The John C. Bogle Center for Financial Literacy is pleased to sponsor the 35th episode of Bogleheads® Live. In this episode Bill Bengen, financial planner and creator of the 4% rule of thumb, answers questions regarding retirement withdrawals from investment portfolios.
Bill Bengen
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Jon Luskin: Bogleheads® Live is our ongoing Twitter Space series where the do-it-yourself investor community asks their questions to financial experts live on Twitter. You can ask your questions by joining us for the next Twitter Space. Get the dates and times for the next Bogleheads® Live by following the John C. Bogle Center for Financial Literacy on Twitter. That's @bogleheads.
For those that can't make the live events, episodes are recorded and turned into a podcast. This is that podcast.
Thank you for joining us for the 35th Bogleheads® Live, where the do-it-yourself investor community asks questions to financial experts live.
My name is Jon Luskin, and I'm your host. Our guest for today is Bill Bengen.
Let's start by talking about the Bogleheads®, a community of investors who believe in keeping it simple, following a small number of tried-and-true investing principles.
This episode of Bogleheads® Live, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a 501(c)(3) nonprofit organization dedicated to helping people make better financial decisions. Visit boglecenter.net to find valuable information and to make a tax-deductible donation.
Speaking of donations, you have a few days left to get your donations in before the end of the 2022 tax year. That's boglecenter.net/donate.
Before we get started on today's show, a disclaimer. This is for informational and entertainment purposes only, and should not be relied upon as the basis for investment, tax, or other financial planning decisions.
Let's get started on today's show with Bill Bengen. Bill Bengen is a retired financial advisor who first articulated the 4% withdrawal rate as a rule of thumb for withdrawal rates and retirement income. It is known as the Bengen Rule.
Bill Bengen, thank you for joining us today on Bogleheads® Live. Let's jump to our first audience question from Javier.
Javier (audience #1): I've been testing different portfolios, and I realize that usually adding an amount of gold lets you withdraw more money when you retire. According to the backtest, you could withdraw 4.5% or 5%. How much can we rely on the past to foresee the future?
Bill Bengen: Yeah, that's a great question, Javier. I've always warned when I've written articles that my research is based upon historical precedent, but that the future could be different from the past. And it's possible that right now we're entering something that might be different from the past.
My 4% rule was actually based upon a worst-case situation. An investor who retired in October of 1968 who ran into just a terrible, perfect storm of bad stock market results and very high inflation, which forces withdrawals up every year.
Are we in a similar period beginning with this year with very high inflation and potentially low stock market returns? Entering something even worse? I don't know, unfortunately. And we won't know for quite a few years. But I think it's serious enough that investors perhaps should be a little bit more conservative, perhaps plan as if this is a new situation and maybe take a little bit less than the original of what the rule suggests.
My rule, by the way, has been updated to 4.7%. So, it's no longer the 4% rule as my research included a lot more asset classes, which increased returns. But perhaps investors might consider taking 4.5% on this time retiring until the smoke clears when we get a better idea of where inflation is going. Inflation is the big wild card in this current environment.
Jon Luskin: This one is from username ‘Lawrence of Suburbia’ who writes: “Is the 50% to 75% stock allocation still required for the 4% rule to work?”
Bill Bengen: My original research specified a pretty wide range, 50% to 75%, as I started adding more asset classes. I started with US large cap stocks and intermediate term treasuries. Since then, I've entered mid cap stocks and small cap stocks and international stocks and treasury bills. As you increase the number of assets, the window has been getting narrower, primarily because some of the volatility of some of the assets involved, since the small cap and micro-cap stocks.
I would recommend now, the optimum if you want to get the most out of your portfolio, the highest withdrawal rate, consider somewhere between 55% and 60% of your portfolio in equities. If you have much less than that in equities, the portfolio will not generate enough return to give you a good withdrawal rate. If you have much higher than that, the volatility of the portfolio will also reduce withdrawal rate. It's a sweet spot, which is pretty narrow on there, about 55%, 60%.
