The 4 Percent Rule Is Not Dead. What You Need To Know #132

 In this episode, host Josh Nelson dives into a topic that has been debated and discussed quite a bit in the financial planning community: the 4% rule. Is it still relevant, or is it outdated? He answers the question, 'What is the 4 percent rule?' Perhaps it's not so much a rule as it is a guideline for ensuring we have enough money as we get older.

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Transcript

Wiser Financial Advisor – The 4% Rule is Not Dead

Hi everyone, and welcome to the Wiser Financial Advisor show with Josh Nelson, where we get real, we get honest and we get clear about the financial world and your money. This is Josh Nelson, founder and CEO of Keystone Financial Services. Let the financial fun begin! 

Here at the Wiser Financial Advisor Podcast we talk about personal finance and investing, and how to make better decisions. Today, we are diving into a topic that's been debated and discussed quite a bit in the financial planning community: the 4% rule. Is it still relevant or is it outdated? If you read a lot of financial stuff, the Wall Street Journal or anything like that, you probably have seen an article at some point questioning the 4% rule and asking if it still makes sense. The title of this episode gives you a hint at my stance, which is that the 4% rule is not dead. So let's get into it. 

First of all, let's talk about what the 4% rule is. Financial planner William Bengen came up with the 4% rule, and the idea around this premise is simple: If you withdraw 4% of your retirement savings each year, (adjusted for inflation—that's key), your money should last for a 30-year retirement period. Bengen’s research was based on historical data and market returns. You can dig into the details of his study if you Google it. For today's purposes, this is about a straightforward guideline for retirees. It's a starting point, which is something I want to continue hitting home. The 4% rule has been a cornerstone of retirement planning for decades. I've used it probably my entire career. This is my 25th year as a financial advisor, but with the changing economic landscape, of course, things have changed dramatically over that period of time.  

Now, with low interest rates and market volatility, many journalists are questioning the viability of the 4% rule. Some say it's too conservative; others argue that it's too risky. So where do we stand? Do we still use this or is it completely outdated? Let's start with the critics. One major criticism is that the 4% rule doesn't account for today's lower bond yields. And yes, I get it. Interest rates are higher than they were a few years ago, but really it's only your short term bonds, your money markets, your short term CD's where you're seeing higher interest rates. If you look at the longer term funds, most of them are still at pretty low yields, so it is true that they are lower than they were in the 90s. 

For Bengen’s purposes, he used a balanced portfolio. A balanced portfolio generally speaking is about 60% stocks and 40% bonds. So the bond portion of it is fairly significant overall for factoring in lower yields. That means lower returns probably on the bond portion, but that isn’t necessarily absolute. Bengen himself more recently revisited his research and concluded that a withdrawal rate closer to 4.5 % might still be sustainable under certain conditions. The key is really just flexibility and adaptability. I think we could say that about life in general, and certainly in business. It isn’t meant to be a one size fits all approach. You might remember in Curse of the Black Pearl, Pirates of the Caribbean, Captain Barbosa talking with Elizabeth about the Pirate’s Code, and she was trying to cite it as something he had to adhere to—and Barbosa said the code is more what you'd call guidelines than actual rules. I think that's a good way for us to approach the 4% rule. It really is more of a guideline, not a strict rule. It's something we should be looking at, maybe using as one test against what we're doing just to make sure that we're on the right track. But it is a good guideline. 

Let's talk about market volatility. The past few years have shown us that markets can be unpredictable, and that's always the case. Markets are always unpredictable. Warren Buffett, one of the most successful investors, has been managing Berkshire Hathaway over the last 50 plus years, and he’s never met a person that can consistently time the market. So I just wanted to dispel that myth. I know day trading is a really big thing right now. It comes back every now and again after the markets have had a nice run. All of a sudden there's a group of people that start to say, “Oh, I can outsmart the market.” It's not something sustainable, certainly in Buffett's eyes, and I have not seen it either, at least not over time. People can get lucky from time to time, but certainly not over and over during a period of years. So historical data still supports the 4% rule even through periods of high volatility. 

For example, during  the dot com bubble or the pandemic in 2020, the important thing was to have a diversified portfolio and a solid financial plan allowing for adjustments based on market conditions. I think that's really the key. Bengen didn't account for that when he said that a portfolio should last 30 years; he didn't account for people making adjustments. Really, mathematically, if you've got a diversified portfolio—and of course, we can't say the word guarantee—but if you've got a diversified portfolio and you're taking 4% off of whatever your portfolio value is, you'll be taking a lower dollar amount during a year like 2008 after the market's gone down 50 percent. Then, if we're adjusting over time, mathematically  although we can't say guarantee, isn't it kind of impossible that we'd run out of money? Taking 4% of a smaller amount means that we're going to be making adjustments. During a year like 2008, which is a good example, I remember  the Cash for Clunkers program, where the government said, “We'll let you drag in your vehicle and we'll give you cash for it.” They were trying to stimulate the car companies at the time, but ultimately, a lot of people ended up saying, “I don't need a new car. My portfolio is down 50%, the economy is in in crisis. I don't need to go on vacation; I don't need to go out and buy a new car right now; I don't need to upgrade my home.” And of course, that just exacerbated the financial crisis, the recession, until things burned out finally in the first quarters of 2009. So just accounting for things like that in your mind, you would ask, “Four percent of what?” And it's whatever your portfolio value is at the time. Then Bengen’s rule really works, not just over 30 years, but probably longer than that. 

