In retirement, how much of your savings and investment can you spend without running out of money? William Bengen, a financial counselor, produced a paper answering this subject in 1994.

The Journal of Financial Planning published his article, Determining Withdrawal Rates Using Past Data. Bengen discovered that seniors might comfortably spend around 4% of their retirement funds during their first year. In the following years, the yearly withdrawals might be adjusted for inflation.

Bengen discovered, using this basic method, that most retirement portfolios will survive at least 30 years, and in many instances, portfolios stayed intact for at least fifty years. As straightforward as the 4% Rule is, many misapply it or fail to recognize some of Bengen’s underlying assumptions.

**How the 4% Rule Works**

The 4% rule is simple to apply. In the first year of retirement, you are permitted to remove up to 4% of the value of your portfolio. Using the 4% rule, you might spend $40,000 when you retire if you have $1 million in retirement savings.

Starting in the second year of retirement, this sum is adjusted for inflation. If inflation were 2%, you could withdraw $40,800 ($40,000 multiplied by 1.02). If prices fall by 2%, you will withdraw less than last year, or $39,200 in our example ($40,000 multiplied by 0.98). In the third year, you would take the allowable withdrawal from the previous year and adjust it for inflation.

A prevalent misunderstanding is that the 4% rule requires retirees to remove 4% of their portfolio’s value yearly. The 4% only applies in the first year of retirement, and following then, the amount withdrawn is determined by inflation. The objective is to preserve the buying power of the 4% withdrawal made during the first year of retirement.

**How Bengen Tested the 4% Rule**

Bengen examined the onset of retirements during fifty years from 1926 to 1976. He utilized real market returns from 1926 through 1992. For years beginning in 1993, he anticipated a 10.3% return on equities and a 5.2% return on bonds. After each year, withdrawals were made, and the portfolio was rebalanced.

Using this, he determined the portfolio’s up to fifty-year viability. For instance, he analyzed whether a 1926 retiree’s portfolio would continue until 1976. For those who retired in 1976, he determined if their portfolio would endure until 2026.

The term “4% rule” was not coined by Bengen but derived from the data he reported. He discovered that an initial withdrawal rate of 4% enabled the majority of portfolios to persist for at least 50 years, and those that fell short lasted at least 35 years, which is sufficient for most retirees.

**Dismantling the 4% Rule**

Several significant assumptions underpinning the 4% rule must be understood. The 4% rule is based on exact asset allocation limits; however, fees, inflation, and sequence of returns risk can lead to varied outcomes.

**Asset Assignment**

Bengen assumed that a retiree’s portfolio would be invested 50% in equities (the S&P 500) and 50% in bonds after evaluating different asset allocations (intermediate-term Treasuries). With this asset allocation, he examined a range of withdrawal rates during the first year:

- All portfolios with a 3% withdrawal rate survived 50 years.
- A withdrawal rate of 4%: most portfolios lasted 50 years. Ten of the fifty investigated retirements fell short of this benchmark but lasted at least 35 years.
- With a 5% withdrawal rate, more than fifty percent of the portfolios were depleted in less than fifty years, with the weakest portfolios surviving little more than twenty years.
- At a 6% withdrawal rate, seven portfolios survived 50 years, while around ten portfolios lasted less than 20 years.

Bengen discovered when studying other asset allocations that having too few stocks was more detrimental than holding too many. The lifespan of portfolios with a 0% to 25% equity allocation was seriously impacted. Moreover, he discovered that the 50/50 allocation was best if portfolio longevity was the only objective.

If a retiree desired wealth growth as a secondary objective, Bengen suggested raising the stock allocation to as close to 75% as feasible. Some retirees find it difficult to stomach a 50/50 portfolio, making a 75% allocation to equities an even greater risk hurdle. However, Bengen’s 4% rule implies a 50% and 75% stock allocation.

**The Effect of fees**

Bengen did not consider that investment management costs may affect portfolio returns over time. The negligible fees paid by people who manage their assets in low-cost index funds should not impact Bengen’s performance. The 4% guideline may not apply to those who pay a financial advisor.

It is usual for financial advisors to charge an annual fee of 1 percent of managed assets. Total costs can surpass 2% if the adviser picks actively managed mutual funds, which generally charge 75 basis points or more annually. The influence of high investment management costs on portfolio results would undoubtedly undermine the 4% rule.

**Risk of Sequence of Returns**

Regarding the 4% rule, the sequence of returns risk refers to the possibility of negative returns in the early years of retirement, draining a portfolio. Alternately, a sequence of returns may greatly boost a portfolio’s worth if one retires at the beginning of a bull market, leaving a retiree with a sizeable balance even after 30 years, assuming the rule is adhered to.

The greatest obstacle for retirees, regardless of the plan they adopt, is that it is impossible to anticipate the future performance of markets. A retiree in January 1929 would have been unaware of the historic stock market crash that would usher in the Great Depression. A retiree in January 2009 would not have known that the market bottom was just three months away, followed by the longest bull market in history.

The good news is that Bengen’s research accounted for the negative risk of return sequences. By studying real market data beginning in 1926, his results evaluated pensioners who entered retirement during or immediately before a really bad downturn in the market and the portfolios of retirees who entered retirement in or just before these years and adhered to the 4% guideline survived for at least 30 years.

**Inflation Influences**

Considering the preceding weak markets, one may assume that 1929 to 1931 was the most difficult for pensioners, and it turns out that this is not the case. Those who retired in or around 1929 and utilized the 4% rule had their portfolios endure for a half-century. Individuals who retired during the market period of 1937 to 1941 fared less well, with portfolio longevity falling to around 40 years in the first three years. Yet, individuals who retired in the years preceding the 1973-1974 market suffered the most. Why? Simply said, inflation. From 1973 to 1974, prices increased by 22.1%. Pensioners were forced to significantly raise their yearly withdrawals to maintain the same standard of living.

In contrast, the period from 1929 to 1931 was marked by deflation, with prices decreasing by 15.8%. When retirees endure huge decreases in the value of their portfolios, they might cut their yearly withdrawals and keep the buying power of their money.

**Variable Withdrawal Fees**

The 4% guideline implies a consistent withdrawal rate during retirement. In the first year of retirement, retirees withdraw 4%, and then, they adjust their yearly withdrawals by the inflation rate (or deflation). Bengen stated in his research that dynamic withdrawals provide retirees with considerable flexibility.

In the middle of a bad market or unexpectedly strong inflation, a retiree may lower their annual withdrawal by 5%, for instance. A 5% reduction may not seem considerable, but it may significantly enhance a portfolio’s lifetime.

**Is the 4% Rule Valid Today?**

In recent years, some have questioned the validity of the 4% rule. Given the high prices, they anticipate limited returns from equities. In addition, they highlight the low yields on fixed-income instruments. While both worries are legitimate, the 4% rule has proven accurate in various challenging environments.

As mentioned above, Bengen’s analysis of the 4% rule has survived the 1929 stock market crash, the Great Depression, World War II, and stagflation in the 1970s. History implies that the 4% rule is a solid method for predicting how much one may spend in retirement, even though no one can predict the future.

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