• Basic Membership Access to Journal, Shadow Stock portfolio & monthly updates for stock screens
  • A+ Investor Full access to AAII.com, Journal, and a power data suite for investment ideas
  • AAII Platinum Full access to all of AAII's model portfolios and premium services at a significant discount
  • Dividend Investing Newsletter and model portfolio that focuses on dividend growth
  • AAII Growth Investing Find secular growth stocks poised for outperformance regardless of macroeconomic conditions.
  • Retirement Investing Discover trusted strategies for every stage of retirement. Get actionable insights and resources for smart retirement planning.
  • Sentiment Investing A research-driven newsletter with 10+ signals decoding sentiment across retail and institutional behavior.
  • Stock Superstars Report Get stock ideas inspired by the market's leading professionals
  • VMQ Stocks For the value investor looking to harness academic research in an actively managed portfolio
  • Bits and Bips Newsletter delivering insights on linking traditional finance, macro trends and cryptocurrency opportunities to help investors build stronger, more diversified portfolios.
All premium products come with free basic membership.
Explore All Membership Options
Join Now
Dispatches Retired Investor

FIRE Followers Need to Adjust the 4% Rule

Withdrawing 4% from retirement savings and then increasing that amount during each subsequent year of retirement is not appropriate for all retirees.

by Jack Gilleland | September 2021

Withdrawing 4% from retirement savings and then increasing that amount during each subsequent year of retirement is not appropriate for all retirees.

The so-called 4% rule, developed by William Bengen, is based on a retiree having a 30-year retirement horizon. Those facing a longer retirement may need a more conservative withdrawal strategy.

By reducing management costs, diversifying to include international assets and adjusting spending dynamically, the probability of a retiree successfully not exhausting their savings can be improved.

Investment strategists with Vanguard reached this conclusion after seeking to improve the probability of retirement savings lasting long enough for followers of the Financial Independence, Retire Early (FIRE) movement.

The dynamic spending approach increases or decreases spending based on market conditions. When down markets occur, spending is constrained, reducing the dollar amount of needed withdrawals. When the portfolio performs well, spending—and the size of withdrawals—is increased. This approach is paramount to stabilizing and protecting a retiree’s portfolio to increase the probability of success. (See “Vanguard’s Dynamic Spending Strategy for Retirees” in the January 2017 AAII Journal.)

Reducing fees, mainly by using exchange-traded funds (ETFs) and mutual funds with lower expense ratios, can increase the probability of success. By reducing the expenses on a portfolio from 1% to 0.2%, the probability of not outliving one’s savings over a 50-year retirement horizon increases by 20.2%. Lower expenses equate to higher returns, which are then compounded. The 0.8% difference in expense may seem insignificant, but long term it can have a huge impact on a retiree’s portfolio.

Increasing the diversification of assets—not just between bonds and stocks, but also between international and domestic assets—also helps. The study found that when relying on only domestic assets, investors have a 36% probability of success. Whereas when international assets are included, the probability shoots up to 56.3%.

The Vanguard strategists note that while their analysis focused on longer retirement spans, the concepts are appropriate for most investors to help improve and secure their returns for the future.

Source: “Fuel for the F.I.R.E.: Updating the 4% Rule for Early Retirees,” Paulo Costa, Ph.D., David Pakula, CFA, Andrew S. Clarke, CFA; Vanguard, June 2021.


Discussion

ROBERT A from NC posted over 4 years ago:

What about a simple 5% withdrawal (no inflation adjustment) of the average of the ending balances of the preceding 3 years? With such a withdrawal rate, an investment in the S&P500 could never go to zero unless there was a sudden decline of about 95% in the value of the index -- and you continued withdrawing money. I backtested this idea with S&P500 data going back to 1928. There was no 30-year period in which the portfolio value did not increase. Sure, there were some meager returns back during the depression, but nearly everybody else was living on meager rations during that time too. My theoretical 1928 portfolio of $100,000 would have grown to over $7.7 million today with this year's withdrawal exceeding $300,000. Total withdrawals over all the years were nearly $6.5 million. Anyway, I think any withdrawal rule ought to be based on a percentage (of the recent portfolio value -- not its original value) with no inflation adjustment. Market declines would be like periods of unemployment or salary cuts during your working years -- you just have to tighten your belt. Market increases (and accompanying increases in withdrawals) should more than make up for inflation.


You need to log in as a registered AAII user before commenting.
Create an account

Log In

Get your free copy of our special report analyzing the tech stocks most likely to outperform the market.
Download the FREE Report Here: