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Ten Reasons Why the 4% Rule is Too Simplistic for Retirement Planning
06-28-2012, 05:22 AM
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#1
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Dryer sheet aficionado
Join Date: Mar 2012
Posts: 40
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Ten Reasons Why the 4% Rule is Too Simplistic for Retirement Planning
Here is a link to Wade Pfau's blog writing about the risk of a simplistic 4% withdrawal rate. Dr Pfau has a PhD in economics from Princeton and is a very thoughtful writer on issues regarding personal financial planning for retirement. What he is saying makes a lot of sense to me. What do others think?
Jackson
Retirement Researcher Blog: Ten Reasons Why the 4% Rule is Too Simplistic for Retirement Planning
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06-28-2012, 07:11 AM
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#2
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gone traveling
Join Date: Apr 2009
Location: Eastern PA
Posts: 3,851
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I agree with his comments, but unless I missed it, the article does not comment on those lucky/blessed (as many on this forum are - including me) that retire earlier than what is considered "normal retirement age". Correction - I see he comments on this with #5.
For those that retire earlier than most (as I/DW did), without all our retirement income sources coming "on-line" on day one (including any pensions, SS, etc.) our withdrawl rate may exceed the "magic 4%" in the early years, but in fact may meet (or even be under, as we will be) once those delayed income sources become available.
For the general public? Upon my first read, he hits the high points...
Thanks for the info/link.
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06-28-2012, 07:18 AM
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#3
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: Nov 2010
Location: Sarasota, FL & Vermont
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Quote:
Originally Posted by rescueme
....For those that retire earlier than most (as I/DW did), without all our retirement income sources coming "on-line" on day one (including any pensions, SS, etc.) our withdrawl rate may exceed the "magic 4%" in the early years, but in fact may meet (or even be under, as we will be) once those delayed income sources become available.....
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+1 and I think it is important to focus on the ultimate rate rather than the ER rate.
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06-28-2012, 07:47 AM
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#4
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: May 2006
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I read the article and he brings up some good points. The item #7 indicates that the 4% rule Phau is referring to is achieved by taking 4% of the beginning portfolio and forever increasing it by the inflation rate. This is quite unrealistic as many 30 year periods will require mid-course corrections.
For this reason I'm tending towards using the 4% "of the current portfolio" approach. This generally will mean corrections each year to spending. It is most easy to implement if you can comfortably go down to 3% of the portfolio. Not everyone can go to 3% without suffering serious retirement spending issues.
This is an important point I've just come to realize. We just started taking SS and that has allowed us to go to 3% spending should a really bad stock market (plus maybe rising bond rates) take the portfolio down a lot. I'm not sure that I've ever seen this mentioned as a reason to take SS early, i.e. the ability to be more flexible in maintaining portfolio assets in poor market periods. Or more likely, it has been mentioned but it went right by me.
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06-28-2012, 07:54 AM
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#5
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
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I think of this diffferently though. Once I turn 62, I then have the option to take SS if investment markets sour and my WR becomes uncomfortably high, but I wouldn't exercise that option unless I needed to because if investment performance is such that my WR doesn't become uncomfortably high waiting to start SS also gives me financially attractive longevity insurance.
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06-28-2012, 08:33 AM
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#6
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: May 2006
Location: west coast, hi there!
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Quote:
Originally Posted by pb4uski
I think of this diffferently though. Once I turn 62, I then have the option to take SS if investment markets sour and my WR becomes uncomfortably high, but I wouldn't exercise that option unless I needed to because if investment performance is such that my WR doesn't become uncomfortably high waiting to start SS also gives me financially attractive longevity insurance.
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Certainly that is a good way to look it, as a starting plan. That's the way I started thinking.
We took SS at 64 because our withdrawals were higher then 4% partly because DS was in college and the markets of 2008-2009 didn't behave -- out sized declines. We did not plan on DS to be in college late but he was a late bloomer and now has graduated and found a job. So that is a really big help now. The SS gives us the emotional and financial flexibility to relax and enjoy things. Also we have a large expensive house and that is always a possible plan B revision should things get tighter in later years.