Jon Luskin: That certainly makes sense. As you add in those more volatile assets, that's going to impact how much you can take out sustainably because you want to avoid selling low. You have more volatile assets, that's more stocks you're selling low, that's going to impact your rate of return. Holding fewer stocks, that manages that risk.
This one is from username ‘nigel_ht’ who writes: "Does the 4% rule still work?"
Bill Bengen: The 4% rule has been in effect for over 50 years. That's the longest period of time that a particular withdrawal rule has remained in place since 1926. It's declined a bit. It started higher and then came down.
Are we going to enter a period of time in which we'll have to reconsider and reduce to withdrawal rate? I honestly don't know. And we won't know for considerable amount of time.
I just recommend folks be a little conservative now until we sort out where inflation is going. If it just lasts for a few years, it may not do permanent damage to a withdrawal rate. But if this goes on for a decade, 5%, 6%, 7%, going to have to take a look at a new era, so to speak.
Jon Luskin: Bill, when you say let's be a little conservative with respect to that distribution rate, does that mean 4%? Does that mean something less? What does that mean for you, being conservative right now?
Bill Bengen: Well, if my current research says that the rule is 4.7%, and when I say rule, I mean a specific situation where you're looking to get 30 years out of your money and you withdraw from something like an IRA account, and you're willing to have zero money in your account with your last breath, then I think 4.5%. A couple of tenths less than that would for me be a sufficiently conservative attitude to have at this point.
I don't see any reason for a wholesale reduction, like down to 4% or 3.5% or even less. I heard some other folks suggest those numbers. Just too pessimistic, it seems to me, in terms of what investments will produce in the future.
Jon Luskin: Looks like we've got Andre who has a speaker request.
Andre (audience #2): I'm definitely curious your thoughts on how workers in their thirties that are pursuing 60-year early retirement plans should be thinking about the 4% rule and how they should adjust that appropriately.
Bill Bengen: My research indicates that as the retirement period lengthens you have to reduce your withdrawal rate. Based on history anyway. 4%, though, from a tax-deferred account should be great for a 60-year or 80-year or 100-year or even longer period investment.
Jon Luskin: Jon Luskin, your Bogleheads® Live host jumping in for a quick podcast edit. For clarification here, Bill Bengen says you've got to decrease your withdrawal rate for longer periods down to 4%.
Earlier in our conversation, Bill told us that the long-term sustainable withdrawal rate has increased to 4.7% given the addition of micro-cap stocks to a portfolio. So that sustainable withdrawal rate baseline is now 4.7%. And then as that timeline increases that 4.7% drops down to 4%. And now back to the show.
This one is from username, ‘firebirdparts’, who asks about that worst case, and you mentioned that just a few moments ago, Bill. That's October 1968. A period of high inflation. And ‘firebirdparts’, he wants to know were there several worst cases and what does that specific worst case teach us today?
Bill Bengen: Okay. Looking backwards from our vantage point, the worst case is October of 68. Of course, if you were, let's say, doing my work back in the fifties, you would've looked back probably to a period in the late forties. Maybe it's the worst case. And if even earlier, sometime in the late thirties. So, the worst case has progressed from 1926. And the last revision we've had to make is the October 68 investor. And for over 50 years from then, we have not faced conditions any worse than they did. So that rule has worked. In fact, that rule probably is too conservative for most periods of time.
Jon Luskin: The worst case has gotten worse over time. That is a fascinating takeaway. I can't help but wonder what that means for our current environment where stock valuations are relatively high and we've got temporary, at least for now, inflation. Could we be looking at a new worst case right now?
Bill Bengen: It's entirely possible, and if you take a look at it right now, if you use the Schiller CAPE – the cyclically adjusted PE ratio – as a guide for stock market valuations, we're at levels basically that the stock market was at back in October of 1929. And, you know what happened after that?
I don't think we're going to face another 90% decline as it did back then. But it's once again a reminder that despite the recent losses, stocks are still considerably overvalued and could have a lot further to go on the downside.
Usually a very high stock market valuation is a precursor to a bear market. Bear markets don't happen when stocks are cheap. They happen when stocks are expensive. Although it's possible that stock market valuations could remain high for a long time as they have here for the last five or six years.
Where the CAPE has been 30 or above. And historically it's very few times since it reached that level. But we've been at it for years. It's an uncomfortable time for those who are in retirement. I can tell you that personally because that's where I'm at.
Jon Luskin: Bill, you made an excellent point. Hey, stock market valuations are high, but that's not to say that they can't go higher.
Bill Bengen: Looks like we got a speaker request from Ricky.
Ricky (audience #3): Have you looked into how we would actually modify your 4% rule if you added TIPS, something that adjusts for inflation? And, if you have looked at it, what did your data find? Did the 4% rule really go up when you have something like an inflation hedge like TIPS?
Bill Bengen: Unfortunately, I can't find a database, that takes TIPS all the way back to 1926 where I start. I've got that for a lot of other asset classes, but TIPS are a relatively new development, so I haven't really been able to do any effective work with it yet.
I hope to start exploring that to see what's happened in the last 40 or 50 years. But I don't know how conclusive that research might be, given how short the database would be.
Jon Luskin: Absolutely. With TIPS being first issued in January of 97, it's going to be challenging to create some sort of synthetic database saying, hey, here's what you would've gotten if you invested in these things all the way back from 1926.
This question is from the Bogleheads® Forums, and it's related to the question we got from Andre.
“I'm 56. Is my sustainable withdrawal rate lower than if I was 66?”
Bill Bengen: The answer is assuming that you are going to live to about the same age - let's say 90 - yes, your withdrawal rate would be less. I did some computations about that which laid out the withdrawal rate for each retirement horizon. So, if 30 years is what we're talking about when we used the 4.7% rule, for let's say 40 years, I think it dropped down about two tenths less to about 4.5%.
And the longer time horizon is, as the FIRE people, we get closer and closer to 4% on the lower end.
Jon Luskin: This one is from username ‘Dcabler’ who asks: “What do you think of alternative withdrawal strategies?”
Bill Bengen: I've experimented with a lot of them, including taking out a fixed percentage of your portfolio every year. That just doesn't seem to work particularly well. Taking out a fixed dollar amount each year, which works better, but really hurts you if you get into a period of higher inflation.
And I've also experimented with, traditionally people feel that when they get into retirement, the first 10 years, they're going to spend more because they'll be traveling more just spending money on things that they might not be able to enjoy when they get into their eighties and nineties. You can establish a withdrawal rate for that. Let's say first 10 years you use withdrawal eight and then drop it down for the rest of retirement.
Caveat I have with that is that you're frontloading all your expenses, which diminishes your portfolio. And the more you diminish your portfolio, the less you have to sustain you for the years out further, later in retirement, so that the reduction of withdrawal rates may be surprisingly high.
If you want to start out with let's say 5.5%, you might end up with 3% or 3.5% for the last 20 years of retirement, and you'll have to decide whether that will really work for you or not.
Jon Luskin: It's certainly a cruel twist of fate and math that, hey, you're young at the beginning of retirement, you want to spend your money, you want to do all these things. But that's when it's most risky to spend the most amount of money.
Bill Bengen: Yeah, it is. Because effectively you're creating your own bear market.
Jon Luskin: Looks like Ricky has returned. I'm going to have Ricky ask another question.
Ricky (audience #3): Did you do any research in the bear market? Just draw down the bonds instead of just sticking to an asset allocation. Not touching your stocks until they come back to its previous level before the bear.
Bill Bengen: I assumed in my research, as do many investors, that the portfolio be rebalanced to its original allocation once a year. When I started looking, I started playing around with different rebalancing periods, intervals, and I learned that if you actually let the rebalancing interval run longer - 3, 4, 5 years - it can actually significantly add to your withdrawal rate. Up to as much as 0.25%. And the reason for that, of course, is that stocks tend to run in bull markets. They average probably about five or six years.
