Really basic ? about the 4% rule

[disneysteve]

I should know this but does the 4% rule refer to just principal or does it include income?


Let's say you have $1 million and between interest, dividends, and capital gains, it throws off $40,000 in income which you draw out. Would that be the 4% even though you haven't touched the principal?

 

[MichaelB]

I should know this but does the 4% rule refer to just principal or does it include income?


Let's say you have $1 million and between interest, dividends, and capital gains, it throws off $40,000 in income which you draw out. Would that be the 4% even though you haven't touched the principal?

Yes. The withdrawal amount is a % of the total portfolio value, which includes dividends and interest.

 

[Retireby45ish]

Yes. The withdrawal amount is a % of the total portfolio value, which includes dividends and interest.

Agreed. It’s total portfolio. Because remember when the portfolio pays out 40k in dividends the stocks go down by 40k on the ex dividend date. Equal to you selling 40k and being left with 960k if you held non dividend paying stocks.

Then hopefully the stocks appreciate and get ya back to 1m…or more…

 

[disneysteve]

Thanks. That's what I always thought.

 

[foxfirev5]

I just want to know where the 4% income comes from in today's environment. Furthermore there is no 4% rule. It's just a tabulation of historical returns. It may be better or worse in the future. Good luck.

 

[disneysteve]

I just want to know where the 4% in income comes from in today's environment.

True. I was just using the 40K on 1M for illustration, not because we can actually achieve it.

 

[CRLLS]

I just want to know where the 4% income comes from in today's environment. Furthermore there is no 4% rule. It's just a tabulation of historical returns. It may be better or worse in the future. Good luck.

It is a 4% rule (of thumb). It is not a guarantee. It is just a study of historical performance. You know the routine: "Past performance......."

 

[pb4uski]

I should know this but does the 4% rule refer to just principal or does it include income?


Let's say you have $1 million and between interest, dividends, and capital gains, it throws off $40,000 in income which you draw out. Would that be the 4% even though you haven't touched the principal?

Yes. But after that first year, withdrawals are inflation adjusted no matter what the portfolio did. So if inflation were 2% then the second year withdrawal would be $40,800 whether the portfolio balance at the end of the first year is $800k, $1m or 1.2m. If inflation for the second year was 3% then the withdrawal for the third year would be $42,024 no matter what the second year ending balance is.

So the base... $1m in your example... is always the retirement date value of the portfolio.

Some people think that it is 4% of each year's portfolio balance... but that is not the 4% rule.

 

[Dash man]

Yes. But after that first year, withdrawals are inflation adjusted no matter what the portfolio did. So if inflation were 2% then the second year withdrawal would be $40,800 whether the portfolio balance at the end of the first year is $800k, $1m or 1.2m. If inflation for the second year was 3% then the withdrawal for the third year would be $42,024 no matter what the second year ending balance is.

So the base... $1m in your example... is always the retirement date value of the portfolio.

Some people think that it is 4% of each year's portfolio balance... but that is not the 4% rule.

Yes, but there aren’t really any rules. The withdrawal amount can easily be adjusted downward if the market is doing poorly, as long as spending can be adjusted.

 

[pb4uski]

Well golly, of course you can do anything that you want to, but then you are not using the 4% rule.

The rule is based on the withdrawal rule that was used in the Trinity Study, which increase withdrawals annually for inflation and concluded that a 4% initial withdrawal rate increased for inflation survived for at least 30 years 95% of the time. If you use a different withdrawal scheme then the likelihood of portfolio survivability could change.

Or put another way, the conclusion on portfolio survivability was based solely on 4% inflation adjusted withdrawals.

 

[Dash man]

Well golly, of course you can do anything that you want to, but then you are not using the 4% rule.

The rule is based on the withdrawal rule that was used in the Trinity Study, which increase withdrawals annually for inflation and concluded that a 4% initial withdrawal rate increased for inflation survived for at least 30 years 95% of the time. If you use a different withdrawal scheme then the likelihood of portfolio survivability could change.

Or put another way, the conclusion on portfolio survivability was based solely on 4% inflation adjusted withdrawals.