When we think about life expectancy, which is an area that I think people probably don't appreciate as much as they should, the fact is that people are living longer in general. There's been some recent stuff bringing down the life expectancy number, probably affected by the pandemic and drug problems, things like that. But for people that didn't die during the pandemic, who got vaccinated or whatever the case, ultimately people are living longer as a trend. And with the medical technologies and advancements that are likely to come out over the next couple of decades, a 30-year retirement might not be enough for some people. Many will end up living far longer than that, especially if they retire early. So if you retire in your 50s or even 60s, you might be one of those people that have not just a great lifespan into your 90s or hundreds, but medical advancements may allow you to have a great health span as well, where you can still be active. 

This is about flexibility, right? The 4% rule is a guideline, like Barbosa said about the Pirate’s Code. Flexibility is key, and by monitoring spending and adjusting withdrawals as needed, you can ensure your savings last your entire lifetime. That's one thing that I preach consistently: Be careful about how much you're taking out once you start going beyond 4%. Sometimes people are raiding their investments and just pretending that they're always going to be there, always going to grow. But if you're consistently taking larger percentages than  4%, you are probably going to run out of money at some point or have to make a major adjustment in your spending later on. It’s important to look at your individual circumstances and be mindful about how much you're taking per year. There are other things that may come up down the road that you're not planning on now, and as a Certified Financial Planner, I'm trained to help plan for the unexpected. One of the ways we do that is by controlling spending during the good years. 

Things come up like healthcare costs or lifestyle choices like making a big move to be closer to kids or grandkids, or other unexpected expenses that come up along the way. That’s just life—if you've got a house; if you've got a dog; if you've got kids, grandkids, or just your own health, stuff comes up all the time that is kind of hard to plan for. We can plan for certain things like vacations or vehicle purchases, things like that, but there is something that happens with the house or the car all the time. Those are things we really can't plan for other than adjusting and making sure we've got enough wiggle room in our overall budget to cover those things when they come up. 

This is about creating a personalized strategy that aligns with your unique needs and goals. For a lot of people, travel becomes their big thing when they retire and want to start knocking out some bucket list items. For other people, that's not really it. They plan on doing more modest travel or maybe they're big into camping. Or it could be something completely different where they just like to hang around Northern Colorado. Wherever you're at, if that's where you like to be, you may just decide to spend a lot of time there and do stuff you want to do, making sure that your unique needs and goals are accounted for.

One other item I want to address is Social Security. and if you have any other kind of income source out there like a PERA income or a government pension, something like that, we want to take those things into account. The 4% rule assumes that your retirement savings are your only income source. You might have other sources such as Social Security benefits or pensions. You could be working part time doing consulting. We see all kinds of stuff throughout people's retirements that end up supplementing that income and  reduces the pressure on retirement savings. As you listen to this, you might say, “I don't think I've got enough money to retire. If I can only pull 4% off one million, that's $40,000 a year, or 4% of  two million, that's $80,000 a year. That's not going to do the job with what I was planning on. But don't forget, Social Security or a pension would be on top of that. We also see people doing some part time work; or maybe  working at the golf course so they get free golf, things like that. I've seen people that work in the travel industry so their travel is covered. They work for an airline part time, and all their flights are covered. You can get creative about this, depending on what you want. 

So, to round this out, how do you actually put the 4% rule into place in today's environment? First of all, remember that it's a guideline, not a rule. 

Number one, diversify your portfolio and ensure your investments are spread across a lot of different asset classes. We don't want to have all our eggs in one basket. We want to manage risk and do our best to enhance your returns. 

Number two, monitor and adjust. Regularly review your financial plan. That means no less than once per year. Usually we do that a couple of times a year with our clients and of course making adjustments as needed based on market conditions and your spending. That's something to do all the time, not just every once in a while. If you are a client of ours, you've got the benefit of paying us to worry about this stuff so you can go have fun and work on your career and hang out with your family. You’ve got somebody else moderating this on an ongoing basis.  

Number three, plan for longevity. Because of longer life expectancies, you might have a longer retirement horizon than you think. Adjust your withdrawal rate accordingly and adjust to market conditions. When the market throws curveballs and we have a bear market, you need to take that into account. Work with a professional financial planner, specifically a Certified Financial Planner, which is the gold star in our industry, to help you navigate the complexities of the financial world, retirement planning, Social Security, income taxes and estate planning. Make sure you've got a plan that takes all of these things into account. 

In conclusion, the 4% rule is not dead. It's a valuable guideline that I think can still serve as a jumping off point. It's a great check for what we're doing and how to be careful about how much we're taking out per year. It's also useful in the accumulation phase. If you're still working right now, it can help you figure out how much money you will need to be able to live the life you want. And of course, that's all over the board. We see people that have very modest retirement plans. We see other people that have very robust retirement plans. So we want to make sure you've got a financial situation that can support you. We want to be flexible and adaptable considering your unique circumstances because you have a different financial situation than everybody else. You might have some similarities, but it's important not to just do what your neighbor or a family member does, because you have unique circumstance that need to be taken into account. We want to make sure you have a sustainable retirement plan that provides Peace of Mind. The emotional payoff of having a plan for financial security that gives you a high likelihood of not outliving your money is huge. 

Thank you for tuning in. If you've got any questions or topics that you'd like us to consider, Communications@keystonefinancial.com is the best way to do that. Don't forget to hit subscribe on your favorite podcast service and if you have time, leave a review or a rating. We would love for you to interact with us and support us in that way. You can pass feedback on to me directly at josh@keystonefinancial.com .  Until next time, I am Josh Nelson reminding you to stay wise. Have a good week, and God bless.

This episode has been prepared for informational purposes only and is not intended to provide or should not be relied upon for tax, legal or accounting advice. You should consult your own tax, legal or accounting advisors. Investment Advisory Services offered through Keystone Financial Services, an SEC registered investment advisor.