Inflation has made the ‘4% rule’ in retirement ‘too aggressive’
The difficult economic situation has hammered the 4% rule – a longstanding guide for retirees looking to sustainably spend down their assets – according to the rule’s creator
High levels of inflation and high stock valuations mean that any retiree following the longstanding “4% rule” – in which a retiree withdraws 4% of their total investments in the first year of retirement before adjusting the rate in following years – could be too aggressive for retirees in today’s economy. This is according to Bill Bengen, a retired financial advisor who devised the 4% rule in a paper published in 1994.
“Based on Bengen’s original paper, this approach would have protected retirees from running out of money during every 30-year period since 1926, even when considering the Great Depression, the tech bubble, and the 2008 financial crisis,” writes financial planner David Chang in a new piece at the Motley Fool. “However, due to the combination of high inflation and high stock and bond market valuations, Bengen believes retirees will need to make some adjustments to their spending.”
Bengen himself described his newly-emerged unease with his own rule in the context of the modern economy for the Wall Street Journal in April.
“The problem is that there’s no precedent for today’s conditions,” he told the Journal, describing how he has cut his own spending. “I won’t eat in restaurants as much. I live a fairly simple life. I don’t take a lot of trips and I’m happy with a deck of cards and three other bridge players.”
According to a recent study by Morningstar published in November 2021 (and picked up soon afterward by CNBC), a withdrawal rate of 3.3% in the first year of retirement is recommended in light of the current economic situation.
“This assumes a 50/50 stock and bond portfolio and a 90% degree of certainty of not running out of funds over a 30-year timespan,” Chang explains of the new proposed withdrawal rate. “The key thing it found was that the more flexible retirees are with their spending, the greater the chance they can raise the withdrawal rate over time.”
Stock valuations are now much higher, as well, trading at roughly 36 times corporate earnings over the past 10 years, Chang says.
“This is double the historical average,” Bengen said according to Chang. “While low interest rates justify higher stock valuations to some extent, I think the market is expensive.”
Spending is likely the first thing retirees should deal with. From there, reducing exposure to stocks and bonds is advised, according to Chang based on Bengen’s writings.
“By having more cash or other assets such as income-producing real estate, when the market drops, there may be an opportunity to purchase