The 4% Rule Is Not Your Friend for Early Retirement Savings // ournextlife.com, Tanja Hester, author of Work Optional: Retire Early the Non-Penny-Pinching Way, financial independence, FIRE movementthe process

The 4% Rule Is Not Your Friend

With a post title like that, I know you’d like me to get right to it, specifically to why I’m growing increasingly convinced that essentially none of us should be planning to withdraw 4 percent from our retirement — early or otherwise — investments. But first, a few quick notes.

The Plutus Awards

The Plutus Awards nominations are open. These awards recognize the best in independent personal finance media, and I hope you’ll submit a ballot to recognize your favorites. It means a ton to bloggers and podcasters to be award finalists, so I especially hope you’ll nominate some newer bloggers you’re digging who haven’t been recognized before. If you’d like to show this blog or any of my projects some love, I’d be so grateful for your nominations for financial independence/early retirement blog (Our Next Life), best new personal finance book (Work Optional), best personal finance podcast for women and podcast of the year (The Fairer Cents), and biggest impact and community builder (Tanja Hester, for Cents Positive, my blogger transparency push, and other work to amplify the voices of those who’ve often been underrepresented in our community). Submit your ballot here. (They do make you include an email address, but it’s easy to immediately unsubscribe if you’re guarding your inbox.) Thanks for considering!

Upcoming Events

The last few weeks have been fairly packed with community events, from CampFI Mid-Atlantic over Memorial Day weekend to speaking at Tesla last week, to book events in Reno and Sacramento, it’s been an incredible privilege to meet a bunch of you, answer your questions and hear about your journeys to work-optional life!

There are two more book events coming up, and I’d love to meet you there if you’re in the area! Events are entirely free, as always. (You’re welcome to buy a book, of course, but it’s certainly not required. And if you already own one and would like it signed, please bring it!)

Women in FIRE

If you’ve been reading long, you know that I’ve been working hard for a while to create space for women pursuing financial independence and work-optional life, not because there’s anything wrong with the advice the most visible bloggers (mostly men) have been offering, but because a lot of women have told me that they haven’t felt welcome because they didn’t see themselves reflected in the movement, or because they wanted to discuss different kinds of issues than mixed-gender groups tend to discuss. This is doubly true for women of color and other people of color, as well as LGBTQ+ people (happy Pride month!), those with disabilities and those with lower incomes.

Other bloggers have been working to bring more visibility to the diversity of the FIRE movement, too, like Angela at Tread Lightly Retire Early, who created a list of women in the financial independence movement, and Kiersten and Julien at Rich and Regular who’ve delved into tough conversations like the racial wealth gap.

The whole goal of this work is to help more people feel welcome in the FIRE community, and there’s been some recent evidence that it’s working, namely this incredible story that ran in the New York Times on Friday. There was also a Nightline story from March that focused on Cents Positive and including women, and we devoted an episode of The Fairer Cents to the topic of how we diversify the FIRE movement, including excellent thoughts from Vicki Robin, author of Your Money Or Your Life

The photo and caption from the NYT story // The 4% Rule Is Not Your Friend for Early Retirement Savings // ournextlife.com, Tanja Hester, author of Work Optional: Retire Early the Non-Penny-Pinching Way, financial independence, FIRE movement

If there’s more bloggers and podcasters can be doing to help you feel welcome here, please let me know! Leave your thoughts in the comments, or if you’d rather they not be public, email me at MsONL [at] our next life dot com. (You can always comment under a pseudonym, as lots of folks do.) I’m committed to continuing to push our community to be as inclusive as possible, and value your input on how we can all continue to improve together.

Let’s Talk 4% Rule

At last to the topic of the post! Last month, Mark and I both spoke at CampFI Mid-Atlantic, and we decided to flip gender expectations by choosing a heavy financial topic for me and a touchy feely topic for him. The next post will be a blog adaptation of the talk he gave, about transitioning to retirement, but today, I’m sharing an adaptation of my talk on the 4% rule, and why I believe it’s not your friend. 

4-percent-rule-not-enough

I’ve argued against the 4% rule before, in this post, and in it, I started with this:

The 4 percent safe withdrawal rate, short-handed as the “4% rule” is the cornerstone of most discussions about retirement planning, along with its inverse, “25x” (the idea that you need to save roughly 25 times your annual spending, and then you’re good to retire forever on that spending level).

