I recently read Bill Bengen’s new book A Richer Retirement: Supercharging the 4% Rule to Spend More and Enjoy More and loved what he put together.
For the uninitiated, Bengen is the creator of the 4% Rule, which revolutionized the retirement planning industry in the mid-1990s. Before Bengen, we had to guess about what to do with our money during our golden years. But now, with some simple arithmetic, anyone can determine how much money they can spend throughout their retirement worry-free.
Despite the usefulness of the 4% Rule, in A Richer Retirement, Bengen questions whether it’s still the right guidance for today’s retirees. After all, 30 years have passed since Bengen’s original research and it’s fair to ask whether we should still be following it.
Surprisingly, Bengen’s answer is “No”, but not in the way you think. Bengen demonstrates that the 4% Rule isn’t the right guidance anymore, not because it’s too risky, but because it’s too conservative.
Yes, you read that right. The founder of the 4% Rule thinks that we can withdraw more from our portfolios given the updated historical data (through December 2022). To grasp the significance of this shift, let’s revisit how the 4% Rule works in the first place.
The 4% Rule, Revisited
In Bengen’s original research, he used a 50/50 U.S. stock/U.S. intermediate bond portfolio and found that the maximum safe withdrawal rate for any 30-year time period from 1926-1992 was 4%. This meant that any person who retired between January 1926 and January 1963 would not have run out of money over the next three decades if they only withdrew 4% of their portfolio (and adjusted for inflation each year thereafter).
For example, if you started with a $1 million retirement portfolio and inflation was 3% per year, you would withdraw $40,000 in Year 1 [$1M * 0.04], $41,200 in Year 2 [$40,000 * 1.03], $42,436 in Year 3 [$41,200 * 1.03], and so forth.
The 4% Rule made retirement planning easy because, if you knew your retirement savings, you could multiply by 4% (0.04) to determine your initial retirement spending (before future inflation adjustments):
Initial Retirement Spending = Retirement Savings * 0.04
Alternatively, if you knew how much you wanted to spend in retirement in Year 1, you could divide this number by 0.04 (or, more simply, multiply by 25) to get the amount of money you would need to save up for retirement:
Required Retirement Savings = Initial Retirement Spending * 25
Voilà. A complex problem solved with basic multiplication.
Now that we know how the 4% Rule works, let’s review why I think the 5% Rule will replace it.
How the 4% Rule Became the 5% Rule
When Bengen revisited his research, he realized that it needed a refresher. Not only did we have 30 more years of market data (since the mid-1990s), but we also have better data on other asset classes. This meant that Bengen could go beyond the simple 50/50 U.S stock/U.S. intermediate bond portfolio from his prior research. And that’s exactly what he did. As Bengen states:
The first asset class I added to the original two was US Small-Company Stocks…Adding Small-Company stocks boosted the “4% Rule” to the “4.5% Rule.”
One additional asset class provided a major improvement to the safe withdrawal rate.
But Bengen didn’t stop there. He then added four more asset classes—U.S. Micro-Cap stocks, U.S. Mid-Cap stocks, International Stocks, and U.S. Treasury Bills. This increased the safe withdrawal rate to 4.7%! Bengen admits he could’ve gone further by adding Real Estate Investment Trusts (REITs), crypto, and other asset classes, but decided against it because of the diminishing returns from the recent four additions.
The other change Bengen made was that he altered the asset allocation slightly. Instead of having a 50/50 portfolio of just stocks/bonds, he changed it to a 55/40/5 portfolio of stocks/bonds/cash. By increasing the equity allocation to 55%, reducing the bond allocation to 40%, and adding 5% cash (Treasury Bills), Bengen got better results.
Why did the results improve? Diversification. By adding more asset classes that weren’t perfectly correlated with each other, our hypothetical retiree could spend more over time without running out of money.
You can see a summary of these results (with Bengen’s improved portfolio) in the chart below. The chart shows the percentage of retirees that did not run out of money over 30 years based on initial withdrawal rate (given Bengen’s revised asset allocation). As you can see, not a single retiree ran out of money with a 4.68% withdrawal rate (which Bengen rounds to 4.7%):
Bengen’s book is worth buying for this chart alone. Not only does it summarize a vast number of historical simulations, but it also gives you an idea for how risky it is to withdraw more than the 4.68% safe withdrawal rate.
For example, if you used a 5% withdrawal rate, you wouldn’t run out of money in 98.4% of all 30-year periods from 1926-2022. And this assumes you withdraw 5% initially and adjust for inflation every year, like a robot. But, if you make slight adjustments to how you spend money in retirement, you can make it work.
The Two Conditions for the 5% Rule to Work
Though Bengen technically never argued for the 5% Rule in his book (he only argued for 4.7%), I will. My argument hinges on two conditions:
- Bengen’s data and analysis are accurate and reasonable. I believe they are given the historical data and change in allocation outlined above.
- You are willing to decrease your spending during market crashes. For example, you might delay a vacation during a 20%+ downturn or reduce your spending when inflation runs hot. As this table illustrates, even with just 20% of your spending being discretionary, you can increase your withdrawal rate from 4.0% to 4.5%. Therefore, with a safe withdrawal rate of 4.7%, you could easily increase that to 5% if 20% of your spending is discretionary.
This is how the 4% Rule becomes the 5% Rule.
This might not seem like much of a change, but it has huge implications for retirees—they can either save less or retire earlier as a result. Instead of saving up 25x your initial retirement spending (with the 4% Rule), you only need to save 20x your initial retirement spending with the 5% Rule. Someone who wants $100,000 a year in retirement only needs to save $2 million (instead of the $2.5 million required by the 4% Rule). That’s $500,000 less in required savings!
Overall, retirees don’t spend enough in retirement as it is. This underspending has been documented both in the U.S. and in Canada. This is also why the book Die with Zero has become so popular. Among retirees with portfolios, underspending is quite common.
This is why I am arguing for the 5% Rule: many retirees can afford to spend a little more. If they’re flexible with that spending, they shouldn’t have to worry either. Overall, the 5% Rule allows retirees to enjoy more of their wealth while they’re still young and healthy enough to savor it. This is the premise of Bengen’s book and a message that more retirees (and future retirees) should take to heart.
But don’t just take my word for it. Run the numbers for yourself to see if you can live A Richer Retirement after all. Happy investing and thank you for reading!
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This is post 469. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data