So if you rebalance too soon, which is annually, and you're doing it during a bull market, basically you're cutting off some of the returns your stocks would've earned and effectively reduced your withdrawal rate. I recommend looking at longer withdrawal rates and maybe do that with some kind of context of where you are in a bear market or a bull market.
Jon Luskin: To add some context to Bill's takeaway here, rebalancing less often has historically meant a higher sustainable withdrawal rate. And the reason is we've managed to increase our return by taking on more risk. If we're not rebalancing, we're taking on more risk, which might lead to a higher return and could result in a higher sustainable withdrawal rate in retirement. Yet if bull markets become shorter in the future, less than the average of five or six years as quoted by Bill just a moment ago, then the strategy of rebalancing less often may not necessarily increase a sustainable withdrawal rate in retirement.
Ricky (audience #3): I know you've commented before about adding something like small cap value, which can also boost the 4% rule. Are there any other asset classes that you have found like REITS, for example, can actually boost the 4% rule or maybe some of the other factors like profitability, or quality?
Bill Bengen: When I added US micro-caps in my last round of research, it did increase the volatility but significantly increased the returns of the portfolio and helped the withdrawal rate. That's what helped bumped it up to 4.7%. There are other classes I would like to look at, like gold and REITs, and once again it's a problem with finding databases that extend as far back as 1926 that I can reliably use.
I use now in my research seven asset classes, including cash, five in stocks, and treasury bonds. I think we're starting to approach closer to what a sophisticated investor would use in a diversified portfolio.
I don't think even if I start any more asset classes, I'm going to be able to increase our withdrawal rate a heck of a lot more. I think we're starting to reach the point of diminishing returns. We might get to 5%. I kind of doubt it. I'm going to try another round in a couple years and see if I can find some assets that I can add in.
Jon Luskin: This one is from username ‘er999’, who asks about a safe withdrawal rate that doesn't take an increase for inflation. How does a safe withdrawal rate change?
Bill Bengen: Okay, that's basically a fixed withdrawal rate or let's say a fixed dollar amount, probably each year, which is kind of like the old fixed annuity concept.
I ran those numbers and it comes out the withdrawal rate is higher. You can start basically about 0.5% higher than the withdrawal rate I've established for increasing with inflation. So that would maybe be about 5.2%. Would be fun at the beginning, but if inflation picks up, it's not so much fun later on. So that's the decision only the investor can make.
Jon Luskin: I can't help but think about some of the research on retiree spending that shows that spending does decrease partway through retirement and then ultimately increases later on for those long-term care expenses, those medical expenses. But as folks move from the go-go years, that's when spending decreases. In those circumstances, I could see how least part of a retirement cycle, that fixed distribution rate could make sense not taking that inflation increase, because your spending is actually decreasing on a real level. It's that last tail end where expenses increase for medical expenses that makes it not necessarily the best fit, that approach in that circumstance.
Bill Bengen: That's a good point.
Jon Luskin: Looks like we've got a question from Javier.
Javier (audience #1): I would like to know what role plays dividends into the 4% rule. If I have a portfolio that is giving me 2% in dividends, does it mean that I should just withdraw 2%, or does it mean that it would be like 4% and then the dividends would be 2% extra?
Bill Bengen: My methodology involves the assumption that investments generate a certain total return, a certain portion of which is from capital appreciation, another of which may be from dividends or interest, and that it doesn't matter too much where they come from, just that they exist.
I don't try to distinguish between the two. The 4.5% can be drawn from either, it doesn't make any difference. What counts for me is the total return of investments over time and not whether they generate a high level of current income or not.
Although, I will say that dividend paying stocks, a lot of folks like them, there is some merit to that because you have investments which pay a high level of income during retirement. Even though their value is declining, that income may support your withdrawals and prevent you perhaps from panicking and selling your stocks at the wrong time.
So there's something to be said for using dividend paying stocks as a certain comfort they provide.
Jon Luskin: Colleen Jaconetti, who was our guest on the 26th episode of Bogleheads® Live, Senior Investment Strategist over at Vanguard, made the exact same point that dividend investing can help folks stick with their investing plan.
This one is from username ‘Iamblessed’ who asks: "What is the maximum distribution rate without small caps?"
Bill Bengen: My original research was based on just using intermediate term treasuries - like five-year US treasury bonds - and large cap stocks. There were no small cap stocks, and that's where the 4% rule actually came from.
It's actually 4.1%. When I added the small caps in, it jumped from 4.1% to 4.5%, so that had a big effect. That's partly because they returned about 2% more than large cap stocks, and also their returns are not that strongly correlated with the returns from the large cap stocks. So, they really were an effective addition to the portfolio.
Jon Luskin: This one is from username ‘rgs92’ from the Bogleheads® Forums, who writes: “Now that yields on bonds are higher, does that justify a higher sustainable withdrawal rate? Does it matter if these yields are nominal versus real?”
Bill Bengen: I didn't change my withdrawal rate because of bonds declining yield, so there's no reason for me when they rise to change that. It's a comforting thing to happen because if you recall the last two bear markets, we had very, very low interest rates so that when stocks went into a bear market, there was very little alternatives to invest in. Cash was earning about zero. Very, very uncomfortable.
If I can say the word comfortable, this bear market to me, feels a little bit more comfortable to bear, because now you can invest your cash in things yielding 4%. 30-day CDs or treasuries of similar maturity. So, I'm really quite pleased by what's happened here, although I'm never thrilled by a bear market.
Jon Luskin: This question comes from username, ‘Young Boglehead’ who writes: "Have you ever known anyone to actually use the 4% rule for their retirement?"
Bill Bengen: Well, I do for one. And yes, I used it with a lot of my clients when I was in practice. And I do have friends and people I know who tell me they're using it. So yes, the answer to that would be yes.
Jon Luskin: Ricky is back to ask his question.
Ricky (audience #3): A lot of the FIRE folks will use the 4% rule, but like make it, oh my God, I'm retiring and I have a 50-year retirement. I should use a 3% rule. But my argument, and I always thought of this, is that if you already passed the sequence of returns risk, really do you have to lower the 4% withdrawal rule because, once you're past that first 5 to 10 years around your retirement, you should almost be guaranteed to last in perpetuity, based on your research.
Bill Bengen: With respect to the FIRE folks, I think 4% is a good, solid, conservative rate to use from a tax-deferred account over a very long period of time. Although quite frankly, even if you get through the first 10 years of retirement, it's no guarantee you'll get to 20.
I've run models which show some portfolios failing after 45 years or 55 years. Depends really upon circumstances, but 4% is so far below the 4.7%, which I now recommend, is a huge margin of error in there. And, they should easily cover very, very long retirement horizons.
Ricky (audience #3): I know, Bill, that you really didn't use taxes or account for taxes in your initial research. Have you now applied taxes and, if so, what assumptions and also what retirement accounts you might be assuming you're drawing down from?
Bill Bengen: With respect to taxable accounts versus tax-deferred accounts, and of course the 4% rule or the 4.7% rule applies to a tax deferred account. I've studied taxable accounts. In my book, which I published in 2006, I had a table in which I listed the effect of various tax rates on the withdrawal rate, and the higher the tax rate - as you might expect - the lower the withdrawal rate.
For a typical overall tax rate of maybe 25%, I think withdrawal rate was reduced about 10%, maybe from 4.7% to 4.3%, 4.2%. Higher tax rates, you get lower withdrawal rates. So yeah, there's definitely an effect as a result of tax rates.
