Is a 4% Withdrawal Rate Too Much or Too Little for Early Retirement?

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We are planning to take the plunge into early retirement within the next  two years.  Before doing so, we are devouring as much information as possible on the subject.  We are trying to assure that our early retirement is what we are envisioning.  The last thing we want to do is trade in the drudgery of 40 hour work weeks for a life of worrying about whether we have enough money.  We especially value the opinion of other early retirees who have already taken the plunge.

Around the early retirement community, the general consensus is once you have built a portfolio to 25X your annual spending, then you are financially independent.  This is based on research that indicates that you can withdraw 4% of a traditional stock/bond portfolio on the day that you retire and then continue to do so every year going forward, adjusting for inflation annually, without running out of money.

However, this assumption is not without debate.  I recently read a couple of interesting posts on this topic from two of my favorite bloggers.  If you are planning for your retirement I would highly recommend reading both to get a deeper understanding of this issue.

The Optimist:  GoCurryCracker

The first was from the blog GoCurryCracker (GCC) entitled “What is Your Retirement Number-The 4% Rule”.  In this post, Jeremy cites the Trinity Study (the origin of the 4% Rule) and points out that researchers analyzed “84 years that covers a wide range of economic environments including 2 World Wars, the Great Depression, the oil embargo and high inflation period of the 1970’s, and the Boom period of the 1980’s”.  Throughout all of these conditions, a portfolio of 50% stocks and 50% bonds, using the 4% rule had a 96% success rate.  Even better, a slightly more aggressive portfolio of 75% stocks would have never failed.  And even better yet, he concludes that “Even a 4% withdrawal rate will be too conservative in most cases.”  He points out that in many cases, after 30 years of making consistent 4% withdrawals (+ inflation adjustments) portfolios managed to double or triple.  In the case of a 100% stock portfolio the median portfolio grew to 10X the original amount!  Sounds pretty good.

The Pessimist:  Financial Mentor

The second post was written by Todd Tresidder at the Financial Mentor blog entitled “Are Safe Withdrawal Rates Really Safe?”.  This is an older post I had read a while ago.  It came to my attention again when seeing it getting blasted in the Mister Money Mustache Forums for its negativity and “scare tactics”, which people accused Todd of using to drive people to buy his books or use his coaching services.  While I personally love Todd’s work and thought this post was packed with useful information, the tone was very pessimistic.  Here are a few of the most discouraging.  “Don’t believe that 100+ years of economic history is as bad as it can get.”  “How a long, healthy life is a financial problem.”  “…our 2010 retiree is looking at a 1.8% safe withdrawal rate…”.  In his post, Tresidder cited the Trinity Study as well as many other of the same researchers that were referenced in the GCC post.  He tried to drive home the point that what happened in the past does not guarantee success in the future.  He advises that future outcomes are a result of starting valuations which are currently not favorable for investors with the markets at highs and interest rates very low.  Sounds pretty bad.

Same Data, Different Conclusions?

Half-Full or Half-Empty?
Half-Full or Half-Empty?**

In reading these two posts, I definitely detected different tones and themes.

Jeremy is a young, new early retiree.  His blog has recently been featured in some main stream publications and is growing in popularity.  I love to read his work because of his combination of optimism and encouragement with in-depth analysis of financial issues effecting an early retiree.  All were present in this post.

Todd writes from a different perspective.  After retiring, he started a financial coaching business.  He has witnessed mistakes that people have made.  His writing attempts to add depth and nuance to the oversimplifications that are seen in so many places.  He recognizes that people like Jeremy, myself and the people who read blogs like our’s are in a minority that actually read beyond soundbites and tackle these topics in-depth.

While the GCC post at first read comes across as wildly optimistic and the Financial Mentor post comes across as very pessimistic, the funny thing is that they really are saying the same thing.

