In 1994, Bill Bengen, as a fledgling financial advisor, undertook a research project to answer recurring client questions about how much money was needed to retire and how much could be withdrawn each year in retirement. In looking at market returns spanning 1926 to 1976, he found that withdrawing 4 percent in year one, coupled with adjusting that amount for inflation and rebalancing the portfolio in each subsequent year, would have protected retirees from running out of money in every 30 year period since 1926.
In late 2021, a whitepaper produced by Morningstar questioned the 4 percent “rule,” which has been widely adopted by the financial planning industry for nearly 30 years. It suggested that 3.3 percent was the number needed for reliability, but that with tradeoffs like delaying retirement or increasing spending in retirement at a lower rate than inflation, a higher starting withdrawal rate was still achievable.
Earlier this year, Ben Rizzuto, a director with Janus Henderson, took a broader look at the historical analysis, literature and debate around the “4 percent rule.” In contrast to Morningstar’s recent controversial revision, he notes that Bengen himself had previously revised his SAFE starting withdrawal rate as high as 4.7 percent when accounting for additional asset classes.
He also highlighted work done in 2008 by Michael Kitces, who added to the conversation by numerically demonstrating the role market cycles can play in choosing a sustainable starting withdrawal rate. His work showed a strong inverse correlation (-.74) between the Shiller Cyclically Adjusted PE (CAPE) Ratio and the safe starting withdrawal ratio, suggesting that market valuation (as a proxy for the likelihood of an impending correction), in addition to inflation and rebalancing, was a factor to consider in choosing a starting withdrawal rate confidently. Rizzuto concluded that like many things, the rule is really more of a guideline to be adjusted with the times.
But with the CAPE Ratio currently above 30 (levels seen in only two other periods historically: Black Tuesday of 1929 and the period preceding the dotcom crash of 2001), the market posting its worst April in 52 years, bond yields remaining in historically low territory and inflation continuing to climb to levels not seen since the 1970’s we may just have a situational trifecta looming; a dark cloud destined to rain on the retirement parade. Regardless of what number you adopt, all fingers point toward the current environment warranting an exceptionally conservative approach.
Christy Charise, Founder & CEO of Strategic Advisor