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The Father of the 4% Rule Says Retirees Can Withdraw Much More
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- [00:00]
William Bengen
Foreign.
- [00:06]
Robert Brockamp
The father of the 4% rule says 4% is likely much too low. You're listening to the Saturday personal finance edition of Motley Fool Money. I'm Robert Brochamp, and this week we're going to do things a little bit differently. We're going to forego our last week in MONEY and get it done segments and just feature a guest interview. And that guest is none other than William Bengen, the financial planner whose research established 4% as the safe withdrawal rate in retirement. Bill and I talk about his new book, why Most Retirees can withdraw more than 4%, how factors such as market valuation and inflation affect the safe withdrawal rate and whether retirees should decrease or increase their allocation to stocks as they get older. If you ask the typical investor how much someone could safely withdraw in the first year of retirement, the answer they'll likely give is 4%. That rule of thumb has been around since 1994, thanks to the research report published by a financial planner named William Bangan. Over the subsequent three decades, Mr. Bangan has done a lot of additional research, which he has summarized in his excellent new book, A Richer retirement supercharging the 4% rule to spend more and Enjoy More. Bill, welcome to Motley Fool Money.
- [01:21]
William Bengen
Hey, thanks for inviting me. I'm looking forward to it.
- [01:24]
Robert Brockamp
We're looking for it, too. Let's start with a little bit of your history. You got a degree in aeronautics and astronautics from mit, but instead of working in the space industry, you joined a family owned soda bottling business and eventually became the president. The company was sold in 1987 and you started a whole new career in your 40s as a financial planner. What led you to the financial planning profession and then eventually your research into withdrawal rates?
- [01:48]
William Bengen
Well, I never used a financial advisor and it was still a new concept at that time. I figured that if I was going to have to deal with a lot of this stuff, I better it wouldn't hurt me to learn about it. And then once I've learned it, perhaps then offer my services to others to give advice. And this seemed like a very appealing field to me because it's an area where you can make a difference every day in people's lives.
- [02:15]
Robert Brockamp
And then from there you had to determine a lot of your clients were boomers, not quite yet in retirement, but getting close. I'm sure they asked you, all right, how much can I spend in retirement? You looked for an answer and you couldn't find one.
- [02:29]
William Bengen
Yeah, I looked through all the literature. You know, it's not like today where we go on the Internet, type in a few words, and there's thousands of sources of information. Back then it was a library and talking to friends and associates, and nowhere could I find the answers to the questions. Probably not surprising, since that issue really hadn't been of importance up until the early 90s when people were starting to live longer in retirement and the baby boomers were thinking living into their 90s, unheard of. You know, back in the 50s, you'd retire at 65 and 10 years, you'd die and that was it. But when you live in 85, 90 or more, it creates a whole new host of issues.
- [03:13]
Robert Brockamp
So you fired up your Lotus 1, 2, 3 spreadsheet, bought some data, figured it out, and your initial research found that the safe maximum withdrawal rate, which you call the Safe Max was 4.15%. Then you moved it up to 4.5% after doing additional research that you published in a book in 2006. So it's been above 4% really since the beginning. Yet the term 4% rule has stuck. It is now widely referenced. So what was it like to see your research become so well known, but also be given a name that's kind of outdated and doesn't really quite capture all the nuance and depth to your research?
- [03:53]
William Bengen
Yeah, it kind of led to mixed feelings on my part. It was fun to see my name out there and associate with this research. I had no idea what to expect. But the 4% rule as it's been formulated applies to such a small number of retirees. Almost every other retiree can aspire to take out more than that and should look at that. They should not adopt that off the cuff. Start their planning.
- [04:20]
Robert Brockamp
With your recent research, you have moved up the Safe Max to 4.7%. What are the biggest factors that have resulted in your increasing the number over the years?
- [04:32]
William Bengen
Primarily, I've made my portfolios more sophisticated. I started out with just two assets. I'm up to seven assets now. Probably still not what some would consider a well diversified portfolio, but it's getting there. Probably means my research still understates the true withdrawal rate by a little bit. I Suspect the number 4.7 could eventually become 5. If you throw in gold and commodities and emerging markets and alternative investments and Bitcoin digital currency, who knows what can go in the portfolio today?
