The 4% Rule

Written by Prio Wealth Relationship Manager, Robert Devinney, CFP®, ChFC®

One of the most common questions we get from retirees is, “how much can I be withdrawing from my portfolio every year?” Unfortunately, there is not one single, or easy, answer to this question. We know that every client has different needs, lifestyles, and goals – some of which will need to be funded at the same time, while others arise at different times. Per the Wall Street Journal, for decades, a 4% initial withdrawal rate has been used as a guideline for a sustainable approach in ensuring your portfolio’s ability to supplement your annual income needs over time. But with record inflation, historically low interest rates, and uncertain stock and bond valuations, does the 4% rule still hold true?

What is it?

First, let’s define the 4% rule. Bill Bengen, financial advisor, published a study in 1994. He found that for every 30-year period going back to 1926, if a retiree took 4% from their portfolio in the first year of retirement, and then adjusted future withdrawals for inflation, a mix of 50% stocks and 50% bonds lasted for 30 years or longer, every time. This included the 1970’s when we saw what was likely referred to as ‘unprecedented inflation’ at the time. Interestingly, in the opening remarks of his study, he also hypothesized about future periods of high inflation and market corrections, many of which are eerily similar to what we are experiencing today.

The phrase, “unprecedented times” is used to describe a lot of things lately, including today’s financial environment. We’ve just had a historically strong bull market, driven in part by historically low inflation. A key component of the original study was that ongoing withdrawals are adjusted for inflation, thereby maintaining the same lifestyle. What we have seen is that many people have, perhaps unintentionally, been increasing their withdrawals based on returns, not inflation. Those higher withdrawal amounts quickly lead to lifestyle creep and then when inflation spikes, withdrawals need to be increased even more to maintain the ‘new normal’ lifestyle. This puts immense pressure on your investments to earn a higher return so that you can maintain the longevity of your portfolio. Several sources are now recommending a less aggressive withdrawal rate so that retirees do not draw down their portfolio prematurely due to inflation or sequence-of-returns risk.

What can I do?

Strategies differ depending on your life stage. Viable options include working longer, saving more, and spending less. But not everyone has the luxury or desire to do so. If you are retired or are about to start making withdrawals, taking a second look at your plan and understanding the reasons for the withdrawals and stress testing these ‘newfound risks’ would be prudent.

While the 4% rule has been an industry “standard” since the mid-90s, there is no standard when it comes to individual retirees. At best, it’s a guideline. Everyone has different goals, lifestyles, and risk tolerances. With the current market volatility, low interest rates, and rising inflation, there is no better time than now to review your asset allocation and ensure that it is in line with your life’s priorities.

If you are in or near retirement, it is important to build a retirement income plan that is both reliable and flexible. That might mean employing multiple withdrawal strategies and not putting your entire portfolio at the mercy of one single method. One such approach is the bucket strategy which earmarks portions of your assets for short-term, mid-term, and long-term expenses. Each bucket would be invested according to its time horizon which would alleviate some of the pressure from inflation and market volatility. Another strategy could be breaking out a portion of your assets for essential expenses and another portion for discretionary expenses. In doing this you are recognizing if money is being withdrawn for your wants and wishes or for necessity.

It is our mission at Prio Wealth to identify the goals and priorities that are unique to you so that we can build an effective income plan and a sustainable investment strategy to navigate you through all phases of life and market conditions.