What The 4% Rule Leaves Out for Near-Retirees

Dave and Mark McGrath explain why the 4% rule is often misunderstood — and shouldn’t be treated as a plan.

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You tweeted out yesterday, uh, a little piece on the 4% rule and I want to talk a little bit about that because a lot of our listeners are early retirement or within five to seven years of retirement. They’re thinking a lot about retirement income, et cetera.

Talk to us about what the rule is, and then both you and I are gonna come at the rule a little bit and talk about some of the negatives and how it’s overused and abused.

Yeah. So the 4% Rule was created by Bill Bengan and essentially what he did is he looked at different asset mixes using historical US stock returns and US bond returns, and he applied some withdrawal rates to that portfolio and said, if you had held a portfolio of, let’s say 50% US stocks and 50% US bonds, and you withdrew X percent of that portfolio per year and then increased that withdrawal every year based on the inflation rate, how many times did you run outta money?

Right. So what I think he was trying to hone in on is what is the probability of running out of money on an inflation adjusted basis if you spend some percentage of your portfolio every single year, uh, different asset mixes right now, he didn’t, he never called it the 4% rule. Um it got kind of perverted after the study and became almost gospel in early retirement communities and that type of thing.

And it got kind of perverted to the point where people go, you can always just infinitely spend 4% of your money and never touch the principle. And that is not at all what the study showed, not even close. Right. In his study you actually ran outta money sometimes. Not just had to encroach on the principle.

You literally ran out of money altogether. Right. So I think the 4% rule, I have mixed emotions on it because we were talking earlier about how like we want to kind of shift back to simplicity a lot of the time. I think it’s too simple to be used as a, it’s not a rule and it’s certainly not a decumulation plan.

I think for young people who are thinking about how much money am I gonna need to save to, to retire? Like it can be a bit of a north star like aim towards it. But do not mistake the 4% rule for a legitimate retirement plan cause it’s certainly not that.

You did a great job yesterday. I thought I really liked your tweets yesterday. I thought you summarized some of the key aspects of the way he put that together, that don’t get enough attention. You talked about you have to know the portfolio construction, which was 50% US big cap, right, large cap bonds.

I think so. Yep.

And you know, he is trying to make it last at least the 30 years. But one of the things that I’ve been astonished never got attention with his original work is he didn’t include any ongoing cost to have the money managed.

And at the time he did it, of course, nobody was in low cost index funds and ETFs.

You were in actively managed funds or you had a portfolio manager often charging 1 to 2%. That’s part of the withdrawal. So I mean, if you’re taking out four and only, um, matching market returns and then the manager was taking an additional 1 to 2, then obviously that changes the math dramatically.

So it’s there’s a lot that it doesn’t include. So I don’t like people going. Well, Well, I’ve got a million bucks. I can spend $40,000 forever. No, that’s probably not the case. Right. Look at the 4% rule as a starting point, but get some professional advice along the way.