The 4 percent rule has been discussed and debated so much that we can all practically recite the details of the study that brought us the rule, right? Trinity study… 75% equities, 25% bonds… Spend 4% of your investable asset portfolio each year (not your total net worth)… 30-year time horizon… Monte Carlo simulations… 100% rate of backward-looking success… 

Of course there are other analyses that show lower rates of success over the same period, arguing for the 3% rule instead if we hope to get something close to a guarantee that we won’t outlive our money. And there are the endless debates about what “spending 4 percent” actually means, how inflation factors in, etc. This will go on forever.

But here’s the thing about the whole discussion: Debating whether it should be the 4% rule, the 3.5% rule, the 3 percent rule — heck, the 1 % rule — all of it misses the point.

It especially misses the point for early retirees, who have much more than a 30-year horizon, if we’re all lucky — perhaps several decades more. The 4 percent rule is likely sound mathematically, as explained eloquently by Michael Kitces on a recent Mad Fientist podcast, and it could very well hold into the future, despite dire predictions about future economic growth and market gains.

The specific percent isn’t the issue. Any percent isn’t the issue.

The fundamental problem with any “safe” withdrawal rate is the underlying assumption of level spending over time. 

I stand by that assessment that the assumption of level spending is a big problem with the 4% rule, or any consistent withdrawal rate, and J.D. Roth wrote an excellent post at Get Rich Slowly that backs me up, based on his real-world experience with retirement spending. 

But more and more, I’m growing skeptical that saving “25X” (25 times your anticipated annual retirement spending, the inverse of the 4% rule) will be enough for most of us.

(From here forward, I’m drawing from the presentation, so it’s a little more bullet-heavy than usual.)

WHAT ACTUALLY IS THE 4% RULE?

A guess based on historical data of how much you can safely withdraw each year in retirement and not run out of money. The 4% rule does not predict the future. And there’s good reason to believe that the future is unlikely to mirror the past.

HOW IT ACTUALLY WORKS

You do not withdraw 4% of your balance each year.

Instead, at the start of your retirement, you withdraw 4%, and then each year you increase that amount by – at most – a standard inflation marker like the consumer price index (CPI). You don’t recalculate 4% of your new balance.

Over time, you’re withdrawing far less than 4% a year.

THREE MAJOR PROBLEMS WITH THE 4% RULE

  • It assumes you spend the same thing every year.
  • The future is unlikely to be like the past.
  • Life can change.

As for spending the same thing every year, see J.D. Roth’s post linked above. For the other pieces, keep reading.

THE PAST VS. THE FUTURE

Economic indicators are… problematic. For example, wages have been stagnant for decades. Productivity has gone up but workers don’t see the benefit of that, only shareholders do. Some economists argue that growth is no longer inevitable, and that in fact, the U.S. high-growth period ended back in the 1970s.

In the past, new technologies created more jobs. Now, for the first time, technology is beginning to steal large numbers of jobs. More jobs will be lost to automation in the future. Large numbers of out-of-work people will challenge the economy in a multitude of ways.

There’s this little thing called the climate crisis (which I’ve written about here).

And, most importantly:

HEALTH CARE

The 4% rule assumes that all of your spending at best keeps pace with inflation, and currently, health care is increasing in cost by three times the rate of inflation, and it could get worse. Any time your spending goes up relative to inflation, you’ll need to withdraw more, and the 4% rule falls apart. We’re in a health care crisis, and we can’t ignore it.

CLIMATE CRISIS VS. YOUR MONEY

Costs are going up for:

  • Food
  • Fuel and utilities
  • Homeowners and renters insurance
  • Homes in more resilient areas
  • More frequent home repairs

Some areas may shortly be uninhabitable, and a new report out of Australia says it’s a plausible scenario that human civilization could collapse as a result of climate change in as little as 30 years, by 2050.

Meanwhile, financial institutions are doing virtually nothing:

Many of the largest U.S. investment funds, including pensions, are doing nothing to protect their investors’ savings from the financial risks posed by climate change… At least 117 American funds, with a combined $4.6 trillion in assets, have taken no action to mitigate the risks associated with a warming planet.

— Huff Post

That’s all the stuff external to you, but even in your own life, unexpected things can happen.

LIFE CAN CHANGE

Moving to a different area

Kids

Health surprises, for you or loved ones

Divorce — Are you still FI with half of 25X? 

Related post: In a Couple? Aim for Real Financial Independence, Not Financial Dependence

Which means: SAVING 25X ONLY MAKES SENSE IF YOU CAN SEE THE FUTURE

WHAT ACTUALLY IS SAFE, THEN?