What I'm saying in a nutshell is that one can plan all this stuff, but then one decides to make mid-course corrections based on real life happenings. I know I'm not saying anything really original except it really happened to us, not just theory.
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06-28-2012, 08:35 AM
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#7
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
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Posts: 18,085
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So the Evil Dr. Pfau is at it again, eh? The simple answer is that nobody knows whether 1%, 4% or 8% or any other rate until after the fact. The best way to manage this is to start out with a modest number and remain agile, mobile and hostile.
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Ezekiel 23:20
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06-28-2012, 08:37 AM
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#8
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
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I agree that a key to living with a high WR would be flexibility in spending and potential backup moves if things don't go as planned.
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06-28-2012, 08:45 AM
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#9
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Thinks s/he gets paid by the post
Join Date: Jul 2006
Location: Denver
Posts: 3,506
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Wade Pfau, good as he is, is getting repetitive. Time to move on from the 4% rule.
I think the use of immediate annuities and bond-ladders has been also studied a lot - their advantages & disadvantages.
Real retired people use variable withdrawals.
I would like to see more research on failure rates on variable withdrawal schemes that rely partly on portfolio performance. Guyton made a start using historical data. I'd like to see Wade Pfau use those rules (or others like them) using the same forward looking model that he used for the traditional SWR.
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06-28-2012, 08:54 AM
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#10
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
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Quote:
Originally Posted by walkinwood
Wade Pfau, good as he is, is getting repetitive. Time to move on from the 4% rule.
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While I don't disagree, it's amazing how often people misuse the 4% rule even here, #5 is misused here over and over. I don't think several of the others are widely understood either, #2 & #3 for example. His top ten reasons would be a nice add to a sticky on the 4% rule if there is one...or good narrative to add to FIRECALC.
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No one agrees with other people's opinions; they merely agree with their own opinions -- expressed by somebody else. Sydney Tremayne
Retired Jun 2011 at age 57
Target AA: 50% equity funds / 45% bonds / 5% cash
Target WR: Approx 1.5% Approx 20% SI (secure income, SS only)
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06-28-2012, 08:58 AM
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#11
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Recycles dryer sheets
Join Date: Aug 2011
Posts: 106
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Great article. He makes some really great points, thank you for sharing!
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06-28-2012, 10:49 AM
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#12
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
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Yes, this has all been covered before. I don't disagree with what Pfau says about actually "using" the 4% rule, but for planning purposes, it seems to be the best we have. Having the 4% rule during planning gives us a "number" to shoot for in our stash and lets us know about when we might pull the trigger on ER. But, once the trigger is pulled, flexibility is the key for me. I would never slavishly use the 4% figure (plus inflation) to figure yearly withdrawal. I simply used the 4% rule to know when it was relatively safe to ER. YMMV
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Anything which can be used can be misused. Anything which can be misused will be.
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06-28-2012, 11:03 AM
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#13
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Moderator Emeritus
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Quote:
Originally Posted by walkinwood
Wade Pfau, good as he is, is getting repetitive. Time to move on from the 4% rule.
I would like to see more research on failure rates on variable withdrawal schemes that rely partly on portfolio performance. Guyton made a start using historical data. I'd like to see Wade Pfau use those rules (or others like them) using the same forward looking model that he used for the traditional SWR.
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I think he's laying the academic & research groundwork for whatever "Son of 4% SWR" will be called.
I'm tremendously enjoying his blog posts and his papers, and I think we're going to see a good variable-withdrawal system come out of his work.
And I'm not just saying that because he's smart enough to read this board and respond to our commentary!
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06-28-2012, 11:13 AM
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#14
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Thinks s/he gets paid by the post
Join Date: Apr 2006
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Quote:
Originally Posted by brewer12345
So the Evil Dr. Pfau is at it again, eh? The simple answer is that nobody knows whether 1%, 4% or 8% or any other rate until after the fact. The best way to manage this is to start out with a modest number and remain agile, mobile and hostile.
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Yes.
I respectfully apologize in advance for this comment, but I didn't see anything in the article that requires a CFA or PH.D. to deduce. OK, you can't just say 4% is the magic number, but what is the magic number? Where is the conclusion?
