The Father of the 4% Rule Says Retirees Can Withdraw Much More

0:05The father of the 4 % rule says 4 % is likely much too low. You're listening to the Saturday Personal Finance edition of Motley Fool Money.

0:21I'm Robert Brokamp and this week we're going to do things a little bit differently. We're going to forego our last week in money and get it done segments and just feature a guest interview. And that guest is none other than William Bangan, the financial planner whose research established 4 % as the safe withdrawal rate in retirement. Bill and I talk about his new book, Why Most Retirees Can Withdraw More Than 4%, how factors such as market valuation and inflation affect the safe withdrawal rate, and whether retirees should decrease or increase their allocation to stocks as they get older. If you ask the typical investor how much someone can safely withdraw in the first year of retirement, the answer they'll likely give is 4%.

0:59That rule of thumb has been around since 1994, thanks to the research report published by a financial planner named William Bengen. Over the subsequent three decades, Mr. Bengen has done a lot of additional research, which he has summarized in his excellent new book, A Richer Retirement, Supercharging the 4 % Rule to Spend More and Enjoy More. Bill, welcome to Motley Fool Money. Hey, thanks for inviting me. I'm looking forward to it. We're looking forward to it. Let's start with a little bit of your history. You got a degree in aeronautics and astronautics from MIT, but instead of working in the space industry, you joined a family-owned soda bottling business and eventually became the president.

1:36The company was sold in 1987, and you started a whole new career in your 40s as a financial planner. So what led you to the financial planning profession and then eventually your research into withdrawal rates? Well, I never used a financial advisor, and there's still a new concept at that time. And I figured that if I was going to have to deal with a lot of this stuff, it wouldn't hurt me to learn about it. And then once I've learned it, perhaps then offer my services to others to give advice. And this seemed like a very appealing feel to me, because it's an area where you can make a difference every day in people's lives.

2:14And then from there, you had to determine a lot of your clients were boomers, not quite yet in retirement, but getting close. I'm sure they asked you, all right, how much can I spend in retirement? You looked for an answer and you couldn't find one. Yeah, I looked through all the literature. You know, it's not like today where we go on the Internet, type in a few words and there's thousands of sources of information. Back then, it was a library and talking to friends and associates. And nowhere could I find the answers to the questions. Probably not surprising since that issue really hadn't been of importance up until the early 90s when people were starting to live longer in retirement.

2:56And the baby boomers would think of living into their 90s. Unheard of. Back in the 50s, you'd retire at 65. And 10 years, you'd die. And that was it. But when you live in 85, 90 or more, it creates a whole new host of issues. So you fired up your Lotus 1-2-3 spreadsheet, bought some data, figured it out. Yeah. And your initial research found that the safe maximum withdrawal rate, which you call the safe max, was 4.15%. Then you moved it up to 4.5 % after doing additional research that you published in a book in 2006. So it's been above 4 % really since the beginning. yet the term 4 % rule has stuck.

3:38It is now widely referenced. So what was it like to see your research become so well-known, but also be given a name that's kind of outdated and doesn't really quite capture all the nuance and depth to your research? Yeah, it kind of led to mixed feelings on my part. It was fun to see my name out there and associate with this research. I had no idea what to expect. But the 4 % rule, as it's been formulated, applies to such a small number of retirees. Almost every other retiree can aspire to take out more than that and should look at that. They should not adopt that off the cuff to start their planning.

4:19So with your recent research, you have moved up the safe max to 4.7%. What are the biggest factors that have resulted in your increasing the number over the years? Primarily, I've made my portfolios more sophisticated. I started out with just two assets, all up to seven assets now. Probably still not what some would consider a well-diversified portfolio, but it's getting there. Probably means my research still understates the true withdrawal rate by a little bit. I suspect the number 4.7 could eventually become 5 if you throw in gold and commodities and emerging markets and alternative investments.

