By Dr. James M. Dahle, WCI Founder
An important rule of thumb for the physician investor to understand is the 4% rule. Especially if they're thinking about becoming a part of (or are already involved with) the FIRE community.
What Is a Safe Withdrawal Rate (SWR)?
A safe withdrawal rate is the amount you can withdraw from a portfolio every year without running out of money during your retirement. It seems straightforward, but it can actually get quite confusing. If you only spend the increase in value of a portfolio (or the income you get from it, which is often even less), you will never dip into principal. You will also end up spending much less than you could have during your retirement. At the same time, you also don't want to spend so much principal that you run out of money.
Since you do not know how long you will live, you do not really know how long the portfolio must last. Thus, the need to know the safe withdrawal rate. It gets even more complicated when you realize that your withdrawals must also account for future inflation, which is again unknown and unknowable.
What Is the 4% Rule?
Four percent is the amount you can withdraw from a portfolio each year and expect it to last you through retirement. You get to increase that 4% with inflation each year. That means that to retire, you need a portfolio 25 times bigger than the amount you plan to spend from it each year. That 4% has to include ALL of your spending, though, including taxes and advisory fees. Where does this rule come from? Put on your evidence-based investing hats and follow me to what is called “The Trinity Study.”
What Is the Trinity Study?
This study came out of Trinity University in the 1990s with updated data in 2010. It is a classic of personal finance literature. The investigators simply wanted to answer this question:
“How much of a portfolio can an investor spend each year, adjusted upward with inflation, and not run out of money during a 30-year retirement?”
The researchers divided all of our past financial data into rolling 30-year periods (from 1929-2009, so 53 overlapping 30-year periods) and then tested how likely the portfolio was to survive for the whole 30 years at various asset allocations and various withdrawal rates. In the 1990s, there was this idea prevalent in the financial planning community that if the stock market returned 7%-12% a year, you could spend 7%-12% of your portfolio every year in retirement and expect it to last.
This important study threw a lot of cold water on that idea, which turns out to be false due to something called the Sequence of Returns Risk. The Sequence of Returns Risk is the idea that even if your average portfolio returns are fine over your retirement years, you could still run out of money if the market performs badly at the beginning of your retirement. That's because you are withdrawing money from the portfolio at the same time it is losing value. It turns out that if you were spending more than 5% of your portfolio a year (again, adjusted to inflation), you would be very lucky if your portfolio lasted 30 years due to the Sequence of Returns Risk. There are ways to mitigate that risk, especially if you're retiring in 2022 when the markets are cratering and inflation is soaring, but it's something of which you have to be aware.
Let's look at the retirement withdrawal rate chart from the study. This is the most important table from the paper:
This table tells you three things. First, your portfolio is much more likely to last if you include stocks in it throughout retirement rather than holding a bond-heavy allocation. Second, with a typical retiree asset allocation of 25%-50% stock, any withdrawal rate larger than 4% is quite reckless with a significant risk of running out of money prior to death. Lastly, if you decrease your withdrawal rate to 3%, just about any asset allocation will do.
There are two important caveats to this paper on safe withdrawal rates. The first is that it is based on past data. You can no longer invest in the past. Four percent may only be safe inasmuch as the future resembles the past. If returns are significantly lower in the future or if inflation is significantly higher, then 4% may turn out to be a pretty risky number.
Stocks are also risky investments. We intuitively understand that in the short term, the volatility of stocks makes them pretty risky. But they are also risky in the long term. Sometimes stocks go down and DON'T come back up. Entire stock exchanges have disappeared, and investors have lost 100% of their investment. It hasn't happened in the US, but it could. Increasing your allocation to stocks in retirement because you didn't save enough or because you spend too much probably isn't a good idea.
The second caveat is that the data is pretty limited. Sure, there are 53 different periods of time, but how many independent 30-year periods are there? Only about three. As Dr. William Bernstein discusses so eloquently here, we only have two centuries of financial data. There's no way you could sneak data that shaky past the FDA to get a new treatment approved, but it is the best we have in investing. The wise doctor (and investor) knows the difference between robust data and not-so-robust data, and they're careful about putting their confidence in the shaky stuff.
Plus, with more people retiring in their 50s instead of their 60s and 70s (and with people tending to live longer), retirements now could last longer than 30 years. They could last 40 or even 50 years. That's why some in the FIRE community who are retiring in their early 50s feel more comfortable with a 3% or a 3.5% withdrawal rate.
Either way, whether the safe withdrawal rate turns out to be 2% or 3% or 5%, it surely isn't going to be 8%. So, when setting goals for your retirement nest egg, you'd better plan on having 25 times what you'll need each year set aside before pulling the cord on the ejection seat at work.
