Will inflation and the stock market conspire to eradicate the 4% rule?

A recent Wall Street Journal headline sent chills into every retiree’s back — “Reduce your retirement spending now, says the creator of the 4% rule.”

In the article, the Wall Street Journal quoted “There is no precedent for today’s conditions,” said William Bengen, the father of the 4% rule. Stock and bond prices remain at record levels. Mix in reference to an 8.5% inflation rate, and the Wall Street Journal is starting to sound like an insurance salesperson touting indexed annuities.

So are things really that bad? And do retirees need to rethink the 4% rule? I don’t think so, which is why.

The 4% base is now the 4.4% base

In the article, Mr. Bingen said he believes the safe initial withdrawal rate is 4.4%. Yes, this is more One of his preliminary findings in his 1994 research paper.

In his 1994 research paper, he hypothesized that retirees invested in the S&P 500 and intermediate Treasuries. This is. It has since expanded its asset classes to include mid-, small- and micro-equities and international equities. This diversification increased the safe withdrawal rate from 4% to 4.7%. Because of the unprecedented circumstances mentioned above, he said, new retirees may want to start at 4.4%.

As far as I can tell, the 4.4% rate is not data dependent. However, it represents a 10% increase, not a decrease, from the initial 4% base. This doesn’t sound so bad.

Do we live in an unprecedented time?

Bill Bingen believes that we live in unprecedented times. From the Wall Street Journal,

“The combination of 8.5% inflation with elevated stock and bond market valuations makes it difficult to predict whether the standard rules of the game will work for new retirees,” Bengin said. He’s even gone so far as to put 70% of his personal wallet in cash. When a dad loses the 4% rule, right?

I do not think so. For starters, it’s important to understand how Bengen developed the 4% rule. He examined 50-year retirement periods dating back to 1926. For each, he determined the highest withdrawal rate one could have in the first year of retirement, adjusted for inflation in subsequent years, without running out of money for at least 30 years.

As you might imagine, each year had a different initial withdrawal rate. In some years the starting rate was double what it was in others. Here’s the main point. Not all of these initial withdrawal rates had to come to the 4% rule. He had the worst year ever – 1968.

here more How does the 4% rule work?.

What does this mean? This means that the 4% base has survived the stock market crash of 1929, the Great Depression, World War II, the Korean War, the Vietnam War, inflation in the 1970s and early 1908, the 1987 market crash, 11/11 and the Great Recession. and Covid-19.

stock prices

No matter how difficult times past were, current conditions look horrific in ways never before seen in history. One need not look further than Robert Schiller Cape (cyclically adjusted price-to-earnings ratio) of the S&P 500 index to raise concerns. It stands at about double its average and at historical highs. It was only higher once, and that was during the tech bubble.

However “unprecedented” this may sound, it is not for two reasons. First, most portfolios do not have the same expected price as the S&P 500, even if measured using CAPE. Add medium, small, and international stocks, and PE drops significantly.

Second, and more importantly, the CAPE for the S&P 500 will fall to average with a 50% drop in the S&P 500. That wouldn’t be fun, but it wouldn’t be unprecedented either.

As noted above, the market lost 90% to start the Great Depression. Going back to the tech bubble, the market lost 9%, 12%, and 22% from 2000 to 2002. That’s not a 50% overall loss, but it’s close. From peak to trough during the Great Recession (2007-2009), the market lost more than 50%.

The 4% rule has survived like a cockroach.

Bond prices and inflation

Bond yields were at historic lows. I say “was” because that’s not the case anymore. The yield on 10-year Treasuries is still roughly 3% below average, but there are plenty of years dating back to the 19th century when it was lower. And when Bengin published his paper in 1994, TIPS was three years away and my first bond was still four years away. So now we can at least keep up with inflation.

This is the key. The 4% rule has survived Treasury yields as low as 1 to 2%. It also survived inflation of over 13% and a decade of inflation at 6% or higher.

And like the Energizer Bunny, it keeps working and going (or beats you, Timex fans).

last thoughts

This year may come worse than 1968 for new retirees. 2022 may be the worst time to retire since the late 1960s. Maybe in 30 years, we’ll know that for 2022, the safe initial withdrawal rate was 4.2% instead of 4.4%.

But can we really expect that based on current conditions, when the 4% rule has weathered much worse? I do not think so.