4:58And Bitcoin, digital currency, who knows what can go in the portfolio today. As you point out, the safe max of 4.7%, it's almost like a worst case scenario. It would have survived the worst conditions since 1926. And as you say, the majority of retirees would have been able to take out more, in some cases, much more. So what would have been the withdrawal rates if you look at maybe like an average case scenario or even maybe a best case scenario? Sure. Along across 100 years of retirees, the average has been a little bit over 7%, which surprises people a lot because they're stuck on a 4 % rule.

5:37And all of a sudden, 7 % is an average. And there are people who are able to take out double digits. Of course, if you retire in July of 1932 and the stock market goes off 100 % the next quarter, you're off to a very good start with your retirement plan. That's what happened. That's where people got 15%, 16 % withdrawal rates. Not realistic to expect anything like that today, but I think we can do a lot better than 4.7 % in this environment. You just found out that your sales team is at risk of missing quota. Don't panic. Just ask Rippling AI. Since it's built on your real-time people and business data, Rippling AI can pull metrics from Rippling and Salesforce into a meeting-ready dashboard showing quota attainment, headcount plan, and monthly revenue to quota by region.

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7:01That's R-I-P-P-L-I-N-G dot A-I slash F-O-O-L. Sign up for exclusive access today, rippling.ai slash fool. In your book, you do provide success rates of other withdrawal rates. So withdrawing 5.5 % did not deplete a retiree's portfolio in 90 % of historical periods. A 6 % withdrawal rate was successful 75 % of the time. And as you point out, a 7 % withdrawal rate was about the average, so around a 50-50 success rate there. What you've done more recently is try to find clues that would help retirees determine whether they could take out more than 4.7 % and enjoy more of their money in retirement, and also when they should play it safer.

7:43And you eventually came across the research of financial planning expert Michael Kitsis, who documented a relationship between stock market valuations and the SafeMax. Tell us about that. Yeah, Michael's a good friend and a brilliant guy. And back in 2008, he published in his newsletter a chart which tracked the valuation of the stock market using the Shiller capes, a quickly adjusted PE ratio against withdrawal rate on the other end of it. And when you take a look at those two charts, they seem like when one's going up, the other goes down. One of the things you pointed out in your book is that generally speaking, if the market is cheap, it's going to do OK.

8:36You point out that there was only really one bear market when the stock market was cheap. That was in the early 80s when Paul Volcker, the Federal Reserve chairman, raised rates to bring down inflation. Whereas when the market is expensive, you're more likely to see a bear market, which, of course, can be very rough on your retirement. As a good example of that, the person retired at the bottom of the market after the great financial crisis back in April of 2009, my calculations indicate they could have taken out 8 % because the stocks were so cheap at that time. And that's the cheapest they've been over the last 30 years.

9:12We haven't approached that since. So you found that market valuation was helpful. Not a perfect predictor, though, whether a retiree could enjoy a higher safe max. So then you moved on to researching whether inflation at the start of retirement was the most important factor. What did you find? Well, I knew from the beginning that inflation had a role to play because the worst case scenario, the 4.7%, was generated by the person who retired in October of 1968. And they hit two bear markets back to back, deep ones, and then got hit with very high levels of inflation for over a decade, which forced them to increase their withdrawals.

9:49You would think, though, that 1929 to 1932, where the stock market dropped twice as much, would have been worse. But it wasn't because it was a deflationary period. Actually, you were able to reduce withdrawals by 10 % a year. And that offset the huge losses in the stock market and made 1968 the worst case, not 1932. You provide in your book some what you call safe max finder tables based on three inflation regimes, low inflation, middle inflation, high inflation. And then once you determine which inflation regime you're in, then you look up the CAPE ratio. And that gives you a hint of what could be your safe max, although you point out in the book there are other factors to consider and we'll touch on some of them.

10:32But when you look at that chart, it implies that withdrawal rates could be as high as 6 % or 7%. And that might be surprising to a lot of people. Yeah, it could be. I think in today's environment, I'd probably be recommending something around 5.5%, which is low historically compared to the average, but it's a lot better than 4.7%. It's about 15 % to 20 % higher, which ain't chicken feed. And we're in a medium inflation environment. But I'm assuming you recommend that withdrawal rate because the CAPE is so high at this point, about the second highest level it's ever been. Yeah. And of course, if the inflation rate were to take off and we're going to a period like the 70s, that would reduce withdrawal rate significantly.

