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“The 4% Rule is now the 5% Rule”
A financial expert named Bill Bengen, who created the famous 4% Rule, has a new book called A Richer Retirement: Supercharging the 4% Rule to Spend More and Enjoy More. The 4% Rule was a game-changer for retirement planning because it gave people a simple way to figure out how much they could safely spend from their savings each year.
The rule works like this: you start by withdrawing 4% of your total portfolio in the first year of retirement. For example, if you have a $1 million portfolio, you would withdraw $40,000. In each following year, you adjust that amount for inflation. So if inflation is 3%, your next withdrawal would be $41,200. Bengen’s original research, which looked at a portfolio with 50% stocks and 50% bonds over a 30-year period, found that no one who followed this rule would have run out of money.
The 4% Rule Is Now Too Conservative
In his new book, Bengen reveals that the 4% Rule is no longer the best advice for today’s retirees—not because it’s too risky, but because it’s too safe. He found that with updated market data and a more diverse portfolio, retirees can actually afford to take out more than 4%.
To get to this new number, Bengen expanded his research beyond just a simple portfolio. He included a variety of asset classes like small-cap stocks, mid-cap stocks, international stocks, and U.S. Treasury bills. He also slightly tweaked the portfolio to have a higher percentage of stocks (55%) and a small amount of cash (5%). The result? The safe withdrawal rate increased to 4.7%. This shows how diversifying your investments can help your money last longer and allow you to spend more.
Why a 5% Withdrawal Rate Is Possible
The author of the post suggests that while Bengen’s research points to a 4.7% withdrawal rate, a 5% rule is achievable for many retirees. The argument for this higher rate is based on two key ideas:
- Bengen’s research is sound. The updated data and more diverse portfolio truly make it possible to withdraw more without running out of money.
- Flexibility is key. The 5% rule works if you are willing to be flexible with your spending. For example, if the stock market takes a big dip, you might put off a major trip or hold off on a large purchase. This small change in behavior can make a big difference and allow you to take out more money over the long term.
For anyone planning for retirement, this change has huge implications. Instead of saving 25 times your desired yearly spending (the old rule), you might only need to save 20 times that amount. For someone who wants to spend $100,000 a year, that means needing to save $2 million instead of $2.5 million—a difference of $500,000.
Ultimately, the message of Bengen’s new book is that many retirees may be underspending and can afford to enjoy their wealth more, especially while they’re still healthy enough to do so. This is a powerful idea that could change the way people plan for their future.
The Genesis and Legacy of the 4% Rule
To fully appreciate the significance of Bengen’s new findings, it’s helpful to understand the context of his original work. In the mid-1990s, the concept of a “safe withdrawal rate” for retirement was a topic of much speculation and debate. Before Bengen’s groundbreaking research, financial advisors and retirees alike relied on guesswork or overly conservative assumptions, often leading to a fear of running out of money. This fear frequently resulted in people living far more frugally in retirement than they needed to, leaving large sums to heirs or simply unspent.
Bengen’s research provided the first empirically-backed framework for retirement withdrawals. He simulated a wide range of historical market conditions, going back to 1926, to determine the highest initial withdrawal rate that would survive a 30-year period. The result was the 4% Rule, which offered a straightforward and reliable benchmark for financial independence. The rule wasn’t about what a portfolio could do on average, but what it would do in the worst-case historical scenario.
The Evolution of Financial Planning
A lot has changed since the 1990s. The financial landscape has evolved, and the available data has expanded. This is the central premise of Bengen’s new book. He recognized that his original research, while revolutionary, was based on a limited set of asset classes and historical data. By expanding the scope of his analysis, he was able to provide a more accurate and generous guideline for today’s retirees.
The key to the new 4.7% rule is diversification. Bengen’s new simulations don’t just include U.S. stocks and intermediate bonds. He incorporates small- and mid-cap stocks, international stocks, and U.S. Treasury bills. The inclusion of these additional asset classes, which don’t always move in lockstep, helps smooth out overall returns, which allows for a higher withdrawal rate.
The author of the article takes it a step further to a 5% rule. The crucial caveat is dynamic spending. The original 4% rule assumes a retiree withdraws the same inflation-adjusted amount every single year, like a robot. But in reality, people are much more flexible. During a year when the market is doing poorly, a retiree can choose to reduce their spending, perhaps by delaying a home renovation or a major trip. This simple act of flexibility has a profound impact on the longevity of a portfolio.
You can see a summary of these results (with Bengen’s improved portfolio) in the chart below. The chart shows the percentage of retirees that did not run out of money over 30 years based on initial withdrawal rate (given Bengen’s revised asset allocation). As you can see, not a single retiree ran out of money with a 4.68% withdrawal rate (which Bengen rounds to 4.7%):
The implications are clear: saving for retirement just got a little easier. Instead of needing $2.5 million to spend $100,000 a year, you might only need $2 million. This difference could mean retiring years earlier or simply enjoying a more comfortable lifestyle. This shift in thinking is not just about numbers; it’s about a fundamental change in how we approach the end of our working lives. It’s a call to move from a mindset of scarcity and fear to one of abundance and confidence, allowing people to truly live out their “richer retirement.”
“These are the opinions of Tony Van Gelder and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice.”