Week 25 Day 2: The 4% Rule Revisited: How Much Can You Spend?

William Bengen's 1994 study found that retirees who withdrew 4% of their portfolio in the first year (then adjusted the dollar amount for inflation each year) never ran out of money over any 30-year period since 1926. A $1,000,000 portfolio supports $40,000/year in spending (adjusted up for inflation every year).

The 4% rule details: Year 1: $1,000,000 portfolio x 4% = $40,000 withdrawal. Year 2: $40,000 x (1 + inflation rate). If inflation is 3%: $41,200. Year 3: $41,200 x (1 + inflation). And so on, regardless of portfolio performance. The worst historical starting year for the 4% rule was 1966 (Vietnam, inflation, stagnant stocks). A retiree starting in 1966 with $1,000,000 and withdrawing 4% (inflation-adjusted) would have run their portfolio down to approximately $50,000 by year 30 -- tight but survived. Every other starting year had more money remaining. The best starting years (early 1980s): portfolios actually grew while making 4% withdrawals -- retirees ended with more than they started. Modifications: Conservative: 3.5% (virtually guaranteed for 40+ year retirements). Standard: 4% (works for 30-year retirements in all historical scenarios). Aggressive: 4.5% (works in most but not all historical scenarios). Dynamic: start at 4% but reduce spending by 10% in years the portfolio drops 20%+. This simple guardrail dramatically increases sustainability.

Bengen's original study (1994) used a 50/50 stock/bond portfolio and the SBBI database. The Trinity Study (Cooley, Hubbard, and Walz, 1998) expanded the analysis to multiple asset allocations and found that the 4% rule had a 95-100% success rate over 30 years for 50/75-25/50 stock/bond splits. Subsequent updates by Pfau (2011, 2024) incorporating international data and varying starting valuations found that the safe withdrawal rate (SWR) is highly dependent on: (1) starting CAPE ratio (higher CAPE = lower SWR), (2) starting bond yields (higher yields = higher SWR), (3) portfolio allocation (more stocks = higher SWR up to approximately 75% stocks), and (4) fee levels. At the current U.S. CAPE of 35+ and bond yields of 4-5%, Pfau's models suggest a historically safe SWR of approximately 3.8-4.2%. For early retirees (40+ year horizons), Kitces (2008) showed that the SWR drops to approximately 3.5% but that adding a guardrail system (reduce withdrawals by 10% when the portfolio underperforms, increase by 10% when it outperforms) raises the effective SWR to approximately 4.5-5.0% while maintaining safety. The most recent advancement is the CAPE-based variable withdrawal strategy: set the initial withdrawal rate = (1 / current CAPE) * 0.5 + 1.0%. At CAPE 35: (1/35) * 0.5 + 1.0% = 2.4% -- very conservative but virtually guaranteed.