependency of people on the money economy and replace it with other forms of capital so as to create a resilient person capable of prospering in any economic environment. Instead people seem to want to create a better SWR (or have religious faith in the 4% Rule) and forgo other capital developments.

Gotcha. I agree with you on general principles. I somewhat disagree with your specific reasoning on the mechanism of demographics, at least at the level of "The market can stay irrational for longer than you can stay solvent."

I probably won't make stinkin' because I'll start spending on services when there's "more than plenty".

Probably schmobably. Doesn't hurt to compose the artful collage where only one path out of 20 disappears into glitter sprinkled clouds. AS LONG as you do the same with the other 19.

@daylen:

Yes. What I was trying to say.

Funny thing is that almost everything in modern financial mathematics is based on combination of description of Brownian Motion and 20th century solutions to 19th century gambling problems. Like maybe you could hit 95th percentile for retail investors if you could explain why the martingale is not infallible, which would require being up to the 1940s in math. Dunno.

I did a fun experiment the other day. I bought 100 shares of a very inexpensive, quite volatile stock, and then attempted to sell a seriously out of the money covered call dated 7 months in the future. Later that day I observed that the Volume was 1. My theory is that you shouldn't content yourself with index funds until you can figure out why you lose money when you attempt experiments like this.

[jacob]

@daylen - The assumption/assertion of stationarity is what turns Trinity from a description of the past into a prediction of the future. The disagreement is between whether the future is like or no worse than the past because world wars, depression, etc. (stationarity holds) or it is because declining productivity and population growth trends (stationarity does not hold). These issues are essentially apples and oranges which is why/where the debate above is stuck. A way forward would be to detrend the past data and replace it with a model of the declining megatrends so that one has a dataset of world wars+depression+... with declining macrofactors and then run the MC again.

[IlliniDave]

I'm surprised to hear this because, to me, ERE is such an obviously superior strategy that I can't imagine wanting to turn back. Put another way, I always suspected that extreme frugality was possible and probably desirable but I didn't understand why. Once I found ERE I understood why. At the higher levels, I don't think ERE separates you from money, except that it separates you from the desire to have (very much) money.

This is where I fall short I think. I see ERE (presumably incorrectly) as a system of tools rather than as a way of life. I want to be able to survive a financially-constrained scenario, but I don't want a financially-constrained lifestyle (up to a certain point). That doesn't mean I litter my path with $20-bills every waking moment like a bridesmaid showering the aisle with flower petals (though occasionally it feels like that). I just like keeping the option to use money to accomplish a purpose in my back pocket at the ready. Then as I go along I can go through the sequence of make/buy decisions and pick the approach that most aligns with my iDave-ism lifestyle. iDave-ism contains a generous dollop of frugality, so I guess I can look like someone (probably a bogleheader) wearing a poorly-fitting ERE suit at a costume party.

[Jin+Guice]

@iDave: I'm not sure a system of tools that you use and a way of life are that different. It's hard for me to view spending money beyond maintenance expenditures as something that improves my life (though I am not perfect in this dimension). This is not the viewpoint shared by our culture and so I spent my whole life worrying I might grow out of this until I found FIRE and then ERE. The former gave me a tribe, including elders, which confirmed my long held suspicion that one does not automatically gain more expensive tastes by aging. The latter provided with me with a framework to go beyond frugality and expand my view of production/ consumption past the monetary dimension.

I had the advantages of youth, ingrained frugality and a somewhat alternative lifestyle already. For where I was in my life, the ERE book could have had a cheesy sticker that said "get more for less" on the cover and it wouldn't have been a lie. Embracing frugality took me from a financially constrained view where resources are scarce to a financially free one where resources are abundant. My own full retirement is the only place where I'm still constrained financially, so I spend my time on the internet debating its value.

[IlliniDave]

J+G, I suppose it might come down to what a person considers maintenance expenditures. What I might consider an essential expense might qualify as frivolous to someone else and vice-versa. And I do apply the YMOYL "criteria" when I consider spending money, although I'm good about not falling into the trap of trying to buy happiness. Happiness comes from within is my oft-repeated mantra as far as that goes.

What I'm saying primarily is that achieving extreme frugality, and/or maximizing the degree to which I decouple my life from financial transactions, is not at the top of my value hierarchy. Specific to frugality, it's something I value and a moderate amount comes naturally to me, but I only push it when it directly supports items higher up in my value hierarchy. If opening my wallet supports those items as well or better, then that approach is in contention too. Just my personal quirks.

[classical_Liberal]

This is not the viewpoint shared by our culture and so I spent my whole life worrying I might grow out of this until I found FIRE and then ERE.

For the 25 years that I've been a self-supporting adult, I've lived at maybe twice ERE spending levels for 4-5 of those years. The first 3 were in two different post secondary schooling periods, both over a decade ago. So let's just say I have 2 of the last 10 years in experience attempting to live/make progress towards ERE, yet have not yet achieved it. This experience is a far cry different than your statement above. This is why I hesitated to go all in on a very different lifestyle. Not because the lifestyle isn't theoretically resilient, but because whatever it is I'm doing may not be resilient and ERE my not be truly achievable for me. So yes, I worry I may grow out of this.

[Jin+Guice]

@iDave: Do you have a framework for your value hierarchy? Would you mind sharing it? Perhaps in your or my journal if you don't want to put it in a thread about the 4% rule.

@c_L: Ah, ok. I've spent all 10 years I've been a self supporting adult (and really the previous 4 of college as well) at ERE* spending levels. Really I was just bumbling around like a drunken jackass, but I wasn't spending much money doing it. Somehow I escaped tying spending money to fun. Sometimes I forget that this is weird/ uncommon, which should be my catchphrase.