11:18Don't know what's going to happen in that picture. It looks like for the time being, inflation is at a reasonable level. But who knows? These days, I think there is more awareness of the impacts of a bear market, maybe right before retirement, but especially right after retirement. And your research bears that out. So tell us about why what happens in that first decade of retirement is so important. Sure. Well, if you encounter a stock bear market early in retirement and your portfolio drops 30 % compared to another portfolio, which might have been making gains, you're behind the eight ball and you never really catch up.

11:56So that early stock market declines, reduced withdrawal rate very significantly. If you have a bear market, say, in your 20th year of retirement or 25th year of retirement, at that point, your research indicates that's, of course, not great, but chances are you're still going to be OK. Yeah. Usually by the first 10 to 12 years, the die is cast as far as your withdrawal plan goes. the success withdrawal plan, all is owed primarily to events occurring in the first 10 to 12 years. There are exceptions. People retired in the late 50s into a low inflation environment, and within a decade, they were facing very high inflation and had to scramble to get back to plan.

12:39So events mid-retirement, if they're severe enough, can affect the withdrawal rate, but not as much usually as the early ones. Your book describes how a personal withdrawal plan can be developed by choosing various options among what you call eight elements. There are two other elements, which we just discussed, valuation and inflation. And then there are eight elements. We won't discuss all eight in this podcast. But the first is your withdrawal scheme, right? You discuss a few in your book. Tell us generally about how a retiree might use guidelines to maybe take out a little bit more if the portfolio is doing well, but maybe cut back if the portfolio declines.

13:16You know, you can do those kinds of adjustments. I think a lot of people just do that naturally. So I'm not going to try to fight that. I think it makes sense if your portfolio is under stress due to inflation or a bear market, that you want to take a cautious stance, cut back a little bit on spending, temporarily at least, and just wait and see how bad the situation becomes. Another important element is time frame. Your base case assumption is a 30-year retirement. So someone who retires at 65 would assume they live to 95, which I think is in the neighborhood of what most financial planners recommend.

13:55What about people who are retiring sooner, maybe in their 50s, maybe a little sooner? Or what if they're already in their 70s or older? Sure. The withdrawal rate is very sensitive to the planning horizon. So if we use 30 years as kind of a midpoint standard, 4.7 % is the associated withdrawal rate. If you were to, let's say, have a 10-year horizon, your withdrawal rate would probably be around an 8%, believe it or not, because you only have 10 years to deal with, and you shouldn't have a lot of stocks probably at that point. one of the interesting features of the planning horizon is that the withdrawal rate drops as the length of the planning horizon increases but eventually reaches a point where it doesn't decline anymore it kind of reaches the floor and uh for the 4.7 percent rule let's say a 60 year would be uh 4.1 percent and it wouldn't get much lower than that for 80 90 100 years as far as i can tell.

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16:07You also looked at how asset allocation affects safe withdrawal rates. And you kind of settled on a sort of a base case allocation for a lot of your illustrations, your book, 55 % stocks, And those stocks are allocated amongst five asset classes, large caps, small caps, mid caps, micro caps, and international. Then 40 % intermediate government bonds and 5 % T-bills. Generally speaking, though, how does asset allocation, especially the stock and non-stock split, affect withdrawal rates? There's a certain minimum percentage of stocks you need to have in your portfolio to get the highest withdrawal rate you can.

16:45However, if you try to raise stocks to too high level, it may be counterproductive because during a major bear market, your portfolio could lose 50 % or more. And that's tough to come back from in any reasonable time frame. So, you know, that's the nature of the beast. So a good range is around what? What would you say is a minimum stock allocation and then maybe a maximum that most people would be appropriately used? I think most people can handle at least 50. And I'm doing research right now that indicates that it may be better to have more than 55-40. Maybe we should be at 65. I read a model right now at 65 % stocks, and it's generating higher withdrawal rates than it would have been under my earlier analysis.