Take Home Points

  • Your planning must be flexible.  There is no magical “safe withdrawal rate” (SWR).  Future inflation and market volatility is unknown.  There is no absolute guarantee that if you use a set 4%, 3% or even 2% withdraw rate that your money will last for the 30 year assumptions used in the Trinity Study and most retirement studies, let alone the 60-70 years possible for early retirees.  Luckily for an early retiree, there are many options for flexibility that can be built into your plan.  Planning on making even small amounts of money and/or having the ability and willingness to cut spending will greatly reduce the risk of running out of money in retirement.
  • The early portion of your retirement is mathematically far more important than the end.  The reasoning for this is simple.  At the beginning of your retirement, any money taken from your portfolio will not only be gone forever, so will all of the compounded growth over many years.  This is true even with standard assumptions with a 30 year retirement.  The effects are greatly amplified with the long time horizon of an early retiree.  It would therefore be wise to be conservative in the early years and then adjust as indicated.
  • Costs and taxes are massively important.  If you have been reading our blog, you know that we emphasize controlling taxes and investment costs during the accumulation phase.  We’ve demonstrated the negative effects these mistakes can have.  Despite their negative effects, these fees can be overcome by earning and saving more.  In retirement, these costs can simply crush you.  When we are talking about withdraw rates typically in the 3-5% range, you simply can’t afford to be paying 1-2% investment fees and then pay even more unnecessary taxes due to poor planning.

How We’re Using the 4% Rule

In future posts, we’re going to start to dive deeper into the philosophy and practical applications of how we will utilize the 4% rule and its inverse, the rule of 25 (you would need 25X your annual spending in investments to withdrawal 4% in year one of retirement).  We will discuss how we will be willing to begin our early retirement with 20-25X our annual expenses in investments with great confidence and minimal worries about ever decreasing lifestyle or running out of money.  Until then, I would encourage anyone who has a genuine interest in following our path to read the two linked articles above and follow their citations to get a full understanding of where these assumptions come from.

Are you using the assumptions of a 4% SWR for your early retirement?  Do you think it is too risky and feel you need to save more?  Do you think it is too ambitious and would take too long to save the amount necessary?  Do you have any alternative strategies for determining when you are financially independent?  Please share in the comments below.

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18 comments on Is a 4% Withdrawal Rate Too Much or Too Little for Early Retirement?

    1. Yes and no.

      We built our allocation to be where we want it when we start our retirement, so no in the short term.

      That said, our whole plan is very fluid. I would not plan to invest in anything long-term with only 2-3% return expectations and potential major downside as is now the case with bonds. If we stay in current interest rate environment, we would look for diversification and cash flow from an area such as owning rental real estate which may require some work but has far greater return potential. Also, we will plan at some point (anywhere from 2-20 years) to sell our current residence and downsize which will both free up capital and lower monthly expenses. This won’t directly effect our stock/bond allocation but will change where we hold our net worth as outlined in our plan in last week’s post.

      Thanks for the question and hope that clarifies.

      EE

  1. I’m currently FIRE at age 42 with a roughly 7% withdrawal rate. I actually posted on my blog about 25X being just too darn much (e.g. you worked ‘too long’). I find a 12% or better annual return is practical with writing options for income. My WR was almost 10% when I went FIRE on 5OCT2012 but due to excess returns, the number is falling. I am piling surplus cash into municipal bonds for tax efficiency and reduction of volatility as a result.

    1. FV,

      I would be interested in learning how you invest to have that high of a WD rate. Can you direct me to a specific post(s) to explain what you are doing? Also, are you worried about market downturns since you haven’t had to ride one out yet? How much time do you spend on your investments in a typical month? I’m curious to learn more if you share some specifics.

      Cheers!
      EE

      1. EE,

        I posted today’s trade on my blog. It is a good example of using the options market on safe, even boring, companies to generate annual yields in excess of 12%. That trade was on Johnson and Johnson (100 strike put June 19 expiry). It paid 1.43 on the 100 at risk over 40 days. Annualized yield is 12.23%. My “downside” is possibly owning JNJ for 1.3% BELOW today’s price. At which point I’d write covered calls for even more income.

        Most of my stash is deployed in high yield REITs, MLPs, and BDCs. I also maintain a 19% and climbing allocation to debt instruments. I easily kick off more than double my spending needs on a bank of less than 500k.

        1. FV,

          Thanks for the reply and input. I honestly have to say that went right over my head and I don’t understand any of the technical aspects of what you are doing.