A Better Idea Than a Fixed Safe Withdrawal Rate
Very few retirees follow any sort of strict fixed withdrawal rate, much less the 4% one. As you have read, the 4% rule is really just a 4% guideline. It's a reasonable place to start. If Sequence of Returns Risk shows up early in your retirement, batten down the hatches and cut your spending. If it does not, bump up your spending. You could even spend 5%, 6%, or even more a year, especially if you can cut back when the market does poorly. The ability to be flexible in retirement is extremely valuable, and it will likely allow you to significantly exceed a 4% withdrawal rate.
What do you think is the true safe withdrawal rate? How do you plan to spend your assets down in retirement? Are you still worried about running out of money? Comment below!
[This updated post was originally published in 2011.]
Just wanted to thank you very much for posting your insights for the rest of us. While I had heard of the Trinity study, the clarity with which you dissected the study helped solidify its meaning for me. The rest of your posts are amazing as well. They are all food for thought without the fluff.
“up to 31 readers on the RSS feed…” !! 🙂
I had not heard of this study. Thanks for hitting the main points.
Do you still use 4% as the benchmark?
I don’t as I’m still in the accumulation phase. I think most retirees are using a variable plan to be honest. When investments do well, they withdraw more. In bad times, they hunker down a bit. But 4% is a great starting point.
I love the Trinity Study table, and its brother the Cooley Table, which uses the same data and shows what the median amount of money is for the different allocations and time frames. That information brings context to the binary nature of the Trinity table which is just run out of money or don’t.
However, it may be time to update this post a bit. Several factors make it more accurate to project in excess of 5% as a withdrawal rate. One of those factors is the addition of small cap stocks to the allocation. When the equity portion has one third small caps the safemax increases to 4.59%.
The other issue is that the 4% Safe Withdrawal rate assumes that spending stays constant (relative to inflation) throughout retirement. This isn’t accurate. It declines 2-3% a year. This has a huge effect on withdrawal rate safety.
Combining those two facts actually leads to a safe withdrawal rate of close to 6%.
Food for thought.
Bob
I agree with all that (except the bit about small cap stocks- that’s probably cancelled out by the fact that the Trinity guys used long-term corporates). Maybe I should do an update on this post and include the Cooley Table. A lot of people are really surprised when they learn they will PROBABLY die with more money than they retired with following a 4% withdrawal rule.
Here’s a link for those interested. Table 3 is the “Cooley Table” he’s referring to:
http://www.onefpa.org/journal/Pages/Portfolio%20Success%20Rates%20Where%20to%20Draw%20the%20Line.aspx
Cooley is the first author on the paper and one of the original Trinity authors. The link probably doesn’t work. Google: Portfolio Success Rates: Where to Draw The Line and it’ll come right up.
I know it’s an old post, but figured it would be a good spot to ask a question. I’m reading William J. Bernstein’s fairly recent book “The investor’s Manifesto Preparing for prosperity, Armageddon…” and he keeps harping on a 2% withdraw rate. To quote him “at 3 percent, you are probably safe; at 4 percent, you are taking real risks; and at 5 percent, you had better like cat food and vacations very close to home.” I always heard 4%, adjusted for inflation, and figured that number into planning. Is there some new info out there, or is this just ultra-safe, no way ever running out, planning?
I disagree with Bill on this point. I think 2% is ridiculous, 3% is hyperconservative, 4% is almost surely safe, and 5% might be safe. I have a post I wrote last night coming up on it this summer. (Yes, I’m that far out right now.) The Trinity data suggests that if you use a 3% rate, and are invested in 100% stocks, you are likely to die after 30 years with 13 times as much money as you had when you retired. That’s on average. Half the investors will have MORE! That data includes the Great Depression, WWII etc etc etc. You really feel like you need to be that conservative? I certainly don’t.
Wow. I think I just wet myself. That is mind-blowing. Never even crossed my mind as possible to come out with half the amount. It really is possible to win at this game.
Good to know, I’ll be looking forward to the post. I see myself pulling out around 4% a year, likely less, but not really increasing with inflation. Most of the things I like to do are the same price they were 20 years ago so unless inflation gets crazy, I don’t see that being to much of an issue for me. Worst come to worse, we can both drive our jazzy over to his place and beg for table scraps when we run out of money at 80!
Does the 4% rule attempt to preserve the original nest egg or does that get consumed as well? I want to die broke!
Most of the time you will die with many multiples of what you started with. Sometimes you die broke and other times you will run out of money before you die. I can’t remember the numbers of the top of my head, but I think 96% of the time you have money in the bank when you die with a 50/50 portfolio, and the rest of the time you run out of money.