17:35So I'm still learning here. And as soon as I get a conclusion, I will pass it along. But I think higher stock allocations are probably beneficial. You just have to be careful. You don't want to have a stock allocation when you retire and you know you're going to have a big bear market or likely to have one. You know, probably best be a little conservative. And then after the smoke clears, go to your higher allocation. I thought one interesting insight from your book was that you include the safe withdrawal rate for a simple two-asset portfolio of bonds and large-cap stocks. And the safe max really starts to tail off at allocations above 75 % stocks.

18:12But then when the stock allocation is more diversified with five categories of stocks, not only does it boost the safe withdrawal rate, but the drop off beyond 75 % isn't nearly as sharp. It's an excellent illustration of the power of diversification. I think you're absolutely right. I should point out, too, that you also examined the allocation between cash and bonds. And in your case, bonds were intermediate term government bonds. And there's a pretty linear relationship between that cash bond split and the safe withdrawal rate, right? The more cash equals a lower rate. That's right, because cash doesn't pay much.

18:50It's not very volatile. But today, it's better than it was, let's say, five, six years ago when it was paying practically zero. But you're not going to get a good withdrawal rate having a lot of money in an asset generating just 4%. Let's move on to portfolio management. You looked at how often retirees should rebalance their portfolios, but also whether they should be decreasing or increasing their stock allocations over the course of their retirements. Let's start with the rebalancing question. How often do you think folks should be rebalancing, which is basically, you know, moving back your portfolio to some sort of originally intended allocation?

19:30Yeah. To a certain extent, it depends upon the retiree circumstances, whether they retire into a bull market or a bear market. But overall, looking across all 400 retirees I study, a period of about one year seems to be optimum. It may not always generate the highest withdrawal rate, but we don't know in advance what rebalancing interval will generate. So one year seems to work pretty darn well in the vast majority of cases. Talk a little bit about your analysis of whether people should be decreasing their stock allocation as they go through retirement or whether it actually makes sense to increase their allocation to equities.

20:12Yeah, I tested a scheme that was developed by two fellow advisors, Wade Pfau and Michael Kitsis. Back about 10 years ago, they published a paper in which they investigated, starting with a low stock allocation, let's say 30%, 40%, and then increasing it 1 % or 2 % a year during retirement. And their conclusion, surprisingly, was that that had a beneficial effect on withdrawal rates. It gave them a bump. It wasn't huge, but it was significant, worth considering. I suspect, and their conclusion is correct, that the reason this pierced counterintuitive thing seems to work is that because when you're in a bear market early in retirement, you're going to find out a lower stock allocation is beneficial.

20:57You will lose less. Meanwhile, after the bear market is over, you're increasing your stock allocation. You're buying stocks aggressively into a rising market, which can only help you. Let's move on to our final question here, Bill. You are an internationally recognized retirement expert, but you've also been retired yourself for more than a decade. So how's it going? Were there any bigger surprises? And do you have any recommendations, financial or otherwise, for those who are preparing to make the transition from work to retirement? Well, I'm really enjoying retirement. I went into the mindset that there are four things that are important.

21:34Family, friends, your health, and passions, hobbies, interests. If you cultivate all four of those, not only during retirement, during your whole life, I think you'll have a very successful life and a very satisfying one. but I find once you let one lapse, it starts to affect the quality of your life. That is excellent advice. You know, Bill, I first interviewed you almost 20 years ago and ever since I've peppered you over the years with so many random questions and you've always replied with thoughtful responses. So I'd just like to thank you personally for being so generous with your research over the years and to congratulate you on the new book.

22:16I highly recommend it. Thank you so much for joining us. My pleasure. Thanks for inviting me. And that's the show. As always, people on the program may have interest in the investments they talk about. And The Motley Fool may have formal recommendations for or against. So don't buy or sell investments based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. I'm Robert Brokamp.

22:48All on, everybody.