Jon Luskin: Bill, this one is from username ‘retireIn2020’, who writes: "I would like to know what his thoughts are for a new retiree using the 4% rule and withdrawing the entire 4% from their fixed income assets - CDs, treasuries, short-term, et cetera - and rebalance every three years from bonds into those fixed assets followed by rebalance from stocks into bonds every six years versus drawing the 4% equally across assets.”
Bill Bengen: My indication I have from other research other folks have done is that it doesn't work that well, to limit your withdrawals from one particular class of assets, because if you let the other asset classes grow too much, the portfolio starts generating too much risk.
Jon Luskin: Certainly, if you're spending down those relatively more conservative assets, you're letting those riskier assets grow, that means more risk. If that stock portion of those risk assets gets large enough, that could mean a lower sustainable withdrawal rate as we touched on earlier.
We have another question related to variable withdrawal rates. This one is from username ‘Dave55’ who asks about variable rates. Have you ever looked at the Guyton-Klinger approach, Bill, which is, hey, we've got guardrails and if the portfolio does better, we'll spend more. If the portfolio doesn't do as well, we'll spend less?
Bill Bengen: Jonathan's a good friend of mine. He's done some great research in this field with guardrails. And I think it was a very important mechanism. The whole reason for Jonathan's research was that if you take the safe withdrawal rate to 4.7% all the time, you're going to find out in many, many cases that you're going to have a lot of money left at the end of retirement, a lot more than you want to have, which means you could have spent at a much higher rate, which you would've wanted to.
The question is, how do you determine when it's safe to take a higher withdrawal rate than 4.7%? The average over time, by the way, has been almost 7%. Believe it or not, that's what the average retiree has been able to take out. And historically, some retirees have been able to take out as much as 13%. They just had very, very fortunate, period of time they were retired.
The dilemma I had for over 25 years was trying to determine how do I take advantage of those higher withdrawal rates? Because if we could come up with a method that would allow us to reliably predict what the withdrawal rates should be, we would probably not need to use a mechanism like the guardrails.
Two years ago, I in fact did that. Up to that point, the sequence of return risk was the biggest topic of interest for folks retiring. We knew that a big bear market early in retirement depresses withdrawal rates. Knowing that wasn't sufficient to be able to predict withdrawal rates to a really fine level. It could be a 50% spread between, let's say, 5% and 7.5%.
Now, how does the individual choose between 5% and 7.5%? When I added inflation into the picture, the inflation at the start of retirement, as well as stock market valuations at the start of retirement, that allowed me to predict historical withdrawal rates with great accuracy.
So now I have a method I believe, which I'm confident, which if you give me your starting inflation rate and you give me your starting CAPE at the day you retire, I can give you a doggone accurate estimate of what your withdrawal rate would be and may well be above the 4.7% level. That hasn't been the case unfortunately for 25 years, and there were only a couple of months here - in fact in 2009 - where the stock market valuations were low enough to really make a difference. And I calculated for the retiree who retired in, say March of 2009, which was the market bottom that had really low inflation, they'd be able to take out 6.5%, maybe even a little bit more.
And that's worked for them so far, even with this current bear market. So that there's hope down the road as we get to more reasonable stock market valuations that we might be able to recommend higher withdrawal rates. But I don't think we're there yet.
Jon Luskin: Well folks, that is going to be all the time we have for today. Thank you for everyone who joined us today, and thank you for Bill Bengen for being our guest on today's Bogleheads® Live.
The next Bogleheads® Live - the first of 2023 - is going to be featuring Christine Benz, Morningstar’s Director of Personal Finance, returning to discuss her team's new research on sustainable spending in retirement. She'll be answering your questions live on Twitter. That'll be Tuesday, January 10th, 12:00 PM Pacific, 3:00 PM Eastern. Between now and then, you can submit your questions for our future guests on the Bogleheads® Forums at bogleheads.org and on Bogleheads® Reddit.
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This episode of Bogleheads® Live, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a 501(c)(3) nonprofit organization dedicated to helping people make better financial decisions. Visit boglecenter.net to find valuable information and to make a tax-deductible donation.
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