Once upon a time, in southern California in 1994, there lived a man named William Bengen.
He read many claims, widespread at the time, that said that since the markets return at least 7-9 percent compounding rates on average, retirees could withdraw and spend 7 percent of their portfolio.
William had a hunch that this was misguided. He decided to prove it.
He looked at 30-year timespans in U.S. history, starting from 1926. The first timespan ranged from 1926 to 1955. The second timespan ranged from 1927 to 1956. And so forth.
He assumed that the retiree held 50 percent stocks, in the form of an S&P 500 Index, and 50 percent bonds, in the form of intermediate-term government bonds.
Then he asked two questions:
First, what was the worst-case scenario? Retiring in 1966. The 16-year timespan from 1966 to 1982 was extra-rough, and experiencing this sequence of returns at the start of retirement made for one sad, sad puppy.
Second, how much could an investor sustainably withdraw from her portfolio during that worst-case scenario? The answer was 4.15 percent in the first year, and 4.15 percent, adjusted for inflation, every subsequent year.
And thus, the 4 percent rule-of-thumb was born.
And we all retired happily ever after.
Or did we? This week’s episode features an interview with Dr. Wade Pfau, who offers counterintuitive ideas about retirement income.
Dr. Pfau is a Professor of Retirement Income at The American College of Financial Services.
He holds a Ph.D. in economics from Princeton. He’s a chartered financial analyst. He won two awards for “most outstanding contribution” from the Journal of Financial Planning. He won another award for “best paper in retirement planning” from the Academy of Financial Services.
This guy knows his stuff.
And he’s … cautious … about the 4 percent rule of thumb.
What are his concerns?
What can we expect?
And how much money can we spend in retirement — whether we enjoy a traditional or early retirement?
Find out in today’s episode.
Resources Mentioned:
- Retirement Researcher
- How Much Can I Spend in Retirement?, by Dr. Wade Pfau
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IKomrad
this episode was interested but it seemed to assume that all retirement income comes from investments, but everyone I know, both retired and nearing retirement has real estate rental income, royalties, online business, pensions, and other forms of income.
I really think that any discussion of retirement income has to include these income types as that is the reality of the situation.
I understand that retirement investment advisors think that 401k’s, hsa’s, 403b’s etc are the only game in town because that is their specialty, but for a realistic view all income types should be considered.
Paula Pant
I totally agree. The over-emphasis on retirement income from investment portfolios alone is one of my biggest pet peeves with the traditional retirement planning scene.
Financial planners and investment advisors are trained / structured / incentivized to focus on investment portfolios. And that means that most online retirement calculators, planning tools, etc., don’t factor for other sources of income. It’s a huge shortcoming.
I think it makes sense to conceptualize income from rental properties, online business, etc., in different spending buckets — e.g. “the income from my rentals will cover my groceries / gas / car insurance, the income from my book royalties will cover my travel, etc.”
Ty Roberts
This was an amazing podcast, Paula. I’m a big fan of the 4% Rule and am applying it to an early retirement so hearing Dr. Pfau’s take and confirming that I’m basically in-line with his thoughts was comforting.
Paula Pant
Thank you Ty! I’m impressed with Dr. Pfau’s work. He’s one of the only scholarly thinkers on retirement planning (a subject that’s been largely ignored by academia), and he’s done an amazing job of establishing this field at the academic level. Dr. Pfau is far ahead-of-the-curve with regards to his ideas.
Markola
Hi Paula, I’m a new listener and started with this episode, because it appealed as 52/54 year olds who want to downshift from full time jobs in 2 years. I’ve studied all this a lot and, like lKomrad above, think the 4% rule is too simplistic for our situation, and I resist the idea that it needs to be a 2.5% rule. Bleck…. I have compiled a VERY long list of safety levers we could pull before we end up eating cat food, as you too noted at the end of the episode.
The approach I’m noodling toward pooled risk/insurance income is to simply assume our seven figure portfolio will likely last at least 15 years until full SS, when we should get $70K/year. That is not crazy. 70k/year x 15 = $1,050,000, so that part goes into a bond index and we spend 1/15th year and treat interest earned as gravy. The rest goes into a 60/40 allocation from which we draw 4%. Voila, we manage sequence risk with a bond tent (U Shaped spend), pull about 5%/year in our case, and reach age 70 with 60/40 index portfolio, full SS and a paid off house. (I, for one, believe we will have most SS left but I know others do not). If all those safety margins go to heck, we rent or sell the paid off house at age 70 and downsize.
Point is, we can’t let even smart professors make the simplistic 4% rule become the 2.5% rule and keep us harnessed to the grindstone for decades out of fear. Thanks for your own inspiring efforts to show that is not by any stretch our only choice.