The 4% Rule – A Castle in the Air

[chenda]

@WFJ - Could you space out your post just a little more?

[candide]

I for one appreciate the post -- though, admittedly I am a bit of a space-taking effort-poster myself.

[prudentelo]

I think 4% is actually based on historical performance, not parameterized projection, so it should not matter what humans expect etc. etc.

Of course 4% has finite failure rate even for 30 year, with implication retirees can fall back on social security and paid off house, so should not be taken seriously as 60 year plan.

[WFJ]

Botom spacing fixed. One can copy the numbers and paste in Excel for one number per cell.

The second simplest critique of the 4% rule is a "relevant range" violation. During the sample period, there was never a period with ZIRP for 12 years. Interest rates are probably the most important factor in estimating asset value and there was not a period of ZIRP for 12 years in the sample period. There are other problems with using 4% rule for estimating SWR which I can provide but are more technical and more about stats than finance.

[MBBboy]

There are also arguments to be made that the 4% rule is conservative - the results had a 5% failure rate, but there was a substantial percentage of outcomes where you had the same or MORE than you started with. I'll have to find something to link, but I recall it being something above 30% of the time.

ETA: No article link, I probably picked this up off of a forum somewhere. But here's a link showing a distribution of outcomes: https://engaging-data.com/visualizing-4-rule/. Using the original 50/50 stock and bond split, the median outcome looks like 85-90% of starting, and 25% of outcomes are 1.75M or above. Obviously there's some asymmetric risk here with failures being more painful than outsized success being pleasureable

And of course, the assumptions were static vs dynamic, with no flexibility at all for tightening the belt if you hit a poor sequence of returns early, and did not account for the tailwind of social security.

In short, of course no one should take 4% at face value without any additional critical thinking. But critical thinking about the 4% shouldn't immediately lead to a conclusion that 4% is a naive max and that the right number has to be lower.

Ironically enough, my reading about the Trinity Study indicates that it and th eventual 4% rule were criticized as being too CONSERVATIVE at the time, and the financial planning community was actually teaching that you could pull something closer to 10%. Interesting to see how the opinion on 4% can shift in ~50 years

[prudentelo]

@WFJ "The second simplest critique of the 4% rule is a "relevant range" violation. During the sample period, there was never a period with ZIRP for 12 years."

Agree. I worry lots about this. It is a historically novel disaster [to come?]

On other hand, central bank no longer feels need to pin currency to gold at an artificial rate at which claims could not be satisfied, which is what caused Great Depression. Maybe that was a worse disaster? From our current point of view, certainly would have been easier to avoid.

SImilar story with 70s Stagflation when many people reasoned, well maybe Soviet COmmunism is the better system. We know more now. Even ZIRP advocates sorta realize it has the potential to explode. Some of them just dont care for whatever career or political reasons - which btw are not all invalid either.

SO to say, this is generally a bad time to retire, sure. You are probably not getting your 5 or 6% SWR now which is average over 20th century. But does it mean you need to drop below the historical floor, to 3%, 2%, 1%...? Not necessarily IMO. The ZIRP "disaster" is different to historical disasters but not necessarily worse.

And frankly if that's so, then the conclusion is ZIRP has made assets so expensive that you're better off doing semi-ERE until the prices go down. No reason to work hard to buy high. Put in your 5 years at a different point in market cycle. If you already have cash, maybe just take a holiday...

[Mister Imperceptible]

On other hand, central bank no longer feels need to pin currency to gold at an artificial rate at which claims could not be satisfied, which is what caused Great Depression. Maybe that was a worse disaster? From our current point of view, certainly would have been easier to avoid.

On the contrary, Western central bankers are extremely concerned with pinning their currencies to a high level relative to gold, because to let go otherwise is to lose credibility. Kissinger, Volcker, and Greenspan acknowledged that “gold is the enemy” for the USD. Gold is still reported on the Federal Reserve balance sheet as having a $42 value.

Some people would contend that it is the knowing creation of irredeemable claims that create a depression. Because you know an activity is not economic, but you do it anyway, even though your resources are not infinite.

And frankly if that's so, then the conclusion is ZIRP has made assets so expensive that you're better off doing semi-ERE until the prices go down. No reason to work hard to buy high. Put in your 5 years at a different point in market cycle. If you already have cash, maybe just take a holiday...

What if ZIRP and the proliferation of well paying jobs went hand in hand? Or rather, if non-profitable (tech, fintech) companies stop being subsided by ZIRP, how would that impact a plan to generate financial capital surplus in order to retire? If you are waiting for ZIRP to end in order to buy assets cheaply, you may find that gainful employment post-ZIRP requires one to pick up a shovel or a rifle rather than sit at a computer.

