Does the ‘4 Percent’ Rule for Retirement Savings Work in Hard Times?

Retirement planning is looming large because my 55th birthday is just around the corner. Unfortunately, planning is extremely difficult because much of life and death is sudden and impossible to predict with any useful accuracy.

Fortunately, it is possible to glean some wisdom by examining history to get a sense of the market’s downside risk. That’s why I’ve been following a small group of investors who had the misfortune of being pulled into the top of the market when the Internet bubble burst in 2000. (The effort was inspired by Norbert Schlenker, the president of Libra Investment Management, who has been tracking them – using slightly different metrics – on the Financial Literacy Forum.)

If you cast your mind back to the late 1990s, you’ll remember that the stock market was booming thanks to new technology stocks that went sky high. Big future gains seemed assured until the market hit a wall and crashed in the summer of 2000. (The period is reminiscent of earlier bubbles and, perhaps, today’s AI craze.)

The Internet bubble provides an external test of William Bengen’s 1994 paper Determining withdrawal rates using historical data. He figured that a retiree’s balanced portfolio of stocks and bonds would last for at least 30 years paying an initial 4 percent annual withdrawal rate, which was then adjusted for inflation.

I applied Bergen’s “4 percent rule” to the Canadian market, where one unfortunate investor began his retirement in late August 2000. They started with a $1 million portfolio, which happens to be a useful figure that can be easily scaled to fit other situations. Half of the portfolio is invested in the S&P/TSX Composite Index (Canadian equities) and the other half invested in the S&P Canada Aggregate Bond Index (Canadian bonds). The investor receives $3,333.33 of the portfolio to live on at the end of each month (an initial annual withdrawal rate of 4 percent) with payments adjusted monthly to account for inflation. (The figures here are based on inflation-adjusted monthly data with dividends and distributions reinvested. They do not include fund fees, taxes or other trading costs. Portfolios were rebalanced monthly.)

The simple portfolio held up well despite market crashes and corrections along the way. It ended in April 2024, near $525,000, and looks set to survive until August 2030. However, investors who used a more aggressive initial withdrawal rate of 6 percent have already failed. Those who chose a rate of 5 percent are likely to lose in four years, or more, because they are currently consuming about 25 percent of their portfolio each year.

Aside from the simple portfolio, I wondered how a more diversified 60/40 portfolio would have done. Here, the retiree starts at the same time and with the same amount of money, but they invest 40 percent in the Canadian bond index, 20 percent in the Canadian stock index, 20 percent in the S&P 500 index (US stocks), and 20 per percent in the MSCI EAFE Index (international stocks).

The accompanying chart shows how the 60/40 portfolio performed using an initial withdrawal rate of 4 percent, then adjusted for inflation, along with similar portfolios using initial withdrawal rates ranging from the more conservative 3 percent to 6 percent. overly optimistic percent. .

Once again, the 4 percent rule held up quite well despite the market storms over the years. She still had about $389,000 by the end of April 2024, in inflation-adjusted terms, and should reach that by the end of August 2030 — barring disaster.

Sadly, the 60/40 investors who chose an initial withdrawal rate of 6 percent went bust in 2018. Those who started with a 5 percent rate ran out of money in May 2024. They had about $2,000 left at the start of month, and the portfolio gained just 2.9 percent in nominal terms in May, which was insufficient to cover the monthly withdrawal of $4,166.

The risk of running out of money in retirement can be mitigated by choosing a modest withdrawal rate and having the ability to make changes along the way. This could mean a little belt-tightening, or taking on a part-time job when times are tough.

More optimistically, adjustments can also be made by those who encounter exceptionally good times, which would allow for more spending than originally anticipated.

For my part, retirement is not attractive at this point and I will continue to find gold while taking the occasional break to enjoy the midnight sun.

Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.

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