Is a 4% Withdrawal Rate Too Much or Too Little for Early Retirement?
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?
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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**Image courtesy of BrianHolm at FreeDigitalPhotos.net
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