"3. The 4% rule is based on a tax-deferred portfolio. For those withdrawing from a taxable portfolio, taxes will play a bigger role than you may expect. Not only are taxes paid on withdrawals, but taxes must also be paid on reinvested dividends, interest, and capital gains when they accrue and even if they are not withdrawn. <snip>".
I'm not getting the part about taxes being paid on withdrawals after taxes are paid on dividends, interest, and capital gains.
Further, in the grand scheme of things, is there really that much difference between 4.15% and 3.67%?
This kinda reminds me of years ago when I was in a sales support role. The district had a $35 million sales quota, and the director hosted a nice luncheon for the sales teams to celebrate making quota. After lunch one of the AE's who was responsible for probably 25% or more of that quota left the room and returned with a dessert. The district manager quickly pointed out that dessert was not included in the luncheon package. A few minutes later, during the director's presentation, the AE stood up and said "Mr <director>, is it OK to get a refill on the iced tea?"
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06-28-2012, 11:17 AM
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#15
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Moderator Emeritus
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Quote:
Originally Posted by Rustward
Further, in the grand scheme of things, is there really that much difference between 4.15% and 3.67%?
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You mean, the difference between portfolio failure and portfolio survival?
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Co-author (with my daughter) of “Raising Your Money-Savvy Family For Next Generation Financial Independence.”
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I don't spend much time here— please send a PM.
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06-28-2012, 11:27 AM
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#16
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Thinks s/he gets paid by the post
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Quote:
Originally Posted by Nords
You mean, the difference between portfolio failure and portfolio survival?
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So if you started at 4.15%, and some years later realize you should have used 3.67%, what would you do?
1. Just shrug your shoulders and say the experts told you 4.15 was the number and blindly stick to it? or
2. Adjust to the new information?
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06-28-2012, 11:57 AM
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#17
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Moderator Emeritus
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Quote:
Originally Posted by Rustward
So if you started at 4.15%, and some years later realize you should have used 3.67%, what would you do?
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Well, sure, it's an important distinction. You'd prefer a retirement system that would give you more flexibility for mid-course adjustments (or at least "graceful degradation") instead of one that has a binary result-- a result which won't be apparent until it's nearly too late to do anything about it.
Guyton & Bernicke both proposed variable withdrawal systems that seemed like a good idea at the time but haven't exactly caught on with retirees or financial planners. I think Bob Clyatt's system is good, and it's simple enough not to overwhelm the average retiree with its "complexity".
I think Pfau's doing a great job of refining a proposal that, at times, appears to have mutually-opposed goals of maximal lifelong spending and zero failure. Better still he's an academic researcher and a credentialed professional who can move this through his fellow financial researchers and persuade financial planners to implement it.
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Co-author (with my daughter) of “Raising Your Money-Savvy Family For Next Generation Financial Independence.”
Author of the book written on E-R.org: "The Military Guide to Financial Independence and Retirement."
I don't spend much time here— please send a PM.
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06-28-2012, 06:50 PM
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#18
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Thinks s/he gets paid by the post
Join Date: Nov 2005
Location: North of Montana
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Wouldn't we all want to know exactly how much we can spend every year and die broke (or with mega-bucks for the kids).
Sorry, that ain't happening. People have back-tested just about any theory. The 4%, 30 year die broke has passed back testing. Will it pass future testing? Ask me (if I'm here) in 30 years.
IMHO, it's like fighting over how many angels can do whatever on the head of a pin. If you think 4% is too high, by all means keep working until you get to 3% (or 2%) or whatever. If you think it's too low, do what you will.
Different people will claim tell you different things about the future, but (trust me and I don't charge for this advice) no-one knows. Make your bed and ly in it.
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06-28-2012, 06:52 PM
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#19
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Administrator
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Quote:
Originally Posted by kumquat
Make your bed and lye in it.
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Sounds pretty basic.
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06-28-2012, 06:54 PM
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#20
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
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Quote:
Originally Posted by Gumby
Sounds pretty basic.
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Groan...
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Numbers is hard
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