Episode 92, Safe Spending in Retirement: Bill Bengen on the 4.7% Rule of Thumb

0:00Coming up on the 92nd Bogleheads On Investing podcast. If you get much higher than 65 % and you encounter a bad, bad market or in retirement, a very high stock allocation will just devastate your portfolio.

0:16How much can you spend safely in retirement without running out of money? Hi, folks. I'm Jon Luskin, board member for the John C. Bogle Center for Financial Literacy. Today on the 92nd Bogleheads On Investing podcast, we're joined by Bill Bengen, creator of the 4 % rule to talk about what's changed and how his new book, A Richer Retirement, shows how you can spend even more money. We'll cover practical strategies like inflation adjustments and spending flexibility. And if you're listening on audio, this is a great episode to watch on YouTube. We'll be showing the relevant charts from Bill's book as we discuss his findings, and we've even created our own visuals just for this episode to help better communicate the concepts discussed.

1:00And now, on to the show. So let's kick it off with what safe spending looks like today. We have a couple questions from Bookloads Reddit. Usernames Hamzahek and Vastglittering. They ask, what should we be thinking about with respect to how much we can spend today, given today's market volatility and inflation rates? In today's market, of course, we're facing, at least in the United States, very overvalued stock markets. And usually when we get very overvalued stock markets, the major bear market is not far behind. And when you have a major bear market early in retirement, it can really have a very negative effect on your withdrawal rates.

1:40So that's one aspect. The other is inflation. Inflation, at this point, I'm not too concerned about. It's what I call a moderate range between 2.5 % and 5%. But it bears watching because the latest producer price index report, as you know, came out a little bit hot. I'm hoping that that's not the start of a trend in the CPI because inflation, in my opinion, is the greatest enemy of retirees. Absolutely. So in your book, you provide guidance for folks. You have a few charts in there, and those charts pretty much sum up. hey, here is what CAPE is, and then here is the accompanying inflation regime.

2:17And you give folks the choice to choose from low inflation, moderate inflation, and high inflation, which you talk about in the book. And you say, hey, given these two variables, here's the safe withdrawal rate you should be considering going forward. John Luskin jumping in here with a podcast edit to explain some of the geeky topics we're going over in the episode so far. CAPE is just a valuation metric. It's a way of determining just how expensive or cheap stocks are. And CAPE can sometimes be used to help determine whether a future market correction is more or less likely to occur. So here, Bill's research looks the question of, hey, if markets are relatively expensive or cheap compared to historic averages, Because perhaps that suggests that we should change what we think of as a safe withdrawal rate.

3:14And now back to the episode. One question I have for you is that insofar as determining the right inflation regime, because we pretty much have to guess what inflation is going to look like. In your research, did you do anything along the lines of, hey, here's what inflation is like at this point in time. and therefore it can indicate what inflation might look like over the balance of the next 30 years? Yeah, you know, that falls into the realm of projecting. And I think my favorite author, Mark Twain, said projecting is difficult, particularly about the future. It's a task you have to perform to have a plan, but it's OK if you don't have a high degree of confidence in it because I don't think anyone can predict inflation with a high degree of confidence.

4:01Got it. So it seems like no correlation between what inflation is today and what it's going to be like 30 years from now. And that's not surprising, right? That would require knowing the future. Yeah, I would think, you know, people in their early 60s when inflation was still pretty low, felt pretty good about things. And then 10 years later, they were in a decade of very high inflation. So it can change on a dime. For years, I struggled to find a method to recreate the sometimes very high withdrawal rates in the past. And it wasn't successful because I was putting stock market valuation first.

4:36And I knew inflation was part of the picture, but I was put in the background. And when I flipped that priority, I made inflation the most important factor. Everything fell into place and the data made sense then. Yeah. Not surprising. Inflation is going to be the driver on what you can spend from your portfolio sustainably. Yeah, assuming that you're using a withdrawal scheme, which involves giving yourself a cost of living adjustment every year like Social Security. I mean, you don't have to do that. You could base on a percentage of your portfolio value each year or some other method, you know, an annuity-like method, a fixed dollar method.

