The 4% rule on investment is very popular. It establishes that in order to retire living on the savings you should not consume more than 4% of them per year. In the past we have already said that its creator, Bill Bengen, was not entirely in agreement with this rule today, but the previous criticisms have nothing to do with the latest information that he has made public.
The 4% rule allows the saved capital not to run out, always based on the history of the stock market and possible decreases in capital. And so it seems like a good idea. But it has a fundamental flaw and it is psychology.
What is the 4% rule?
In 1994 Bill Bengen published an article in which the past returns of long-term assets were analyzed. The conclusion of this study is that, based on historical data, if the withdrawal of capital is limited to 4% per year (increasing with inflation) capital does not run out.
There are a couple of important details of this study: the first is that it is made for a person 60-65 years old. That is to say, the capital does not last indefinitely, it cannot be applied to a 20-year-old person who has received a considerable inheritance because it might not work.
The second is that, in order to make capital stretch for many years, has to be invested 70-50% in stocks and the rest in bondsall from the USA.
Bengen’s earlier review
Two years ago Bengen criticized the interpretation of his article. He said that 4% could be a lower limit, because it was done in the worst case: a retiree does it in 1968, when a bear market with high inflation begins. This is the worst case and it may not happen again.
In his 2022 statements he already said that the rule could be set at 5%. Interestingly right now we are in a bear market with high inflation, so maybe it is better to continue using your original 4% rule or even be more conservative and just withdraw 3%.
Of course, the lower the percentage, the more capital you have to have to retire. If a person wants to live in retirement with 30,000 euros a year, with the 4% rule you need to have accumulated 750,000 eurosif it is with 5% then 600,000 euros but if we are conservative and the rule is 3% then 1,000,000 euros.
reality collides with excel
However recent statements from Bergen have surprised even more. He is already retired and has stated that of all his saved assets he only has 20% in the stock market, 10% in bonds and 70% in cash. You’re not comfortable with the bag right now.
I mean, all the 4% rule calculations are fine when you’re 30-50 years old, accumulating, investing indexed, etc. but what is often not said is that reaching the end of accumulation and beginning of withdrawal is not so easy.
The problem is that when you reach 60-65 years old and you have a significant accumulated wealth, the stock market is very scary. If, with a withdrawal of 4%, it does not matter in principle that the markets fall sharply and there is high inflation, this method can withstand even a situation like that of 1968. But you have to have nerves of steel to see how wealth falls just when you need it. And not everyone supports it.
Therefore, the 4% rule has an underlying psychological problem. Just as there are many investors in the accumulation stage who fail to make regular contributions when markets go bad, the part of the withdrawal is not as simple as an excel paints. Even the great Bergen has faltered.