But who enforces the rule that you’re dead after 30 years? [emoji23][emoji23]

 

[Markola]

^^^^^^^ Or dead before 30 years, resulting in excess unused stash? It also doesn’t allow earning any income in retirement, taking social security, rental income, selling one’s home and downsizing, moving to a lower cost of living area, receiving any inheritance, not spending the full inflationary increase each year, diversifying internationally or more aggressively, or the 95% of market scenarios over the next 30 years that ended up being better than the 5% worst case ones, which meant one could have enjoyed spending MORE than 4%.

 

[OAG]

I am 80 plan to live to be 100 (odds are not good to make it). Regardless I use the 5% Rule (personal rule). Plan is to go out like I came in - Broke.

 

[pb4uski]

But who enforces the rule that you’re dead after 30 years? [emoji23][emoji23]

Who said anything about dead in 30 years? Think.

 

[pb4uski]

^^^^^^^ Or dead before 30 years, resulting in excess unused stash? It also doesn’t allow earning any income in retirement, taking social security, rental income, selling one’s home and downsizing, moving to a lower cost of living area, receiving any inheritance, not spending the full inflationary increase each year, diversifying internationally or more aggressively, or the 95% of market scenarios over the next 30 years that ended up being better than the 5% worst case ones, which meant one could have enjoyed spending MORE than 4%.

But you aren't getting it. The rule isn't an optimization rule, it is a avoid financial ruin rule... and its more of a guideline than a rule but that's a whole nother discussion.

And its obviously only focused on investment withdrawals. perhaps you shuld read or at least scan the study before criticizing it.

 

[Markola]

I do get it, have obviously have read it and am choosing to use it as a guideline, as you say. If applied as a formula, I don’t doubt the 4% Rule will work well as described. Making it the basis of one’s FIRE plan, as the OP implies he/she might be doing, requires many people to work far longer than may be necessary, which is a rather giant problem with the guideline.

 

[disneysteve]

I do get it, have obviously have read it and am choosing to use it as a guideline, as you say. If applied as a formula, I don’t doubt the 4% Rule will work well as described. Making it the basis of one’s FIRE plan, as the OP implies he/she might be doing, requires many people to work far longer than may be necessary, which is a rather giant problem with the guideline.

Just to be clear, I'm not making the 4% thing the basis of my retirement plan. It is one measure that I look at certainly, but it's not the only one. I just wanted to make sure I properly understood what that 4% represents.

 

[Midpack]

I do get it, have obviously have read it and am choosing to use it as a guideline, as you say. If applied as a formula, I don’t doubt the 4% Rule will work well as described. Making it the basis of one’s FIRE plan, as the OP implies he/she might be doing, requires many people to work far longer than may be necessary, which is a rather giant problem with the guideline.

I don't know anyone who's blindly followed/following the 4% SWR methodology, but it was never intended to be used in that way even by Bengen or the Trinity Study authors, it was/is an academic study used for planning purposes. The retiree should monitor and make adjustments accordingly depending on how future returns unfold. For whatever reason this needs to be repeated here over and over...

The Trinity study authors noted in 1998 "The word planning is emphasized because of the great uncertainties in the stock and bond markets. Mid-course corrections likely will be required, with the actual dollar amounts withdrawn adjusted downward or upward relative to the plan. The investor needs to keep in mind that selection of a withdrawal rate is not a matter of contract but rather a matter of planning."

In 1994 Bengen said "the 4% withdrawal rate ("Four percent rule") as a rule of thumb for withdrawal rates from retirement savings." He has restated this many times since 1994...

But I am sure many retirees will continue to misinterpret the intent of SWR...

 

[CRLLS]

I do get it, have obviously have read it and am choosing to use it as a guideline, as you say. If applied as a formula, I don’t doubt the 4% Rule will work well as described. Making it the basis of one’s FIRE plan, as the OP implies he/she might be doing, requires many people to work far longer than may be necessary, which is a rather giant problem with the guideline.

As I see it we are talking about different "rules". The 4% rule says you have a 95% chance of not running out of money. For a 65 year old entering retirement, that would be to live to age 95 with a high chance of success. As I understand it, the current 50/50 life expectancy point is around age 85(Ish). If both of these are somewhat true, of course one would most likely die leaving a large stash.