The best way to die broke is to annuitize a large chunk, perhaps even all, of the nest egg at some point. That allows you to maximize what you spend without having to worry about running out of money until you die. Then you die broke.
4% is much to conservative. Retiresoft. By David Zolt shows you can withdraw up to 6 to 8% annually if you do not increase your inflation adjusted return in bad market years. Why fly coach when your heirs will fly buisiness class?
Remember as people go thru retirement they spend less as they get older. Spend it earlier while you have your health and energy, unless you want to leave a huge inheritance
I agree a variable withdrawal strategy is ideal, but 4% is the right neighborhood to start in. If you don’t have crummy returns in the first 5 years of retirement, 6% is very doable. If you’re very fortunate and retire into a bull market, 8% is quite possible. But historically, 8% (adjusted for inflation) only worked 1/3 of the time with a 75/25 portfolio. But if you tighten your belt in bad years, that increases your odds.
Based on this study, you’d think that the recommended default retirement portfolio would be 75/25 with a 3.75% withdrawal rate, but you hardly ever see that as a suggestion.
Any thoughts?
Seems like a reasonable plan.
As an engineer who did extensive modeling with everything from polynomials to artificial intelligence software I can say with extreme confidence that trying to predict future performance based on past data is a fool’s errand. As long as every pertinent variable stays within the same range as the training data set you can generally do pretty well at predicting future results but we are talking about things that can’t be measured, like behavior and sentiment, and we don’t even know what all the variables are when it comes to stocks, bonds and other investments. It’s not useless to make studies like Trinity’s or Bengen’s but it’s problematic to base future retirement plans on a very limited past data set. All you can do is balance having a rich life now with investing for the future.
I agree that a lot of people are attempting to be precise where precision is impossible. IMHO, the most useful aspect of the Trinity study is that it told you “about where to start”, i.e. somewhere around 4%, not somewhere around 8%. You should then adjust as you go.
Recently joined WCI mail group, great article; thank you! How about a future article regarding IRA conversions to Roth IRA and how to strategically plan for those in hopes of helping further with future taxes and RMD impacts, etc… Thanks again!
How about a past article on the topic? I know you just got here, but I’ve been here for 11 years answering your questions. The search bar is your friend. 🙂
https://www.whitecoatinvestor.com/roth-conversions/
https://www.whitecoatinvestor.com/roth-conversions-and-contributions-principles/
https://www.whitecoatinvestor.com/the-tax-planning-window-and-partial-roth-conversions-for-401k-millionaires/
https://www.whitecoatinvestor.com/the-5-year-rule-for-roth-ira-conversions-podcast-146/
Let me know if you have questions that haven’t been addressed. If so, they may make for a great NEW article.
Wade Pfau, an expert on retirement planning, feels the SWR TODAY IS AROUND 2.5% AND a big fan of annuities
Yea, I think he’s nuts. Okay, maybe not nuts but a bit of a permabear. He’s also a big fan of whole life insurance. I would be too if I thought I could only spend 2.5% of my portfolio.
“No way you could sneak data that shady past the FDA to get a new treatment approved.” Funny, Pfizer, Moderna and J&J sure know how.
The main thing I never see talked about in regard to the 4% rule is that it ignores the fact that many investors have a hard floor when it comes to how low their other assets can go. I have both a fully funded pension and very high SSI (both inflation-adjusted) so it’s unlikely I’ll ever go to zero (within reason). Add in home values appreciating for 30 years, and it seems like the risk of going to zero is highly overblown. Even if all my investments went to zero, I’d still have pIenty to live on. I’m not a fan of annuities, but I know some who annuitize some portion of their holdings just for this reason – to create a hard income floor. What am I missing?? 🙂 Seems like including all these other sources of income argue for being more generous with your withdrawals – especially if you are not interested in leaving a large estate.
Yup. A 4% withdrawal rate is kind of a lame withdrawal strategy isn’t it? You’re not missing anything.
Hey Jim, awesome classic post. It would seem to me the best withdrawal strategy to maximize he SWR would be to keep a balanced stock bond allocation but then if equities fall by say 10% or more, then just draw down bonds, and then when stocks bounce back up you rebalance and continue to withdraw to maintain your chose asset allocation until the next correction/bear where you just draw bonds again. Any studies using this type of withdrawal strategy and the corresponding increase in SWR?
All kinds of studies out there. The bottom is that the more flexible you can be, the more you can withdraw and the less likely you are to run out of money.