5:14But I think most people want some inflation protection, and that's the consequent of that. For those who aren't sustainable spending geeks, I'm going to jump in here to add some context. You want your portfolio distributions to keep up with inflation each year. That means making bigger and bigger distributions each and every year, usually assuming that inflation goes up each year, which it usually does. So for example, if you're making a$47 ,000 a year distribution on a$1 million portfolio in your first year of retirement, you're gonna increase that portfolio distribution next year with inflation.

5:55So if inflation is 3%, then your$47 ,000 distribution goes up to$48 ,410 the following year. That allows you to maintain a similar quality of life year by year, even though the cost of living increases. So most folks are familiar with that 4 % rule of thumb originally created from your original research, you did more research as you talk about in the book and that by adding other asset classes, that 4 % has now increased to 4.7%. Notably, adding small caps to a portfolio initially increased that safe distribution rate by half a percent. And then you added a few more asset classes, micro, mid cap, international stocks that brought it up to 4.7%.

6:43I'm curious of those latter asset classes that you add, micro, mid, and international. Which of them made the biggest contribution going from 4.5 to 4.7? You know, I never did a sensitivity analysis of that, so I don't have a good answer. But I suspect it was probably the micro caps and the small caps because they had the highest returns over the last hundred years. Naturally, you used indexes to get the returns from these different asset classes. Any considerations or maybe any thoughts you'd like to share on how costs could decrease those returns by adding a small cap index, especially the micro cap index, where there could be illiquidity premiums there, decreasing the return that investors might actually net compared to the index.

7:33Costs are very expensive. I'm assuming in my research that I'm using funds, ETFs or mutual funds with essentially zero costs. And that's realistic. When I first started my research, that was not the case 30 years ago. But today, investing is low cost commission-wise and fee-wise, which is great for investors. Absolutely. All Bogleheads were fans of ultra-low-cost investing. Yeah. Makes sense. I hope you're enjoying the 92nd Bogleheads on Investing podcast. If you're finding it helpful, please subscribe to the channel. It helps more investors to Discover the show. And now back to the conversation.

8:12One point that you mentioned in the book, which is rather interesting as well with respect to adding these other asset classes to juice up returns, small cap, microcap, etc. is that with enough of the addition of these higher returning asset classes, the safe distribution rate doesn't necessarily increase anymore, but decreases. So it's too much of a good thing. Yeah, volatility is a factor that offsets some of the benefit of the higher returns. It's particularly important for retirees. Volatility is less important for people accumulating money since they keep adding money. But retirees are not adding money.

8:47They're taking money out. And when you do that and the portfolio is volatile, you can have periods of time when the market is crashing and you're taking out substantial amounts and really depleting your portfolio. And for those folks who want to nerd out on the subject of adding asset classes like small cap, targeting factor premiums in their portfolio, we've done some interviews. on other bulk led series on this topic. I'll link to them in the show notes. For example, we interviewed DFA recently. We've had some folks from Avantis on the show. So folks can check those out if they want to learn more.

9:20So in your book, and you mentioned it just now, talking about other asset classes that you could add to a portfolio. I'm curious, any updates? Have you looked at some of these other vehicles and how they impact a portfolio's return for the long run? Yeah, I think the next one I want to take a look at would be gold probably and beyond that real estate. Those are two pretty substantial asset classes with decent returns over time. So those are the ones I'd be focusing on. And in your book, I believe you comment to the effect of if folks are interested in how these other asset classes add to the return of a portfolio, let you know, and then you'll do that research.

9:58So, folks, if you want to hear Bill do more research on those topics, put your comments in the comment section. Let him know what you want him to research next. I'm happy to help. I enjoy my research immensely. And the prospect of getting something new, perhaps, that no one else has seen is what drives me. Yeah. Gold, silver, right, especially they've seen a recent run up and now drop, right? So it'll be interesting to see how that added volatility contributes or decreases to that safe withdrawal rate. Yeah. And then commodities are important, too, you know, industrial and agricultural. They've had a good run and probably going to continue.