- [05:04]
Robert Brockamp
As you point out, the Safe Max of 4.7%, it's almost like a worst case scenario. It would have survived the worst conditions since 1926. And as you say, the majority of retirees would have been able to take out more, in some cases much more. So what would have been the withdrawal rates? If you look at maybe like an average case scenario or even maybe a best case scenario, sure.
- [05:26]
William Bengen
Along across 100 years of retirees, the average has been a little bit over 7%, which surprises people a lot because they've been stuck on the 4% rule and all of a sudden 7% is an average and there are people who are able to take out double digits. Of course, if you retire in July of 1932 and the stock market goes off 100% the next quarter, you're off to a very good start with your retirement plan. That's what happened. That's where people got 15, 16% withdrawal rates. Not realistic to expect anything like that today, but I think we can do a lot better than 4.7% in this environment.
- [06:08]
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- [06:37]
Robert Brockamp
In your book, you do provide success rates of other withdrawal rates. So withdrawing 5.5% did not deplete a retiree's portfolio. In 90% of historical periods, a 6% withdrawal rate was successful 75% of the time. And as you point out, a 7% withdrawal rate was about the average, so around a 5050 success rate there. What you've done more recently is try to find clues that would help retirees determine whether they could take out more than 4.7% and enjoy more of their money in retirement and also when they should play it safer. And you eventually came across the research of financial planning expert Michael Kitces, who documented a relationship between stock market valuations and the safe max. Tell us about that.
- [07:20]
William Bengen
Yeah, Michael's a good friend and a brilliant guy. Back in 2008, he published in his newsletter a chart which tracked the valuation of the stock market using the Shiller Cape cyclically adjusted PE ratio against withdrawal rate on the other end of it. And when you take a look at those two charts, they seem like when one's going up, the other goes down. One that goes up down, the other goes up appears to be a very strong correlation between stock market valuation and eventual withdrawal rate.
- [07:55]
Robert Brockamp
Yeah, you looked at that. One of the things you pointed out in your book is that generally speaking, if the market is cheap, it's going to do okay. You point out that there was only really one bear market when the stock market was cheap. That was in the early 80s when Paul Volcker, the Federal Reserve chairman, raised rates to bring down inflation. Whereas when the market is expensive, you're more likely to see a bear market, which of course could be very rough on your retirement.
- [08:19]
William Bengen
As a good example of that, the person retired at the bottom of the market after the great financial crisis back in April of 2009. My calculations indicate they could have taken out 8% because the stocks were so cheap at that time. That's the cheapest they've been over the last 30 years. We haven't approached that since.
- [08:40]
Robert Brockamp
You found that market valuation was helpful. Not a perfect predictor though, whether retiree could enjoy a higher safe max. Then you moved on to researching whether inflation at the start of retirement was the most important factor. What did you find?
- [08:55]
William Bengen
Well, I knew from the beginning that inflation had a role to play because the worst case scenario, the 4.7% was generated by the person who retired in October of 1968, and they hit two bear markets back to back deep ones, and then got hit with very high levels of inflation for over a decade, which forced them to increase their withdrawals. You would think though, that 1929 through 32, where the stock market dropped twice as much, would have been worse, but it wasn't because it was a deflationary period. Actually you were able to reduce withdrawal by 10% a year and that offset the huge losses in the stock market market and made 68 the worst case, not 32.
- [09:35]
Robert Brockamp
You provide in your book some what you call safe max finder tables based on three inflation regimes. Low inflation, middle inflation, high inflation. Then once you determine which inflation regime you're in, then you look up the CAPE ratio and that gives you a hint of what could be your safe max. Although you point out in the book there are other factors to consider and we'll touch on some of them. But when you look at that chart, it implies that withdrawal rates could be as high as 6% or 7%. And that might be surprising to a lot of people.
- [10:07]
William Bengen
Yeah, it could be. I think in today's environment, I'd probably recommending something around 5.5, which is low historically compared to the average, but it's a lot better than 4.7%, about 15 to 20% higher, which ain't chicken feed.
- [10:21]
Robert Brockamp
And we're in a medium inflation environment. But I'm assuming you recommend that withdrawal rate because the CAPE is so high at this point, about the second highest level it's ever been.