Rikki, if you want to look at “studies” that will make your head explode, check out the SWR series at Early Retirement Now (ERN). https://earlyretirementnow.com/safe-withdrawal-rate-series/
I think the concern over the (very slight) possibility of running out of money on a 4% withdrawal rate is overblown. Investors and retirees seem to think this is their only risk while there are other risks that, in my opinion, are probably far greater than 1-2% that someone exhausts their portfolio in their 80s and dies on SS + a SPIA, ie not the end of the world either (my guesstimates next 50 years):
1. Everything turns out too well, portfolio balance far exceeds someone’s ability to spend it later in life (30-50%)
2. Retiree dies early in retirement (20%)
3. General nuclear war (20%)
4. Collapse of the American government, private property rights, rule of law (10%)
5. Ecological collapse from climate change (10%)
Bottom line is to, I think, retire early enough to enjoy your money while you still have your health and ability to spend it, and not worry so much about what happens in someone’s 80s or 90s – good chance you may not even be around then.
“not worry so much about what happens in someone’s 80s or 90s – good chance you may not even be around then.”
Excellent point.
Financial columnist Scott Burns has written about the longevity aspect many times. One of his articles is: https://scottburns.com/life-death-and-how-long-your-money-will-last/
“84 percent of 65 year old couples will have no one survive 30 years
16 percent of 65 year old couples will have one person survive 30 years
1 percent of 65 year old couples will both survive 30 years”
“The bottom line, however, is that death reduces the risk of running out of money more than does portfolio management.”
I continue to be amazed at the physician-population not familiar with “DGI/DGR” investing for retirement. Dividend Growth Investments/Dividend Growth Rate focus is a classic example of “time IN the market “. Building one’s own DGI mutual fund with safe/very safe equities paying consistent/increasing/reliable dividends, over time, allows a retirement with minimal harvesting of principal. Balanced investment over the various sectors of the economy avoids being overweight in one sector. For example, a portfolio should not hold more than 25% in any one sector, and preferably a less than 15%. Examples of sectors w one example for each sector:
Information Technology: AVGO
Energy: CVX
Industrials: UNP
Utilities: DUK
Consumer Staples: PG
Consumer Discretionary: HD
Healthcare: ABBV
Telecommunications: VZ
Materials: ALB
Of course one must perform due diligence.
Take a look at SeekingAlpha.com
Good luck to all.
Dividends aren’t magic. They get cut too in downturns.
https://www.whitecoatinvestor.com/5-reasons-to-avoid-focusing-on-dividend-stocks/
https://www.whitecoatinvestor.com/5-reasons-to-avoid-focusing-on-dividend-stocks/
https://www.whitecoatinvestor.com/substituting-dividend-stocks-for-bonds-friday-qa/
https://www.whitecoatinvestor.com/the-pros-and-cons-of-income-investing/
There are a variety of ways to invest. I subscribe to several services that offer great advice. The information I receive is very good, run by previous hedge fund managers on Wall Street. It takes time to learn the various techniques. If the market tanks, everything goes down. So you hedge with put options. For income, you can sell puts all day long and collect the premiums. There are a number of dividend aristocrats that are perpetual dividend raisers, but you need to get information. Remember, Wall Street is rigged against you. Watch your portfolio, real ancestors, and learn. Or, as Warren Buffet states, just get into Index funds. The largest fortunes are made during Bear Markets and panic sell offs. Buy low, sell high. Look into the future and get in early. The new wave is Synbio. Follow the money and be patient. Remember, by the time you read about it, it’s old news. I follow Empire Financial, The Oxford Club, and Altimetry run by Professor Joel Littman, who is a Forensic Accountant, who uses Unified Accounting methods and blows away all of the so called analysts. All of the above services stress the importance of being healthy, getting enough sleep and enjoying life. Peace, health and happiness to all! George Melnyk MD
Ancestors?
When it comes to early retirement I’ve heard it said often that people spend more during Early retirement and less during later retirement. During later retirement you also are going to have Social Security benefits, Medicare and possible inheritance. Is there a way to figure out what you could safely spend extra in early retirement knowing you will have that extra money available later?
Not without a crystal ball. So most just adjust as they go.
The 4 % rule is a least a way to get people thinking about what they will do with accumulated assets in retirement. A better plan is to create a portfolio of dividend achievers/aristocrats and plan to live off the dividends with no or a little draw down as possible, except as desired. No necessary draw downs (for these purposes not discussing RMDs). These stocks have less volatility than the S and P and as a group also perform better. Mix in a small amount of growth stocks (think AMZN, GOOG, TSLA) and you have a receipe to protect downside potential and create significant upside growth. I also sell covered calls against my positions creating an additional $75 to $150K of income per year, although I realize this may not be something everyone wants to do, due to (nearly casual) attention to market required. Also, the spending in early retirement is higher than later in retirement, usually.
Totally disagree. Just spending dividends leaves A LOT of potential spending on the table. Your heirs are lucky to have you!