Ask the grumpies: What do you think of the 4% rule

First Gen American asks:

Once you’ve hit your magic 4% rule retirement number, should you reallocate to a more conservative asset allocation. Why or why not. And what do you think of the 4% rule.

Standard disclaimer:  We are not financial professionals.  Do your own research and/or consult a fee-only certified financial planner before making important life changing decisions. 

I mean, do you have a bequest motive?  Do you plan to make a LOT more money before you retire?

4% rule

The 4% rule is ok in terms of preserving your capital until you die on average.  But it’s bad in terms of volatility and uncertainty.  You don’t know how your monetary needs are going to change over time, so it might be too risky.  It may also end up with you not actually being able to take out enough for your needs during a recession, and if you end up taking out more then you’ve broken the rule entirely.  I think the 4% rule is best if you have an additional emergency fund or have the ability to earn more money if necessary.  I don’t think there is any actual safe rule that will both preserve your capital as needed and ensure that you have enough money for your spending in uncertain times.  The 4% rule doesn’t get rid of the need for lots of money.  So, I probably wouldn’t retire just because the 4% rule says I can, especially not while still youngish and during uncertain times.

If you’re planning on continuing to work, it doesn’t matter that you’ve hit the 4% rule retirement number.  What matters is when you actually retire and stop bringing in new money.  While new money is flowing in, you don’t need as much in terms of conservative assets because your income moderates short-term risk, allowing you to reap the benefits of risky assets that aren’t actually that risky over the long-term.

100% safe vs. 100% stocks

Suze Orman famously keeps almost all her money in safe assets.  She recommends you play the stock market, but she doesn’t herself.  Some wealthy people only keep a little spending money in liquid assets and the rest are all in stocks and other risky assets. When you have a LOT of money, both of these are completely logical because you can live off money that’s eroded by inflation but you will also still be fine if the market drops 40% or more.

The standard calculus changes when you have waaaay more money than you will ever need.  You have to think about what it is you want to optimize.

If you don’t care what happens when you die, you’re probably fine no matter what you do.  If you want to keep things for your heirs, then you will need to think about tax optimization and definitely keep a lot in stocks– your horizon is even longer and your heirs benefit from step-up basis upon your death.


15 Responses to “Ask the grumpies: What do you think of the 4% rule”

  1. Linda T Says:

    I ignore the 4% rule because since my husband retired, our retirement funds are subject to the IRS’s RMD rules.
    We take what they say, or they have a 50% penalty if you don’t.
    My husband worked until he was 74 and only quit because of COVID. He couldn’t take the combination of mask wearing with glasses and then the addition of hearing aids.
    Not taking social security until he was 70 really increased his SS benefit, about 32%.

    • nicoleandmaggie Says:

      That’s a good point about Social Security– it’s a nice annuity that isn’t usually figured into the 4% rule which provides additional support.

      A true adherent to a % rule could take RMDs and reinvest them in the stock market in taxable stocks.

  2. SP Says:

    Also, the 4% rule (if you are actually retired) counts on a certain percentage of that being in stocks in order to have some growth. I don’t recall what it is, but I think it is relatively high (80%-ish?) compared to what one might think of as a typical retired asset allocation.

    I have some pension, so between that and SS, I likely could be comfortable with a 4% rule, even though I’m pretty risk adverse in general.

    • nicoleandmaggie Says:

      And when the stock market dips, your 4% can get too small for your needs/wants.

      • SP Says:

        The FIRE idea is to always pull out 4% of the original balance when you retired, adjusted only for inflation, not by account balance. This can be more than 4% of your profile in a down year and less in an up year. This is why a series of bad years right after retiring is one of the failure cases. But, yeah, 4% is a simplistic rule and it would be dangerous for a person not to understand it more if they are relying on it. Early Retirement Now has a very extensive series on safe withdrawal rates (I have not read it all).

      • nicoleandmaggie Says:

        That’s bizarre.

      • SP Says:

        It makes sense to me (to first order), because you assume you have a fixed yearly spend, then take out 4% the first year, then you keep your spending flat. If the market goes up >4%, your balance still grows, which makes up for a down year later on. The devil is in the details, though.

      • nicoleandmaggie Says:

        Assuming no real volatility.

        Anyway that calculator lets you calculate three versions of the 4% rule.

  3. Debbie M Says:

    On “safe” investments: Nothing’s safe because of inflation. Though Joe Dominguez (co-author of Your Money or Your Life) had all his retirement savings in 30-year bonds, back when those paid actual money. And maybe if I-bonds paid something on top of inflation they would count.

    It makes sense to have less conservative investments while working, hoping that you’ll hit that magic 4% as soon as possible. And then when you do, switch to more conservative investments to better hang on to your winnings. I wouldn’t do it all at once (especially if the market just dropped, like it just has), just contribute your new money differently.

    On the other hand, this could be a good time to diversify into additional less-conservative investments, like international or REITs if you don’t have them already. More baskets is another way to be conservative, but be careful that your new baskets aren’t crazy risky.

    Once you’re done working, many people recommend you keep a certain number of years of expenses in “cash” (money markets?) so that you don’t have to take any money out at all during the bad years. So the rest can still be invested with a pretty high percentage in stocks.

  4. First Gen American Says:

    I’d like to move to some sort of self employed status in my 50s but I doubt I’ll stop working completely.

    I’m now leaning towards putting 3-5 years of expenses in something safe in a different account and investing the rest in stocks. That way I don’t have to worry about rebalancing all the time.

  5. Mike Nitabach Says:

    Very interesting post! This kind of rule of thumb is how universities manage endowments, albeit with a multi-year smoothing function for spending based on endowment performance. This smoothing function means you don’t go on a blow-out bender in years where your investments do unusually well, but you also don’t eat cat food in years where they do unusually poorly. So during an investment boom, you spend less than 4%, but during an investment recession you spend more than 4%. I don’t know if this sort of thing is considered safe for personal retirement finance tho? While the assumption of a university is that it can also manage annual revenues other than endowment income, the assumption of a retiree is that there are no revenues other than retirement fund income?

    • Michael N Nitabach Says:

      OK sorry just read the other comments & see this smoothing function idea has already been discussed. ¯\_(ツ)_/¯

  6. revanche @ a gai shan life Says:

    I clearly always understood the 4% rule wrong, or have been influenced by friends enough to think I’ve always thought that the 4% was an average rather than a set amount every year. Take out less in leaner years (relying on cash buffer) or more in more robust years. I also think I haven’t hit on the number that makes me feel like we could be reasonably safe in retirement for as long as we need. I both very much like the safety of a paycheck and very much want to replicate that set up in retirement / time when we work only when we want to and not have to work daily.

    • nicoleandmaggie Says:

      I did not know there were 3 versions, but apparently there are. They all use the same version of finding your “number” but the risk is not being able to pull out enough every year with one version and running out of money too soon with the version SP describes. Because neither version can really handle ups and downs in the market perfectly.

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