[prudentelo]

Im not suggesting one leave top 1% paying job with 98% saving rate because assets too costly. Sure just get your 1% SWR.

But for rest of us ...

[WFJ]

Power rates in UK/EU are providing a painful example for why long-term financial estimations are problematic and taken with great care. Even Jacob would struggle sticking to a budget this Winter in Europe.

I have a quite low SWR, but still plan to return to work if positions are of interest as my main heuristic is to avoid a cricket eating pod existence in the future. 4% SWR creates this possibility for anyone in ERE.

[Mister Imperceptible]

I was pointing out that the economic shock from leaving ZIRP will make income from labor less available precisely when assets are cheaper. I think working now and having a numéraire repository of value as a tactical reserve is wise. The text I quoted included that advice. What I questioned was the advice to work later. The people who worked at Enron that retired early with their nest egg invested in Enron couldn’t go back to work at Enron when Enron went under.

If one is smart enough to understand that the default risk asset cannot yield 3% or 4% indefinitely, one may be smart enough to find yields elsewhere, that alone may make one with a 99% job able to separate from the rest.

[chenda]

Power rates in UK/EU are providing a painful example for why long-term financial estimations are problematic and taken with great care. Even Jacob would struggle sticking to a budget this Winter in Europe.

Its not been that hard really with an ERE lifestyle. My spending would only require an additional 0.2-0.3% withdrawal as compared to last year. Maybe less as I think I'm in credit with the power company.

[zbigi]

Its not been that hard really with an ERE lifestyle. My spending would only require an additional 0.2-0.3% withdrawal as compared to last year. Maybe less as I think I'm in credit with the power company.

Energy is highly regulated here in Poland. Distributors have to get an OK from government agency before they can increase prices for consumers. For areas where that does not apply (coal and firewood retail market), the government is already handing out 3000 pln (~$650 USD) per household everyone affected to help with price increases.
So, I'm fairly well insulated (ha!) from being directly hit by the crisis. However, all that regulation and government spending obviously cannot be good in medium and long term. That my affect the value of my portfolio more than what I would've spent on energy during the crisis.

[prudentelo]

I was pointing out that the economic shock from leaving ZIRP will make income from labor less available precisely when assets are cheaper. I think working now and having a numéraire repository of value as a tactical reserve is wise. The text I quoted included that advice. What I questioned was the advice to work later. The people who worked at Enron that retired early with their nest egg invested in Enron couldn’t go back to work at Enron when Enron went under.

If one is smart enough to understand that the default risk asset cannot yield 3% or 4% indefinitely, one may be smart enough to find yields elsewhere, that alone may make one with a 99% job able to separate from the rest.

Not sure if it'swhat you mean by "having a numéraire repository of value" (sorry did not learn, eh, your dialect at school) but you are certainly going to want some level of financial wealth to bridge a crisis. Question is whether now is the best time to work to stack assets for 60 year "eternal retirement."

If you think market today will return 3% over 60 (not 6) years - which is worse than historical worst case - then makes sense to keep working. If you think 2, 1%, then hard to see why bother beyond emergency fund.

Unless you think both finances and employment in the toilet for 60 years in which case my advice is join army or flee country

A problem with seeking endless contingency is that you never get to retire

Another problem is you will still fail to hedge every risk, including every catastrophe risk

[fiby41]

It's possible that 1871-2019 US stock market has been an exceptional period in comparison to rest of human history.
What has worked out longer is having atleast 1 child who can take care of an ailing you in old age.

[zbigi]

It's possible that 1871-2019 US stock market has been an exceptional period in comparison to rest of human history.

I quite often wonder about that as well. Everything about our current era is basically an experiment without precedent, so there's hardly any data to draw conclusions about the past from.

[ertyu]

I quite often wonder about that as well. Everything about our current era is basically an experiment without precedent, so there's hardly any data to draw conclusions about the past from.

it -is- exceptional. the us stock market is the stock market of a country that rose from nothing - fields and agriculture - to the economic superpower of our day. So not only does the us stock market capture the full industrialization of the country, it captures the full industrialization of the country that then went on to overtake everyone else. The swrs for other markets are in the 1-2% range, closer to 1. Dr. Wade Pfau did the studies but I don't have references off the cuff.

[prudentelo]

It's possible that 1871-2019 US stock market has been an exceptional period in comparison to rest of human history.
What has worked out longer is having atleast 1 child who can take care of an ailing you in old age.

Americans like to believe their exceptionalism, and all their "Year Zero", but finance is older than U.S.A., and 3% return not new.