*Or morel like MMM spending levels.

[7Wannabe5]

Pr(A|B)= Pr(B|A) Pr(A)/Pr(B)

A= Success 4% withdrawal
B=Stagnant Economic Growth

Pr(A) =.95 (given)
Pr(A|B) = .01 (subjective belief OP)
Pr(B)=.95 (subjective belief OP)
Pr(B|A) = .01 (result)

Pr(A) =.95 (given)
Pr(B|A)=.5 (assumed indifference, "could happen")
Pr(B)=.95 (subjective belief OP)
Pr(A|B)=.5 (result)

Does this make sense?

[IlliniDave]

@iDave: Do you have a framework for your value hierarchy? Would you mind sharing it? Perhaps in your or my journal if you don't want to put it in a thread about the 4% rule.

I don't actually, at least not one I'm conscious of. As pertains to the intersection of money and values, all I really have is an intuitive ranking, some of which had roots in the YMOYL exercise (reviewing expenses and determining whether a given expense improved life/aligns with values, or not; and is in reasonable proportion to the time you gave up to accumulate the money). It's evolved over time as I've ticked off various financial goals. Marginal dollars ten years ago were worth a lot more than marginal dollars today. The next big change will be exiting the workforce. That will change how I approach time management, and giving up time for mundane chores won't be quite as costly. And to stay a little on topic, I place a lot of value on the flexibility I've built into my plan. Similar to ERE in that it stands on a frugal baseline, I don't need to tax my assets at anything close to 4%. That allows me to be flexible in how I utilize money. I guess I try for optimal utilization of money over minimal utilization of money.

[mathiverse]

For the 25 years that I've been a self-supporting adult, I've lived at maybe twice ERE spending levels for 4-5 of those years... let's just say I have 2 of the last 10 years in experience attempting to live/make progress towards ERE, yet have not yet achieved it... So yes, I worry I may grow out of this.

c_L, now that you've got a few more years under your belt. Do you still worry about growing out of your current spending levels? How has your thinking changed?

[WFJ]

From an ERE perspective, the main problem with using the "4%" rule is that it is a "30-year 4% rule". Had the paper been called the "30-year retirement rule" it's possible more would understand using 4% for more than 30 years violates one of the most basic standards in stats called "Extrapolation". This is dangerous as the main culprit for the 4% failing is a run of small returns and runs happen more often and are longer in duration than humans estimate (bias everyone has). Below is a copy of a Montecarlo simulation everyone can build for themselves with standard assumptions of market returns and volatility and the 4% fails, due to a bad 6 year run with only 2 years of small positive returns and 4 yeas of slight negative returns from 2037 to 2042 (1.78, -23.40, -4.83, 2.56, -1.18, -5.76). The total 50-year return is 6.29%, yet the 4% rule fails in year 34. If one was 30 at the inception, they will be broke at 64 and face a bleak future. If volatility is slightly increased, then there are many more failures or if returns are not normally distributed. If one was 65 at inception, then you would turn 100 just as you went broke, which is not a big problem assuming you lived that long.

I wrote before, the first time I saw the 4% rule, thought it was a joke and still surprised how many people accept this as a viable retirement plan for ERE.




Investment $1,000,000
Average Return 7.00%
Std Dev 15%
SWR 4.00%
Withdrawals $40,000



Age 72 90 100
Value $375,713 $(328,525) $(1,744,119)

Years 5 10 Total
Average 3.26% 1.71% 6.29%


Negative Years 1 5 18
Ratio 20% 50% 36%

Age Year Return Ending value
50 2021 3.10% $990,955
51 2022 4.83% $996,905
52 2023 10.28% $1,055,321
53 2024 10.06% $1,117,444
54 2025 -11.95% $948,652
55 2026 -5.00% $863,264
56 2027 -10.08% $740,264
57 2028 26.65% $886,893
58 2029 -7.96% $779,459
59 2030 -2.80% $718,746
60 2031 6.23% $721,057
61 2032 -2.51% $663,985
62 2033 1.69% $634,530
63 2034 9.33% $649,997
64 2035 18.47% $722,636
65 2036 13.25% $773,090
66 2037 1.78% $746,106
67 2038 -23.40% $540,888
68 2039 -4.83% $476,689
69 2040 2.56% $447,878
70 2041 -1.18% $403,070
71 2042 -5.76% $342,148
72 2043 24.35% $375,713
73 2044 -19.74% $269,446
74 2045 23.19% $282,651
75 2046 13.04% $274,284
76 2047 16.98% $274,054
77 2048 14.86% $268,825
78 2049 -20.56% $181,770
79 2050 11.64% $158,275
80 2051 -8.49% $108,229
81 2052 16.81% $79,698
82 2053 15.17% $45,720
83 2054 16.54% $6,666
84 2055 19.30% $(39,769)
85 2056 -16.12% $(66,913)
86 2057 -1.29% $(105,529)
87 2058 5.59% $(153,671)
88 2059 12.03% $(216,964)
89 2060 -15.16% $(218,000)
90 2061 27.33% $(328,525)
91 2062 54.40% $(568,994)
92 2063 17.40% $(714,970)
93 2064 26.68% $(956,401)
94 2065 3.31% $(1,029,381)
95 2066 18.33% $(1,265,401)
96 2067 37.79% $(1,798,756)
97 2068 14.87% $(2,112,188)
98 2069 14.35% $(2,461,057)
99 2070 -22.79% $(1,930,984)
100 2071 -11.51% $(1,744,119)