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The Updated Retirement Rule


April 20, 2022

From the WSJ:

Cut Your Retirement Spending Now, Says Creator of the 4% Rule

The combination of high inflation and high market valuations could require revisions to the retirement rule of thumb

For decades, retirees have relied on the 4% rule to determine how much was safe to spend in retirement. Now, the rule’s inventor says current market conditions may require an even more conservative approach.

The combination of 8.5% inflation with high stock and bond market valuations makes it difficult to forecast whether the standard playbook will work for recent retirees, said retired financial planner Bill Bengen, who first devised the 4% rule in 1994.

He now recommends retirees take a less aggressive approach to drawing down their nest eggs, at least until we determine whether the current surge in prices that has been particularly stressful to those on fixed incomes is a long-term trend or a short-term blip. The longstanding method calls for spending 4% in the first year of retirement, and then adjusting that amount annually to keep pace with inflation. Such an approach would have protected retirees from running out of money in every 30-year period since 1926, even when economic conditions were at their worst, Mr. Bengen said.

“The problem is that there’s no precedent for today’s conditions,” he said. His concern echoes a recent report from Morningstar Inc. , which recommends a 3.3% initial withdrawal rate for those retiring today who want spending to keep pace with inflation over three decades and a high degree of certainty their money will last. Mr. Bengen’s latest revision doesn’t necessarily mean going below 4%, he said. That is because the 4% rule hasn’t really been the 4% rule for some time. His original research was based on a portfolio with 55% in U.S. large-cap stocks and 45% in intermediate-term Treasury bonds. Since 2006, he has revised that portfolio to add international stocks and midsize, small-cap and microcap U.S. stocks as well as Treasury bills. That raised returns and supported a safe withdrawal rate he increased to 4.7%.

Given the challenges of making forecasts right now, Mr. Bengen suggests cutting spending, if possible. New retirees with highly diversified portfolios that would normally support a 4.7% withdrawal rate might want to start around 4.4%, he said.

Mr. Bengen, who retired in 2013, said he plans to do just that. “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.”

In historic 30-year periods, Mr. Bengen said, a 4.7% initial withdrawal rate was a safe starting point. Those who retired in the best of times, when stocks were cheap and interest rates and inflation were low, could have taken out as much as 13% to start without running out of money, he said, adding that “we haven’t seen anything like that since the 1930s.” Since 1926, Mr. Bengen’s research indicates that a 7% withdrawal rate has been successful on average. When inflation is high, withdrawals made under the 4% rule “grow by leaps and bounds,” said Mr. Bengen. That means the portfolio must earn a higher return to prevent depletion, Mr. Bengen said.

Another threat is high stock valuations. Stocks are currently trading at roughly 36 times corporate earnings over the past decade, according to Nobel laureate Robert Shiller’s CAPE, or cyclically adjusted price-to-earnings, ratio.

“That is double the historic average,” said Mr. Bengen. “While low interest rates justify higher stock valuations to some extent, I think the market is expensive.”

In past periods of very high stock valuations, he added, “it usually took a bear market to adjust prices back down to the mean.” As a result, he said, “we could be facing an extended period of subnormal returns.”

When bear markets occur, retirees have to take money out of a portfolio that is shrinking. That is especially dangerous early in retirement because most retirees need their savings to last years, Mr. Bengen said. In contrast, if a bear market comes along after 20 years in retirement, “your portfolio has likely already increased in value, giving you a larger cushion,” Mr. Bengen said. Plus, the retiree may not need the money to last as long. While high short-term inflation poses some danger, the risks multiply when high inflation sticks around for longer, as was the case in the 1970s.

“We have had bursts of high inflation in the past, including after World War II, that have lasted only a year or two,” said Mr. Bengen. While these bouts of high inflation reduced the safe withdrawal rate, “it wasn’t by a dramatic amount,” he said.

Mr. Bengen’s research indicates that the worst 30-year period in which to retire started on Oct. 1, 1968. It wasn’t 1968 itself that was the problem, he said, but the years following, “which were awful.” Inflation was high for much of the 1970s and stocks encountered back-to-back bear markets that started around 1969 and 1973. From the end of 1965 to the end of 1981, the annualized return on the S&P 500 was virtually flat without dividends.

Aside from cutting spending, retirees can try to protect their nest eggs by reducing their exposure to stocks and bonds, he said. While Mr. Bengen said he would normally invest about 55% of his savings in stocks and 45% in bonds, his concerns about both markets have left him with closer to 20% in stocks and 10% in bonds, with the rest in cash.

“I’m uncomfortable holding that much in cash,” he said. But with the Federal Reserve announcing its intention to aggressively raise interest rates, “it’s not a great time to invest in financial assets,” said Mr. Bengen, who said he plans to buy stocks if the market drops significantly and stocks become cheap. Mr. Bengen warns that attempts to time the market can backfire on investors. “It’s hard to buy stocks during bear markets. There’s an emotional obstacle to doing that since investors fear it can lead to more losses.”

“I retired nine years ago, so I’m probably safe,” he said. “But I’m not comfortable because I am still early enough in retirement that the combination of threats we face could be damaging.”

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