  • 3.5% IF YOU KNOW COSTS WILL STAY LEVEL
  • 3% IF YOU DON’T (meaning: most of us)

(If you’ve read Work Optional, this will look familiar.)

BUT DON’T PANIC! THERE’S GOOD NEWS

IF YOU CAN SAVE 25X, YOU CAN SAVE 33X.

Because, net worth trajectory is not linear. It grows geometrically as your gains begin to compound and as your savings rate accelerates. Here are our examples:

Net-Worth-Trajectory

Taxable-Targets-Vs-Actuals

THOSE WHO GET EXCEPTIONS

  • Those with military pensions and health care for life
  • Those with rock solid public pensions
  • Those who will retire at 55 or older and expect to get solid Social Security

WHAT IF YOU ALREADY RETIRED WITH 25X?

  • CONSIDER SIDE HUSTLING IN THE FIRST DECADE TO HEAD OFF SEQUENCE OF RETURNS RISKS
  • OR CUT COSTS DURING THE SAME PERIOD
  • DON’T BURN CAREER BRIDGES, JUST IN CASE YOU NEED TO GO BACK

TL;DR

We’ve got two major X factors out there for most of us facing early retirement costs: health care and climate change impacts. Those two factors alone are enough to blow a standard budget, and when you factor in that Medicare is likely to get more expensive and Social Security benefits may decrease (or potentially go away altogether, though that’s highly unlikely), which removes a lot of the buffer we might otherwise have against rising costs, there’s reason to be better prepared than the 4% rule makes you. And that’s not even counting the high potential for lower stock market growth in the future, as predicted by Warren Buffett and plenty of others, or the other threats to our current job market construction.

So do yourself a favor, and save a little extra. If you can save 25X, you can save more than 25X, and future you will be so glad you did.

FURTHER READING

Work Optional: Retire Early the Non-Penny-Pinching Way, chapter 6 discussion of safe withdrawal rates.

GOT THOUGHTS?

Of course you do! Leave ’em in the comments. Respectful disagreement always welcome.

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21 replies »

  1. I’m a bit confused by this post. The whole point of it is that nobody can know what the future holds, so don’t trust the math (which has been pretty thoroughly vetted) behind the 4% rule. Ok, I guess the future could change for the worse and markets could collapse. That’s a fair guess (but this is just a guess, no matter how many studies are out there. Plenty of people thought nuclear war would end the world long, long ago).

    But then, do go right ahead and trust a 3.5% or 3% rule, with no supporting math? I truly do understand advocating for people to err on the side of caution. I do not plan to necessarily just retire the day I hit 4%. But why 3.5% or 3%? In such a long post, with so much information about why 4% doesn’t work, it would be nice to see the math here. If civilization is going to collapse by 2050, I doubt the 3% rule is going to hold up any better than the 4% rule!

    • Fully with you on this one, missy. We have a weak (by statistical standards) amount of historical data, not to mention the potential upcoming megashifts due to climate change, robotics/AI, healthcare, etc. ERN just posted a great (likely) example of how something that worked for decades has likely stopped working, if not greatly worsened! I completely get that there’s never a way to know for sure, but it seems like the idea of being conservative makes a lot more sense than throwing out specific numbers as “eat this, not that”.

  2. No real substantive discussion of why the 4% rule likely won’t work or should not be relied upon other than a statement that health care costs continue to rise at a rate greater than inflation. But the costs of other goods and services have fallen. And numerous studies have shown that at a certain age, spending begins to decline. While there is, of course, no guarantee that past performance of the stock and bonds markets will continue in the future, the whole point of the rule is that it has proven workable through all kinds of economic crisis, as Michael Kitces has shown: https://www.kitces.com/blog/how-has-the-4-rule-held-up-since-the-tech-bubble-and-the-2008-financial-crisis/

  3. If all humanity will end by the year 2050, the catastrophe (die off) will start earlier than that, so that means most people with live less than 30 years and the 4% rule is safe. Also since you would not want to leave any money in the bank you might as well spend 5%. AOC and the green deal gang, say the world will end in 12 years so why in the heck is anyone still working???

  4. Okay, I’m so glad you included climate insecurity on this list. As the years go by I expect this one to be a continually bigger force in all things on this planet.

    Also, so honored to be a part of that NYT article with you, friend! Feels a bit surreal, but incredible.

