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Will the 4% Rule Still Work in 2022?


What's the 4% Rule?


Once upon a time, back in 1994, a financial advisor named William Bengen, "conducted an exhaustive study of historical returns, focusing heavily on the severe market downturns of the 1930s and early 1970s. Bengen concluded that, even during untenable markets, no historical case existed in which a four percent annual withdrawal exhausted a retirement portfolio in less than 33 years.” -Investopedia


Bengen was a financial advisor who wanted to do a better job of helping his clients utilize their retirement funds- while still helping them make sure these funds lasted a full lifetime.


This was a noble goal.


In order to accomplish this goal, Bengen did an “exhaustive study” on annual withdraw percentages. In his research, he discovered that as long as people didn’t withdraw more than 4% of their portfolio each year, they could live off of that for 33 years. If you retire at 65, that means you’d have retirement funds until you were 98 and that number was long enough for most investors.


However, things have certainly changed since 1994.


Is the 4% amount enough for each retiree to live comfortably today?


To answer this question, we have to first review the make-up of the investments Bengen was studying.


As Rob Williams and Chris Kawashima explain in their article on the 4% rule for Schawb.com, “The rule applies to a hypothetical portfolio invested 50% in stocks and 50% in bonds. Your actual portfolio composition may differ, and you may change your investments over time during your retirement.”


The 4% rule was created from hypothetical portfolios that were invested in 50% stocks and 50% bonds.


This fact is important in order for you to see how the 4% rule was built and how it compares to your own situation. In reality, everyone has portfolios that look extremely different. Not everyone will have a 50% bond and 50% stock portfolio going into retirement.


Clearly, having a “rule of thumb” to follow in order to know how much to withdraw from retirement accounts and have them last for at least 30 years is helpful to many as they review their plans. But, it doesn't always fit every person's situation. With the unique difficulties hitting investors today, it's important to not that following a blanket rule of thumb is not advised.


In November of 2020, Bret Arends published an article after a conversation with Bengen. He writes, “There are plenty of unknowns—both known unknowns and unknown unknowns. We don’t know if the Fed can prevent deflation, let alone get prices higher. We don’t know what Covid is going to do to long-term returns. We also don’t know, for example, whether inflation-protected TIPS bonds would work better than regular government bonds. Although TIPS are designed to adjust their prices to reflect rises in the Consumer Price Index, they weren’t around in the 1970s, so we don’t know how exactly they would have done.”


He goes on to quote Bengen, while discussing the 4% rule, ““It’s not a law of nature,” he says. “It’s empirical”—in other words, based only on the data we have, going back to the 1920s. “One size doesn’t fit all,” and the number you choose “could be anything.”


So, the man who created the 4% rule has been quoted as saying “it’s empirical.” But what does that mean?


That means it’s not a hard-fast law. It means that it’s based on observation.


When something is based on observation, it’s subject to change given a different type of circumstances. Because financial planning is all about planning for an uncertain future, this is the only type of “law” we are going to get in our field. I’m not saying what Bengen came up with is unhelpful, I’m grateful for minds like his, but I am saying it’s incomplete.


At Merit Advisors, we tend to encourage people to move away from using these “Rule of Thumb” suggestions because even the most well-researched “rule” is based off of a certain type of portfolio or market performance.


Rigidly following these rules can lead people to run out of money prematurely or not utilize the entirety of their savings. Retirement is supposed be exciting, fun, relaxing or adventurous. It’s meant to be enjoyed. These are your years to live in financial peace, not to find out too late you followed the wrong advice. That is the major reason we try to make it clear that the 4% rule does not fit every investor, especially in today's economy.


If the 4% rule can’t guarantee longevity in your retirement portfolio and comfortable income for you during retirement, what do we recommend?


What we, at Merit, have found over the years is that if you have a steady stream of income to supply your retirement NEEDS, you’ll be in a place where you can utilize your stock investments and take more risks as well as build them for your legacy.


But don’t take my word for it. Wade Pfau, who “earned his Ph.D. at Princeton, where he wrote his thesis on Social Security…” states:

“Retirees who wanted to front-load their retirements and spend a lot in the early years would be better off with annuities, while those focused on growing their wealth and having more assets in their later years would be better off with equities.

At the same time, however, people concerned about outliving their money might find an annuity attractive. It’s a strange paradox…”


If you want a deeper dive into annuities to understand Pfau better, take a moment to watch our Merit Moment #8: Protected Income Streams.


To make a long conversation short: everyone is different, there’s volatility to consider, there’s inflation that changes the conversation and desired income is different for everyone. These factors make the 4% rule a challenge – It is truly just a base level suggestion that has been used without any planning to gauge whether or not someone can afford to retire. The outcomes of this can be disastrous if you make a decision without the proper tools. We don’t want to see you make this mistake.


If you need some help discerning whether or not you can afford to retire, please reach out. I help people answer these questions every day. It’s important that you understand your specific situation and don’t set up your plan based on a general and empirical “rule of thumb”. Your future doesn’t have to be a complete guessing game. Bengen was an advisor who wanted to help his clients and he came up with a way to help in 1994.


At Merit, we’re expert advisors who are studying the evidence for today and will guide you in the right direction. Give us a call.


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