The 4% Rule: Is It Still A Safe Withdrawal Rate For Retirement?

June 13, 2023

In this highlight, we discuss if the 4% rule is still a safe withdrawal rate for retirement and why it could be changing.

For more information, check out our free resources here.


Does the four percent rule temporarily change to be higher when cash is paying around four percent? Could you tell me what the four percent rule is? I want to make sure I’m trying to put myself in e-money’s headspace and understand their thinking. Does the four percent rule change temporarily because cash is paying high rates? Alright, so the four percent rule is this idea that if I build up a portfolio based on historical market environments, and Daniel, you can nod yes or no, they backtested this back in the 50s or 60s. They studied all these market environments and determined the sustainable withdrawal rate where people didn’t run out of money the most. What was the sustainable withdrawal rate over the long term? The general consensus has been four percent. If I have a portfolio and I draw four percent annually from it, odds are I should not run out of money given the historical average returns on the market. It makes a lot of sense, right? The reason the four percent withdrawal was put into place is so that you don’t have to change your lifestyle based on how the market behaves.

What often happens with the market is that last year it lost 19%, the year before that it made money, the year before that it was up. Sometimes the market is up 14% and then down 2%, then up 20% and down 3%, then down 4%. Very rarely does it hit that four percent number, but on average, when you look at rolling returns, you’re banking on your portfolio making greater than that. So if I’m making six percent, seven percent, eight percent annualized over the long term, and I’m only pulling out four percent, I should be able to maintain the same standard of living.

E-money’s question about whether the four percent rule changes is actually a bit of a conundrum because the entire purpose of the four percent rule was for it not to change. It was designed so that you would not have to change your retirement lifestyle or make any drastic adjustments. Imagine if you have a million bucks and you’re living off four percent of that, and then the market drops, forcing you to significantly reduce your lifestyle the next year. The four percent rule was supposed to provide a stable method for determining how much money you can live off in the long term without having to make such adjustments.

Now, here’s what cash has allowed people to do for the past couple of years. When managing a portfolio, you typically think about it in two segments: risk-on and risk-off, or risk-reduced. Balancing these segments is like squeezing a balloon. How hard do you squeeze each side of the balloon? In the low-interest rate environment we’ve experienced for the last decade, risk-off and risk-reduced have been challenging. We’ve been in an environment with fixed income where it seemed likely that rates were going to rise. When rates rise, the value of bonds drops, so you had to think differently about how to navigate the fixed income or risk-reduced side of the portfolio.

Now that rates have risen and cash is yielding four and a half to five percent, it’s not incredibly difficult to navigate the risk-reduced or risk-off side of the portfolio. Everyone is saying, “Okay, great! I love it. I’m going to put all my money into five percent cash, live off four percent, and things will be great.” But, as Lee Corso would say, not so fast. Here’s what ends up happening. What was the inflation number that just came out this morning, Daniel? It was like seven percent or eight percent. We’re seeing this. If you have cash that’s paying you five percent, but inflation is actually seven percent, you’re losing purchasing power over time.

So, you want to make sure that the portfolio you have in place can not only sustain your withdrawal rate but also grow and account for inflation. So, I don’t think that rising rates have allowed us to adjust or deviate from the four percent rule. I believe that rising rates have now allowed us to move back to a more traditional way of navigating the risk-off, risk-reduced fixed income side of the portfolio.

Want to know what to do with your next dollar? You need this free download: the Financial Order of Operations. It’s our nine tried-and-true steps that will help you secure your financial future.



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