          That said, it simply illustrates that there are many ways to FIRE. As long as you can figure a way to create cash flow in excess of expenses in a way that is sustainable while not depleting your stash, you’re good. You don’t have to be tied to the 4% (or any other number) SWR. There are many ways to leave the standard 40 hour/week behind confidently and pursue a more fulfilling lifestyle.

          1. EE,

            What I do isn’t for everyone. For one thing, it eats up about an hour a day and some people aren’t willing to give up that much time in FIRE. I love it and don’t think of it as work.

            Do what works for you. And devour your prey!

  2. Hey EE,

    Glad to have found you on the internet. I look forward to read more on your early retirement plan and the use of the SWR rule. I think it is a question that many people have: what is enough?
    I think your post makes a good summary and highlights the must do’s.

    My Freedom day is still far away (some 15 years or so) but I hope to move it foreword by trading a fixed job with a freelance job. This would be a first step for me towards Freedom.

    Do you have plans in that direction? Keeping a job (freelance or occasional) the first years of freedom in order to adapt to the new situation and not draw down on the savings?

    1. Amber,

      Glad you found us too. That’s awesome that you’re already thinking about this stuff so far out. I think you’ll find you’ll get there faster than anticipated if you so choose just by gaining the knowledge and motivation so early in the game.

      I think your idea of being more flexible with work and designing a whole lifestyle that fits together and makes sense is much wiser than focusing on killing yourself in your working years to get to a retirement in the traditional sense of the word where you don’t ever work or earn money for the rest of your life. Your idea is very similar to what we plan to do and so we may even jump out of the full time work force and into our early “retirement” even earlier and with less assets than our original plans.

      I hope you continue to follow and contribute and we can learn together.

      Cheers!
      EE

  3. That pessimistic article… man, about 3 hours of reading into a long winded cesspool of negativity, I wanted to scream at the screen and say, “Damn dude, just tell me what is safe then!”

    But you have to pay money to get that answer, so I guess it worked

    It’s interesting that you saw my 4% Rule post as optimistic. I’ve looked for every possible failure mechanism, and think of that post as Realistic

    1. Jeremy,

      Thanks for taking the time to comment and congrats on the arrival of GCC Jr.

      I’ve been loving your writing recently and just also cited you as “our current favorite blog” in this post
      http://eatthefinancialelephant.com/who-can-you-trust/

      I also read your post as very realistic and helpful. I also thought Todd’s post had some very valid points. My whole point of the post was to really read a bit deeper into the articles and look past the tone. The tones were quite different. Many key points were the same.

      I personally really like to read a variety of different perspectives on the same issues to gain a deeper understanding. While I have to agree with most everything you wrote in your post, I like having someone to play devil’s advocate to give the counterpoints to challenge me to think deeper.

      Cheers,
      EE

  4. You guys are pretty close to FI, thats exciting. My takeaway from all of this is being flexible is the key, along with that different allocations to bring home the money is important in the long term plan as well.

    1. ES,

      Agreed!

      BTW, I have a post coming in the next week or two to link over to you explaining how we came to our FI date.

      Cheers!
      EE

  5. Would love to know how you’re actually doing your projections in future posts. Though we believe in the 4% rule overall, it’s tricky when most of our assets are in 401Ks that we aren’t planning to touch for a long time, and our taxable accounts are what we’ll live off of for the first 18-20 years of retirement. So though we’ll be taking out *roughly* 4% of the total holdings each year, our projection math is a bit more complicated since we need the much smaller taxable holdings to last, and because we’re factoring around the mortgage on our rental property, which will be paid off in a few years. Once we shift to 100% 401K, we expect to go to the true application of the 4% rule, but that’s a long time from now!

    1. We will plan on continuing to earn some money so will actually start at less than 4%.

      Regardless let’s assume 4%. We will look at our portfolio in it’s entirety and draw that 4% of our total assets. Like you we’ll plan to use taxable $ first so maybe it will be 10% of our taxable money in a given year but only 4% of our total assets since not drawing anything from he tax advantaged accounts.

      We are in a bit of a unique position in that we have a large percentage of our assets (about 50%) in taxable. It was a mistake to save/ invest this way and slowed the process, but once in retirement it will simplify the process.

      Hope that makes sense. If not, just let me know and I’ll try to clarify.

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