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!)

• SAN FRANCISCO — Monday, June 24, 6 PM, Book Passage SF Ferry Building
• GREATER LA — Tuesday, June 25, 7 PM, Vroman’s Bookstore in Pasadena

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. 

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. 

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:

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.