  5. Totally agree with you about the 4% rule and erring on the side of caution. The impacts of climate change and honestly the continued ridiculous inflation on every type of healthcare expense makes me nervous (not nervous enough to lose sleep but the thoughts aren’t pleasant). I get your point, pick and number much less and make that your target instead…. Surprisingly, I pegged the safe number to be less than yours – I think 2.75% is a good bet and I structured my non-retirement investments so that I wouldn’t have to deplete the principal amount of the total to meet cash flow needs. Big picture – it’s awesome to question all the assumptions behind the 4% rule to fully understand what you are doing if you do choose to walk away from your career at 4%.

  6. I made the decision to retire in early 2017 in part based on 3 percent spending and 33x savings. Okay, my “go for it” numbers were really 3.2 percent and 32.5x, but since these were somewhat arbitrary targets anyway, I figured “close enough.” Actually, these targets were backed up by a spreadsheet that conservatively assumed 4 percent growth and 3 percent inflation over a 40+ year horizon (I’m pushing 60). My biggest worry at that time was escalating healthcare costs and the potential demise of ACA/Obamacare.

    Two years later, I can say that healthcare costs are still a huge concern, but so is any out-of-budget spending. Just as income growth is not steady state, spending is not either. As a homeowner, I can factor in cost of home maintenance and repairs as an annual expense, but I can’t always schedule them that way. What about the car? The mini-van had its 100k mile service and got a new set of tires this year. And that applies to other expenses as well.

    I think that the point of this post is that the 4 percent rule and other financial guidelines may be a good starting point for retirement planning, they do not guarantee anything. There is no such thing as one-size-fits-all when it comes to financial independence, and FI is not an end goal, it is a lifelong pursuit.

    • Tanja had some good advice in Work Optional about how to convert those out-of-budget expenses into planned, budgeted ones. Basic idea was to look at the last few years of spending, and if you find you’re spending $6K/year on those types of “one-off” unplanned/unknown expenses, you then start planning $500/mo in your budget to fill an account that you’ll then draw from each time the car breaks down or whatever.

  7. Tanja, your article is excellent from a mathematical point of view, but I’d like add that for most people, putting all their faith into a 4% or 3.5% or 3% rule is not so easy to do, just from a natural human behavoir point of view – quite simply because its scary.
    For sure the 4% rule is a good starting point, but before I had the confidence to really let go the reigns and to move into a financially independent lifestyle, I needed to run some simulations so I could better understand the consequences of a future lifestyle with un-even spending, un-forecasted events, etc.
    It was only after Id had a good understanding of which potential events impacted us seriously, and we were able to take some risk management actions (insurances, diversification of our investment portfolio, etc etc) that we felt truely confident to be able to say goodbye to our previous careers and lifestyles.
    Great article with super content! FIRE is not magic and should not be taken lightly. For me its this type of post that brings the true value to the FIRE community.
    Robin

  8. I’ve never felt comfortable with the 4% rule, and always figured I’d aim for at least 30x max expected annual average spending.

    Then, my son was diagnosed with cancer and I realized how much a health change can impact plans.

    For example, do most plan to purchase their own healthcare and then always hit the max out of pocket (unless of course, they already have a chronic illness) in retirement? Do they factor in addition to that spending, the increased non insurance costs of chronic illness- travel and managing a home away from home, for example?

    This is a very specific example, but the point is things can and do change quickly.

    I think aiming to be able to still have an income and being flexible with the fact that situations can change quickly is important. Or, really pad that buffer.

    Numbers are great and they give us benchmarks. But, thing are so personal and open to change.

    I think the most important things are being educated and informed in your choices- planning for the worst but hoping for the best- and maintaining a flexible mental mindset.

  9. I’ve had a lot of difficulty with the 4% rule personally because our expenses have been all over the place over the last 5-6 years. Daycare for two children, two new cars (to support the expanding family), college savings, solar panel purchases, and a 15-year mortgage have raised short term expenses a lot.

    The good news is that expenses get a lot better when averaged out over the long term. I’m trying to work more with this average number of expenses even if “average” has a sequence of returns risk. Fortunately, we can use our military pension get-of-4%-rule card you afforded us.

    I’m hoping that health care reaches a point where the costs can’t continue to outgrow inflation. I think it has gone from around 3.5% of the GDP to 17% of the GDP. At some point, a viable option may have to be to move to a country that doesn’t have these issues.