- [10:34]
William Bengen
Yeah. And of course, if the inflation rate were to take off and we enter a period like the 70s, that would reduce the withdrawal rate significantly. Don't know what's going to happen in that picture. It looks like for the time being inflation is at a reasonable level. But who knows?
- [10:52]
Robert Brockamp
These days I think there is more awareness of the impacts of a bear market, maybe right before retirement, but especially right after retirement. Your research bears that out. Tell us about why what happens in that first decade of retirement is so important.
- [11:08]
William Bengen
Sure. Well, if you encounter a stock bear market early in retirement and your portfolio drops 30% compared to another portfolio which might have been making gains, you're behind the eight ball and you never really catch up. So that early stock market declines reduced withdrawal rate very significantly.
- [11:28]
Robert Brockamp
If you have a bear market, say in your 20th year of retirement or 25th year of retirement at that point, your research indicates that's of course not great, but chances are you're still going to be okay.
- [11:40]
William Bengen
Yeah. Usually by the first 10 to 12 years, the die is cast. As far as your withdrawal plan goes, the success withdrawal plan all is owed primarily to events occurring in the first 10 to 12 years. There are exceptions. People retired in the late 50s into a low inflation environment and within a decade they were facing very high inflation and had to scramble to get back to plan. So events mid retirement, if they're severe enough, can affect the withdrawal rate, but not as much usually as the early ones.
- [12:12]
Robert Brockamp
Your book describes how a personal withdrawal plan can be developed by choosing various options among what you call eight elements. There are two other elements which we just discussed, valuation and inflation. Then there are eight elements. We won't discuss all eight in this podcast, but the first is your withdrawal scheme. You discuss a few in your book. Tell us generally about how a retiree might use guidelines to maybe take out a little bit more if the portfolio is doing well, but maybe cut back if the portfolio declines.
- [12:43]
William Bengen
You can do those kinds of adjustments. I think a lot of people just do that naturally. I'm not going to try to fight that. I think it makes sense if your portfolio is under stress due to inflation or a bear market that you want to take a cautious stance, cut back a little bit on spending temporarily at least, and just wait and see how bad the situation becomes.
- [13:09]
Robert Brockamp
Another important element is time frame. Your base case assumption is a 30 year retirement. So someone who retires at 65 would assume they live to 95, which I think is in the neighborhood of what most financial planners recommend. What about people who are retiring sooner, maybe in their 50s, maybe a little sooner? Or what if they're already in their 70s or older?
- [13:30]
William Bengen
Sure, the withdrawal rate is very sensitive to the planning horizon. So if we use 30 years as kind of a midpoint standard, 4.7% is the associated withdrawal rate. If you were to, let's say, have a 10 year horizon, your withdrawal rate would probably be around 8%, believe it or not, because you only have 10 years to deal with and you shouldn't have a lot of stocks probably at that point. One of the interesting features of the planning horizon is that the withdrawal rate drops as the length of the planning horizon increases, but eventually reaches a point where it doesn't decline anymore. It kind of reaches the floor. And for the 4.7% rule, let's say a 60 error would be 4.1% and it wouldn't get much slower than that for 80, 90, 100 years, as far as I can tell.
- [14:23]
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- [14:54]
Robert Brockamp
How asset allocation affects safe withdrawal rates. You settled on a base case allocation for a lot of your illustrations. Your book 55% stocks. And those stocks are allocated amongst five asset classes. Large caps, small caps, mid caps, micro caps and International. Then 40% intermediate government bonds and 5% T bills. Generally speaking though, how does asset allocation, especially the stock and non stock split, affect withdrawal rates?
- [15:23]
William Bengen
There's a certain minimum percentage of stocks you need to have in your portfolio to get the highest withdrawal rate you can. However, if you try to raise stocks to too high a level, it may be counterproductive because during a major bear market your portfolio could lose 50% or more and that's tough to come back from in any reasonable time frame. So you know that's the nature of the beast.
- [15:50]
Robert Brockamp
So a good range is around. What would you say is a minimum stock allocation and then maybe a maximum that most people would be appropriately Used.
- [16:00]
William Bengen
I think most people can handle at least 50, and I'm doing research right now that indicates that it may be better to have more than 55, 40. You know, maybe we should be at 65. I read a model right now at 65% stocks and it's generating higher withdrawal rates than the would have been under the my earlier analysis. So I'm still learning here and as soon as I get a conclusion I will pass it along. But I think higher stock allocations are probably beneficial. You just have to be careful. You don't want to have a stock allocation when you retire and you know you're going to have a big bear market or likely to have one. Probably best be a little conservative and then after the smoke clears, go to your higher allocation.