It is very important to understand the finance does not return to you the economic growth. The economic growth is "for free" to everyone including workers with no savings. Finance is wealth transfer system. Finance will enrich some even in shrinking economy.

Easier still to see this when you understand economic growth is truly the decrease of [some] prices and not the increase of general incomes or values. Economic growth destroys assets as well as create them.

Richest banker ever was Fugger who lived in medieval "Malthusian" economy.

[7Wannabe5]

It also might be relevant that 1871 is approximate to take-off point for S-Curve of fossil fuel era. IOW, graph of the U.S. stock market vs. energy-slaves per American might be relevant.

OTOH, since investment in the stock market can also be thought of as "owning" or "renting" a number of wage-slaves of your own, globally declining birth rates may render the average passive stock market investor like unto an agriculturist with no offspring to help work the field or provide fresh ideas. Dunno.

[prudentelo]

it -is- exceptional. the us stock market is the stock market of a country that rose from nothing - fields and agriculture - to the economic superpower of our day. So not only does the us stock market capture the full industrialization of the country, it captures the full industrialization of the country that then went on to overtake everyone else. The swrs for other markets are in the 1-2% range, closer to 1. Dr. Wade Pfau did the studies but I don't have references off the cuff.

There is a chart posted here some time ago showing very bad SWR for some countries with start year of 1937, probably reflecting massive losses in WWII period.

No one should rule out the possibility of mega catastrophe and sudden expropriation. Keep fit so that you can fight in the WWII. Maintain friends abroad so you can run if your government turns nasty. Money is not forever and "ultimate safety" illusion. Probably best way to "buy more safety" is to get a job doing something essential for functioning of your state, not for the nominal salary, but so state will protect you in the exceptional events. Even civil war USA is not going to stop feeding its army.

But the US stock market "geo political exceptionalism" theory is simply ignorant not just of the facts (Finnish stock market outperformed US in 1900s, though for sure US was a bit above the average) but all finance theory since 1950, and no not all theory is "impractical myth making", certainly not compared to folk wisdom of those who did not even read it.

Current USA stock market is probably overpriced because dominant FED in ZIRP hits US assets first. Whether this is actionable is other question, because early retirement is more sensitive to sequence risk than the total return. If Fed continues the policies five more years, you escape the sequence risk. Of course, you also risk explosion tomorrow which can happen. But people said get out of overheated ZIRP market in 2010, and as FIRE those people would have blew up their retirements by holding only TIPS, either in sense that they ran out of money, or worked far too long.

Broad world stock market - and all globalized stock markets are just components of one world market - should not drastically underperform historical returns on financial instruments in "money transfer" system. It's possible world living standards drop, nothing can be done about that as individual, but as financial asset owner you should keep and better your place in the relative terms.

* * *

Belief ZIRP will end requires believing five impossible thing before breakfast or rather two contradictory things:

- the US government is very imprudent in the financial planning for short term political gain, thus doing ZIRP

- the US government is ultimately very prudent in the financial planning for long term, thus will end ZIRP to restore cosmic balance [also this is likely to happen soon or even tomorrow or even five minutes ago, so ignore the sequence risk benefits of the ZIRP and hold only TIPS]

where is logic here?

US Dollar is more likely to disappaer than World Equity Index, IMO. There is more the historical precedent for it.

Also, if US Government is truly very competent and basically well intentioned, they are capable in theory of returning to 1% or 2% real interest rates without huge nominal stock market crash by the smart monetary policy. Tthough PE will likely return to 20-25, rather than 30-35, this is not 4% SWR-sinking disaster, just moderate bad event.

[steveo73]

A problem with seeking endless contingency is that you never get to retire

Another problem is you will still fail to hedge every risk, including every catastrophe risk

There is no real SWR is there. There are a lot of potential failures but mitigating against those failures is extremely costly if it is even possible. A lot of risks aren't really financial risks as well. Your health is a good example.

People get way too worked up about all these metrics. All your numbers (and mine) are guesstimates (unless they are backward looking) anyway. Who here has hedged/insured their spending for the next 30 years let alone a longer time frame ? The answer is no one.

The calculations are fine and interesting but you shouldn't lose sight of the big picture which is when you retire and an indication of what your budget is going to be.

Quick question. Who is safer ?

Person A has a WR of 3%.
Person B has a WR of 5%.

It's a trick question because you need a lot more information to have any idea who is safer. Person A could be lying about their expenses. Person B may have contingencies all through their budget. Person A could be invested 100% into Cryptocurrencies whereas Person B is in index funds.

The big issue with these discussions is that the WR is just an indicator.