The 4% rule is for a 30 year retirement.

understanding it is a different calculator, try working I-orp or firecalc with a termination date at the average age of both 95 and 85. The amount of savings required to support one's expected expenses, differs widely. So yes planning and saving for age 95 (DW and I are using age 100) will require working longer than age 85 which is where 50% of the population leave this earth. Working only to get a 95% success at age 85 is all that the "average" person needs to do. None of us are average.

 

[marko]

I just want to know where the 4% income comes from in today's environment.

My dividends, interest and MF cap gains come in around 4.9% on a 15 year average. This year was 5.52% with a high of 7.3% in 2018 and a low of 3.11% in 2011. This year's dividends were low at 1.98% but MF cap gains were about 3.7%

 

[Markola]

Regardless of whether anyone realistically employs every detail of the Trinity Study, which is probably rare, it is is undeniable that the belief that one needs at least 25X annual spending accumulated before they can retire is very common and quite strongly insinuated among DIY retirement enthusiasts. That’s what my comment was about.

How many posters do we see here who say that, because of x,y or z forecast, they are only pulling 3.5% or even less? And there’s another string currently about how Bengen now says one can pull 4.5%. Well, if the objective is to prevent disaster, simply factor in social security and home equity and suddenly all of those percentages are suddenly too conservative for many, if not most, retirees. It’s a fine personal choice to spend less than one can. However, that 25X benchmark is tragic if it is causing people to stay in unhealthy work situations longer than they need to. Fortunately, the OP clarified his intentions.

I don’t think I’m disagreeing with others above. Like them, I am pointing out some of the limitations of what we’re all saying is just a 4% guideline that should be adjusted for an individual’s circumstances, where we each have many levers to pull and inputs to factor over very long time horizons.

 

[Animorph]

If you follow the 4% rule rigorously then the study that generated it applies directly to what you're doing. If you only loosely follow the rule the study is less applicable to what you are doing.

Back when the study first came out, when I was thinking of retirement, it was a bit of a revelation that even if you withdrew only an inflation-adjusted 4% of your initial portfolio you could still run out of money. It seemed like hardly anyone was really looking at this. 10% withdrawals seemed way more popular, understandably. It was a good warning that you only have one shot at retirement. You don't get to do it over if the market didn't meet your expectations.

 

[Exchme]

One of the better ideas is the Total Portfolio Allocation and Withdrawal method. The idea is that it solves for annual withdrawals like an amortization table, but can handle lumpy cashflows like SS starting a few years in or a bequest that you wish to make at the end. There is a simple spreadsheet version of it at Bogleheads. I'm not a fan of the author's desire to have us fund certain expenses from TIPS, but you can just leave that column blank if you want and the sheet will give you a feel for the allowed spending. Of course, this is a variable method that would have to be re-assessed each year and that may produce quite unsatisfactory spending for the marginal retiree in a down market.

Early Retirement Now discussed a 1/CAPE idea that cushions the change in withdrawals, but of course takes longer for the portfolio to recover and doesn't consider the expected lifetime.

Ultimately bad events are bad events and we have to react by taking a bigger risk of running out of money in the future, or we can cut back today or if really desperate could increase the overall riskiness of the portfolio and hope for the best.

 

[corn18]

Why does every 4% post have to devolve into a debate about what a rule is? Happens every time on bogleheads and now it's showing up here. It's just a study that drew a conclusion from data. Sure is better than what they used before Bengen's work. Where's the "pulled it out of my arse" emoji?

 

[foxfirev5]

My dividends, interest and MF cap gains come in around 4.9% on a 15 year average. This year was 5.52% with a high of 7.3% in 2018 and a low of 3.11% in 2011. This year's dividends were low at 1.98% but MF cap gains were about 3.7%

Agreed that the past has been good for most. However, as I roll CD's and look at declining SEC yields on MF's I tend to agree with the oft quoted 1% fixed return over the next 10 years. This will almost certainly be a drag on total portfolio returns particularly if you believe in reversion to the mean when it comes to equities. I am hoping for 3% overall with a 45/55 AA gradually rising to 50/50 over the next few years. Meanwhile I'll keep an eye on the total portfolio value and gauge my withdrawals accordingly.