10:37We're probably in what's called a commodity super cycle right now where commodities can go up and up for a decade or more. And they've underperformed for a long time. So apparently this dog is having his day. One thing I can't help but wonder about with respect to commodities is that, yes, there's the index return, but it's my understanding is that there are a lot of costs when it comes to investing in commodities relative to what you can get from the return and an index in large cap U.S. stocks, for example. So I think that would be an important consideration in folks interpreting any results that you might find yourself because there's the index return for commodities.

11:15And then there's the real return that investors are going to get after all those fees for investing in something like a commodities fund. Yeah. Commodities are particularly loaded with costs. Part of it is because most commodity funds use futures, futures contracts, and they need to be rolled over to new contracts as they expire. And there's a cost, substantial cost right there. One investing quote that I think applies here, and it's one of my favorites from Cliff Afness, is there's no investing strategy so good that a high fee can't make it bad. That's a very wise statement. I agree wholeheartedly with it.

11:53Certainly, bogelheads are going to appreciate that one. Yeah, I know when I started out as a financial advisor, I felt advisory fees were too high. So I set my fees at a half, actually, of what the prevailing market rate was. and I thought they'd come down to me, and they never did. And I actually was forced to raise my rates a little bit to cover my costs, which made me feel badly. But, you know, AI and a lot of other things, I think, are going to greatly impact the cost of investing in the future. It would be interesting to see what happens. Yeah, it certainly will be interesting to see what role AI does have in investing and financial planning going forward.

12:31There is a really fascinating article by Michael Kitsis on fee saliency. That's to say you charged half a percent, but most folks don't even really think about what half a percent means. Right. So certainly as advisors, you know, we get the impact of cost when investing. Kit says, he argues that percent, it's sort of a meaningless amount for most folks, at least those folks who aren't really financially savvy. So I'm not surprised that lowering a conventional fee that most folks don't understand in the first place. Right. Didn't really make a difference. Yeah, I think people should spend some time and educate themselves on the impact of fees on their investments.

13:12It's quite an important topic. I wholeheartedly agree. Let's talk about a front-loaded withdrawal scheme. This is the idea that we're going to spend more money earlier in retirement than later in retirement. And it's not only an issue of spending more money because there's certainly the go-go years. Hey, we're relatively younger. We're going to do more things. We want to do more travel, et cetera. But the other thing that I think about with respect to portfolio distributions are larger at the beginning of retirement compared to later retirement is not just that we're spending more, but later retirement, we might have more income.

13:44This is especially going to be the case if we're delaying Social Security, for example. So not only is our spending higher early in retirement, but we have less retirement income to manage the impact of a portfolio withdrawal. So you look at front-loaded withdrawal schemes, and the takeaway is for every basis point or percent that you spend more during the first 10 years of retirement, you have to spend twice as much less during the latter 20 years of retirement. Yeah, it's really significant. When you bump your expenses up early in retirement for anticipated travel and enjoyment and other entertainment costs, you're creating a hurdle for yourself later in retirement because the first 10 years of retirement are the most important because they compound the longest.

14:35And if you're drawing in a higher rate during those 10 years, you're going to have a big cliff to basically go over to get your expenses down to what will be manageable the rest of retirement. Yeah, certainly this is something we've seen before in other research. Those first 10 to 15 years of retirement make the biggest difference insofar as if you're going to run out of money. So it's no surprise that the results here are so extreme. I agree. And a shout out to Mark Fikes from the Bogal's forums for asking about this question. So related to this topic of that front loaded spending in retirement is another subject that you touch on in the book, which is the spending smile.

15:14That is, we're spending more earlier and then later as we reach more advanced ages, we're spending less because we're traveling less. But then at really advanced ages, we might be spending even more. this term, the spending smile, coined by David Blanchett, who we also had on a previous Bogle Heads live series. I'll link to that in the show notes for folks who want to check that out. And in your book, you mentioned that if there is enough interest in how sustainable dwell rates are impacted on this topic, you would do more research on it. I'm curious, any updates since doing the book, any research on the spending smile?