- [16:45]
Robert Brockamp
I thought one interesting insight from your book was that you include the safe withdrawal rate for a simple two asset portfolio of bonds and large cap stocks. And the safe max really starts to tail off at allocations above 75% stocks. But then when the stock allocation is more diversified with five categories of stocks, not only does it boost the safe withdrawal rate, but the drop off beyond 75% isn't nearly as sharp. It's an excellent illustration of the power of diversification.
- [17:14]
William Bengen
I think you're absolutely right.
- [17:15]
Robert Brockamp
I should point out too that you also examined the allocation between cash and bonds. In your case, bonds were intermediate term government bonds. There's a pretty linear relationship between that cash bond split and the safe withdrawal rate. More cash equals a lower rate.
- [17:34]
William Bengen
That's right, because cash doesn't pay much. It's not very volatile. But today it's better than it was, let's say five, six years ago when I was paying practically zero. But you're not going to get a good withdrawal rate having a lot of money in an asset generating just 4%.
- [17:50]
Robert Brockamp
Let's move on to portfolio management. You looked at how often retirees should rebalance their portfolios, but also whether they should be decreasing or increasing their stock allocations over the course of their retirements. Let's start with the rebalancing question. How often do you think folks should be rebalancing, which is basically moving back your portfolio to some sort of originally intended allocation?
- [18:16]
William Bengen
Yeah, to a certain extent it depends upon the retiree circumstances whether they retire into a bull market or a bear market. But overall, Looking across all 400 retirees I study, a period of about one year appears to be optimum. It may always, not always generate the highest withdrawal rate, but we don't know in advance what rebalancing interval will generate. So one year seems to work pretty darn well in the vast majority of cases.
- [18:47]
Robert Brockamp
Talk a little bit about your analysis of whether people should be decreasing their stock allocation as they go through retirement or whether it actually makes sense to increase their allocation to equities.
- [18:58]
William Bengen
Yeah. I tested a scheme that was developed by two fellow advisors, Wade Pfau and Michael Kitces. Back about 10 years ago. They published a paper in which they investigated starting with a low stock allocation, let's say 30, 40%, and then increasing it 1 or 2% a year during retirement. And their conclusion, surprisingly, was that that had a beneficial effect on withdrawal rates. It gave them a bump. It wasn't huge, but it was significant, worth considering. I suspect, and their conclusion is correct, that the reason this counterintuitive thing seems to work is that because when you're in a bear market early in retirement, you're going to find out lower stock allocation is beneficial. You will lose less. Meanwhile, after the bear market is over, you're increasing your stock allocation. You're buying stocks aggressively into a rising market, which can only help you.
- [19:54]
Robert Brockamp
Let's move on to our final question here. Bill, you are an internationally recognized retirement expert, but you've also been retired yourself for more than a decade. So how's it going? Were there any bigger surprises? And do you have any recommendations, financial or otherwise, for those who are preparing to make the transition from work to retirement?
- [20:13]
William Bengen
Well, I'm really enjoying retirement. I went into the mindset that there are four things that are important. Family, friends, your health and passions, you know, hobbies, interests. If you cultivate all four of those, not only during retirement, during your whole life, I think you'll have a very successful life and a very satisfying one. But I find once you let one lapse, it starts to affect the quality of your life.
- [20:43]
Robert Brockamp
That is excellent advice. You know, Bill, I first interviewed you almost 20 years ago, and ever since, I've peppered you over the years with so many random questions, and you've always replied with thoughtful responses. So I'd just like to thank you personally for being so generous with your research over the years and to congratulate you on the new book. I highly recommend it. Thank you so much for joining us.
- [21:05]
William Bengen
My pleasure. Thanks for inviting me.
- [21:08]
Robert Brockamp
And that's the show. As always, people on the program may have interest in the investments they talk about, and the Motley fool may have formal recommendations for or against. So don't buy or sell investments based solely on what you hear. All personal finance content follows Motley fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our Show Notes. I'm Robert Brockamp. Full on, everybody.