    Climate change is a tough one and I wonder if investing in commodities could help offset some of the risk. Maybe we’ll have reduced transportation costs with solar-powered electric, self-driving, on-demand car fleets.

    I think I’m reading part of your article wrong though, because I interpreted part of it as saying that any percent was a problem, but then the end seemed to recommend a 3% as a better number (which I agree with). I like the variable withdrawal rate plans that I’ve seen in a few places, but it might be overkill for trying to come up with a goal like this.

  10. Tanja, you can’t be a matriarch, thou can be the guru or the giant or the spiritual leader of the women’s personal finance movement but you are only 38, that’s just too young to get saddled with matriarch, that sounds old, like me!

  11. 4% rule is not safe. 3.5% rule is not safe. 3% rule is not safe. Is 0% rule safe? Probably not. I’m sorry but I can’t live a life of paranoia. How long does the average Jack and/or Jill need to work to save 33x or more? At one point, enough is enough. 25x in itself is a pretty good achievement. Kudos to those who have done. Worst case, people do side jobs to close the gap and that’s it. It’s not a big deal. If 2050 is the time of the rapture, who cares about any rule. Every generation believes the golden era has passed by and it’s only downhill from here. Is that true? If it really is the case, then no % rule will matter. Eat and be merry NOW! Today’s post is very contradictory.

    This sounded too much like Suze Orman. You can’t retire without a gizzilion dollars. Fear! Fear! Fear! Pffft! I’m disappointed. I’ve read your blog since the near beginning and I really liked it. Now though, not so much. I wish you’d go back to your earlier style of writing.

  12. Ah yes, some of the hate for this post. I’m not a fan of the 4% “rule” myself. Might it work out fine? Yes. But I am not interested in betting that it will based on a few factors, most of which are in already mentioned here.

    I actually wouldn’t mind 2% withdrawal myself so I could stick the money in insanely safe places. Not that we’ll get there, but I’m still willing to work a few more years, part-time, to setup a fairly carefree retirement. One more year syndrome does not actually seem like a bad thing to me at this point.

  13. This is a great post. It teaches me that FI is not necessarily a life without work, but it will make managing the work of life much easier to have such generous pading in the bank. Picking up shifts at a restaurant, workign as substitute teacher or even helping stock shelves at Target will help bridge gaps and pass time if the math doesn’t work out, but going from 25x spending to 33x spending could add 3-4 years onto a working life in prime years while kids are young. I’d rather start sooner and try to stay under 4%, than work longer and save more to spend less, but that’s me. I’d be ok with taking a job at 58 if I was a little off in my math, and i’m 41 now hoping to hit FI at 47.

  14. Is the issue about a withdrawal rate? or is it really about spending assumptions that are too aggressive? If you put a 10% or 20% contingency line in your budget, then you are far more likely to be able to absorb bumps. It results in the same thing—you have to save more.

  15. Nobody believes the 4% RULE! If they believed they would not have to cook up all these side hustles and gigs to fill in the gap. The problem with the portfolio that is open to withdrawal is that it is leveraged. It expects to make MORE than its original value to buy you some extra years of retirement. You save 25x but expect to live for 30 years that extra 5 years comes from leverage. You save 25 x and expect to live 50 years on that, HUGE LEVERAGE. Like any investment the more leverage the more risk and increased risk carries with it the increased specter of failure. Telling yourself the 4% fairy tale won’t buy you a single hamburger once you’re out of money. The problem is retirement happens along a normal distribution like a bell curve. If you’re in the center of the bell with your cash flow if will likely work. Since 50% are above the center they will die rich. The next 25% down will likely survive also but may have less than what they started with. The bottom 25% is where failure happens, so if your “number” or the fairy tale you tell yourself, forces you into the bottom 25%… BAD JUJU. It’s not climate change or medical costs that are at issue, it’s piss poor planning by a crowd deafened by their own echo chamber, and egged on by “experts” who sell them soap (books blogs courses) despite the framework being a house of cards. You are not a victim just stupid my your own choice. There is plenty more to say, but start with leverage. Write a simple spreadsheet and start with a yearly withdrawal. Multiply that by some inflation rate say 2% and that’s next years withdrawal do that 50 times and add it up and that’s what your 50 year retirement is going to cost you. It’s likely you will need twice the money or more after 50 years inflation adjusted than your 25 x. The alternative is to die in 20 years, you’ll be golden. Any financial planner worth his salt will do this calculation because knowing the cost and comparing it to the nest egg tells you how much leverage you carry.

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