15:48I've got it on my research list and And hopefully we'll get into it later this year. It's an intriguing idea and I don't know how it's going to turn out at all. It just, it should be very interesting to do. I have a lot of respect for David. I think he does some wonderful work, so I'm happy to take the lead from him on that. And Bill makes a similar comment in his book. If you guys want to hear him research this topic, let him know, put a request in the comments. That's right. You can do that or reach me through my website if you wish to. I have an ask bill tab there. All right. Let's jump to safe withdrawal rates beyond 30 years.

16:28So much of your research looks at these 30-year time horizons. How much money can I spend safely if I have 30 years to withdraw? And then after that 30 years, my portfolio is extinguished. Now with greater life expectancy and folks possibly retiring earlier and of much interest to the fire communities, what happens to that safe withdrawal rate when we have a longer timeline? So it looks like in your book, you mentioned that beyond 65 years, the safe withdrawal rate drops from to the updated figure of 4.7 percent to a lower figure of 4.1 percent. And then beyond that, it stays fixed at that 4.1 percent figure.

17:05Yeah, it's a very interesting phenomenon. You think it would continue dropping. But I think what happens when you look at very long time horizons, the compounding power of stocks supports the portfolio as time goes on. So you get that asymptotic, that floor kind of a phenomenon. But related to the topic of we're living longer, we're going to need this portfolio to last longer is, in addition to having that lower distribution rate, is how should we be investing? What is the optimal stock bond mix? And you talk about this in your new book as well. So 60 % stocks, nearly ideal, as you mentioned in the book, for that 30-year horizon.

17:43And then that ideal mix jumps up to 67 % for 40 years. and then 72 % for 50 years. So we see marginal increases in the optimal stock bond mix as that retirement timeline, that distribution period increases. Yeah, and I've done some research since I did my book, which I've published on my website. Instead of 60 % for the 30 year, I favor a 65%. And I'm looking at even higher allocations. I suspect though, if you get much higher than 65 % and you encounter a bad, bad market early in retirement, a very high stock allocation will just devastate your portfolio. So I'll be running the numbers on that and advise you soon.

18:24But you're right, the higher, the longer your time horizon, the more you can withstand in the stocks. All right, let's jump to rising glide paths. So this is a really interesting idea. And this idea is instead of having a fixed stock bond mix throughout retirement, we mentioned 60%, 65%, 72%, et cetera, we're going to change our stock bond mix over time. So there's been research done on this by Kitsis and Fowle. I'll link to that article in the show notes for folks to check out. But you looked at this question too. You looked at the question of what happens if I change my stock bond mix over time?

18:59Tell us, what did you find? It's very interesting. And I haven't researched this as much as I'd like to. It's a very interesting idea. Essentially, what probably happens is with the rise equity glide path, If you start with a lower equity allocation, let's say like 40%, and then increase it every year during retirement, and that will actually significantly raise your withdrawal rates. And the reason is a little bit of a mystery, but their theory is, well, and I agree with it, is that probably because if you encounter a bad bear market early in retirement and you have a lower equity allocation, you're not hurt as badly.

19:36And that's the most critical period. Later on, you're increasing your equity allocation into a stock market recovery, which is ideal. It's no surprise. That's the takeaway here. Everything you're saying makes sense. Those initial years during retirement, we've got to be really thoughtful about how much risk we take on. Here's a really easy way to do that. Be more conservative early on. Take more risk later when it's less impactful. In your research, you show that even in a worst case scenario, implementing a rising equity glide path looks like it could improve returns by 0.15%. That's$1 ,500 a year more in sustainable spending for a million dollar portfolio.

20:15Yeah. And, you know, I'm trying to help people squeeze every last dime out of their entire rent savings. So that's important. So as someone who specializes in working with do-it-yourself investors, my concern is always the complexity of any investment plan. And certainly, I love the takeaway of, hey, if we do this strategy, we're going to have more money for folks to spend over their lifetime. The challenge for me, though, is I often find that for the most part, do-it-yourselfers really aren't maintaining their portfolio. They're not even doing their annual rebalance. I'm curious, any guidance or suggestions for how do-it-yourselfers can successfully implement a rising equity glide path themselves?

