Retirees and near-retirees have long recognized that the infamous 4% rule has to be changed to lower the percentage. But how much lower?
That’s the finding of new research that repeats the original study that resulted in the 4%, but with more reasonable assumptions about human life expectancies and a more extensive historical data set.
The repercussions are massive and perhaps disastrous. You would have little risk of outliving you’re $1 million 401(k) if you followed the 4% rule. With the new regulation, you would be permitted to spend only $19,000 annually in inflation-adjusted terms.
That’s assuming you have a one-million-dollar retirement portfolio. The most recent Vanguard report shows that just 15% of Vanguard retirement funds are valued at even $250,000. In addition, according to a Boston College Center for Retirement Research examination of Federal Reserve statistics, only 12% of employees have any retirement account.
The controversial 4% rule may be traced back to 1994 research published in the Journal of Financial Planning by financial planner William Bengen. He based his rule on studies that showed a portfolio of 50% stocks/50% bonds would have survived every 30 years in the United States between 1926 and 1991.
The University of Arizona’s Richard Sias and Scott Cederburg, as well as the University of Missouri’s Michael O’Doherty and Aizhan Anarkulova, a Ph.D. candidate, conducted a study recently that resulted in a much lower spending rule. The study is entitled “The Safe Withdrawal Rate: Evidence from a Broad Sample of Developed Markets.”
Despite specific changes to Bengen’s technique, the researchers’ substantially lower expenditure rule can be traced back to two key explanations. The first is to account for our anticipated longevity.
According to actuarial statistics from the Social Security Administration (SSA), a 65-year-old couple retiring today has a one-in-four probability of at least one spouse living for more than 30 years, according to Sias. SSA data replicates Bengen’s method to account for this possibility.
The second reason for the significantly lower spending rate had an even more significant impact: the researchers used a far larger historical stock and bond returns and inflation database. In particular, the database showed stock, bond, and inflation returns from 38 industrialized countries between 1890 and 2019.
Because the United States has outperformed practically all other industrialized countries during the previous century, this significantly influenced the researchers’ conclusions. Unless you believe in more or less everlasting US market exceptionalism, market returns from other nations are also crucial for estimating the future path of our retirements.
Should you believe in this notion of exceptionality?
Sias believes not, pointing out that the extensive information he and his colleagues relied on only covered industrialized nations. As a result, their outcomes are not influenced by the sometimes subpar returns of developing and frontier economies. Indeed, he noted, several countries had higher GDP per capita than the United States in the initial years they were included in the researchers’ database.
To understand what this implies, suppose if, a century ago, you were wagering on which nations’ markets would yield the highest future profits. If you were betting purely on nation size and income, you would have gambled on other countries rather than the United States as having the best future stock and bond market returns. Sias warns us against basing our retirement plans on the future.
In particular, Sias cited Japan as an instructive example. At the end of the 1980s, its stock market had the most prominent market capitalization in the world, far exceeding that of the United States. Of course, it crashed and was never fully recovered, and it is now one-third lower than when it peaked in 1989.
What makes us so sure that the Japanese experience is irrelevant to employees retiring in the United States today? Many people predicted in 1989 that Japan would not only continue to control the world economy but would grow even more dominating. What makes that different from a comparable statement today that the US stock and bond markets will outperform the rest of the globe by the same margin as they did the previous century?
We can only hope that the United States does not follow Japan’s example after 1989. However, hoping is not a viable retirement plan. And if you replace hope with objective evidence, according to this new study, you would choose a spending rule significantly lower than 4%.