“How much money do I need to retire” is a question I get often. I usually don’t have a great answer, and not only because it happens on the golf course when I’m struggling to hit a stationary ball. It’s because it depends on things like your lifestyle, age, and investment approach. If you want to spend $10,000 a month in retirement starting at 55, you’ll need more money than someone who will spend less and retire later. This is why rules of thumb for how much you need to retire don’t make sense to me. But I am a fan of the 4% rule. Originally shared by William Bengen in Determining Withdrawal Rates Using Historical Data in a 1994 issue of the Journal of Financial Planning, it is Bengen’s answer to the question of what is a safe retirement withdrawal rate.
The 4% Rule
Bengen, a young financial advisor, decided to figure out retirement math for his boomer clients. He reviewed historical returns for a 60% stock/40% bond portfolio and inflation history and concluded that 4% of your initial portfolio value is a safe retirement withdrawal rate increased annually for inflation. His math took into account adjustments for severe market downturns and above average inflation along the way. He defined safe as lasting at least 30 years. A 3% withdrawal rate would last 50 years. He also recommended stocks be no less than 50% of your portfolio and not more than 75% in retirement.
Since that time, his paper has turned into the widely known 4% rule, and has seen its share of critics. Recently, the expensive stock market and low bond yields have some saying the 60/40 portfolio is dead and can’t deliver the returns needed to make the 4% rule work.
U.S. News & World Report: The 60/40 Portfolio Is Dead for Retirement Planning
WisdomTree: The Death of the 60/40 Portfolio
So, it was interesting to see this Barron’s interview with William Bergen recently in which he declared that not only was the 4% still alive and kicking, but he upgraded it to the 4.5% rule! The Originator of ‘the 4% Rule’ Thinks It’s Off the Mark. He Says It Now Could Be Up to 4.5%.
The 4.5% Rule?
Stocks are expensive. Bonds yield next to nothing. When stocks are expensive, future returns tend to be weaker. When bond yields are next to nothing, you tend to have weak future bond returns. Because of this, some have advocated that a safe retirement withdrawal rate should be as low as 2.4%.
He originally used just two asset classes for his paper: intermediate-term Treasury bonds and large-cap stocks. By adding other asset classes, including small cap stocks, he thinks the safe retirement withdrawal rate could be as much as 4.5%.
I’m a fan of the rule and loved the strengthened update.
The pessimism and biases masquerading as sophisticated investment analysis are tiring. If you want to kill the 60/40 portfolio, do it on your own time and stop scaring investors. Sure, markets get expensive and some asset classes look unattractive. But retirement will last decades, today’s market positioning will evolve, and as Bergen himself says, you have the opportunity to redirect your investments to other types of stocks and bonds and improve your portfolio outlook.
So, next time someone asks me what they think “their number” should be, I can now say 4.5% and recommend they sign up for the blog for all the details.
Now, if I could only play golf…
To check-up on your finances and retirement readiness, Your Wealth Management Checklist
For more on why to invest in other areas, Investment Winners Rotate…and they’re doing it again