20:57It requires a little bit of work. You know, each year you have to adjust your portfolio, your equity allocation upwards. I don't think it's a huge amount of work, but it all depends on how comfortable you feel with numbers. Some people have a greater level of comfort than others. For me, it's a second language, so I can't speak for everybody. But there are certain things you have to redo. you know, to maintain that performance. And then related to that topic is rebalancing. You note in your book that not rebalancing is not the same thing as creating a rising equity glide path. That's to say, when you put in this rising equity glide path strategy, you can actually spend more money over time.

21:39But if you don't rebalance, you're probably looking at spending less money over time. Yeah, that's right. The rebalancing is an orderly process that I can test the effects of easily. But just letting your portfolio grow without weeding the garden, so to say, is counterproductive. Your stock allocation may rise too quickly and get yourself into dangerous territory. I think that's a really important takeaway, again, especially for the folks that I find that I'm working with, because sometimes rebalancing just isn't done. And so that's to say, if you're delaying rebalancing for whatever reason, maybe because you want to defer taxes or maybe because you don't necessarily want to sell high and buy low, understand the opportunity cost is that that might mean, at least according to looking at what has happened in the past, that could mean spending less money in retirement.

22:35Yes, which is not desirable. You also looked at optimum strategies for rebalancing, concluding that annual rebalancing, doing it once a year, as a good option. Yeah, I think once a year is pretty close to optimal. It really varies upon the individual retirees' experience. There are some retirees who would have done better rebalancing every three or four years. Some would have been better balancing every quarter. Almost nobody benefits from not rebalancing over the course of their retirement. But I use the one-year rebalance because it seems to strike a good medium, get you a good withdrawal rate without taking unnecessary risks.

23:17All right, let's talk about cash. Now, lots of folks, especially retirees, they like having a cash bucket. And the idea here is, hey, I don't necessarily want to sell stocks when they're down. I want to spend cash instead. Now, certainly there can be a behavioral or a psychological component for that. And you talk about that in the book. But if you want to be a real nerd about it, if you want to be a real optimizer, you note that having cash, having a cash part of your portfolio ultimately decreases the amount that you can spend sustainably. Cash is a low returning asset. It's the lowest returning asset of all the ones I use.

23:56So if you allow it to become too large for the portfolio, it'll drag down returns and take withdrawal rates with them. Yeah, certainly folks really like having the idea of just having cash for that bear market. But you address exactly this in your book, writing, Why didn't the Great Depression, with its nearly 90 % stock market drop, have a bigger impact on portfolio longevity? And you're right. Inflation must be considered on par with stock bear markets as a determinant of the success of a withdrawal plan. If maximizing withdrawals is paramount to you, you might choose to forego treasure bills or cash and invest your entire fixed income allocation in bonds.

24:41Yeah, and that would generate the highest overall return for the portfolio and probably give you the highest withdrawal rate. And not probably. I know that for a fact. But, you know, I don't have any problems with folks looking to have some cash. If it keeps them on plan, that's so important. And I use 5 % in a lot of my research. That's probably roughly your expenses. You know, if you were drawing 5%, that would be your expenses. That's usually good enough to get you by the worst of most bear markets with some exceptions. But you don't want to have an excessive amount. I personally, I don't use anything near 5%.

25:22I use about less than 1 % cash because I find that's perfectly adequate. And I have it constantly replenished from the dividends and interest paid by my mutual funds and ETFs. So it's important to keep that cash reserve at a certain level. And Bill, I totally agree with you. I think if a cash bucket is going to help someone stick with their investing plan, they are going to have my blessing. We kind of owe the idea to Harold Avinsky, who was probably called the Dean of Financial Planning years ago. He came up with that whole bucket concept, a bucket of cash and then your portfolio. And I think it was a brilliant idea and it makes a lot of sense.

26:03Yeah, huge psychological benefit there. And also a very personal decision. I can think of a family that I worked with once, a gentleman. He had a software company, sold it, had a huge liquidity event, right? Had millions in cash and now he's figuring out what to do next. So take some, invest it for the long haul to provide for living expenses. But then also, he ultimately settled on having a$1 million cash bucket. Now, objectively, that's a large amount of money for him. It made sense relative to his net worth. But man, just having that much cash gives you a lot of peace, right? Helps you sleep at night, even if it's not the most optimized way to invest.