Once upon a time, in southern California in 1994, there lived a man named William Bengen.⠀
His friends called him Bill.
Bill was a Brooklyn kid who studied aeronautics at MIT. He wrote a breakthrough paper on advanced model rocketry. He spent 17 years as an executive at a soft drink company. Eventually, he “retired” to sunny southern California.
Except he didn’t really retire.
Bill had too much spark for that. He went back to school for a masters in financial planning. He opened his own firm.
Then he started reading papers that made him scratch his head.
You see, at this time, the financial planning world had a simple story: the stock market returns 7 – 9 percent on average, so retirees can safely withdraw 7 percent of their portfolio each year.
Bill thought this math didn’t add up.
He decided to prove it.
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He studied every possible 30-year retirement window in American markets, kicking off in 1926. Window one: 1926-1955. Window two: 1927-1956. And on and on.
For each window, he imagined a simple portfolio: half in the S&P 500, half in medium-term government bonds.
Then he dug into two big questions:
First: When was the absolute worst time to retire?
The answer? 1966.
Those unlucky folks who retired then faced 16 years of market misery, from 1966 to 1982. If you were one of them… you were one sad, sad puppy.
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Second, in the absolute darkest timeline – the worst market conditions in history — what could a retiree safely take from their nest egg?
His calculations revealed a magic number: 4.15 percent.
Take that much in Year 1. Then take that same amount each year after, bumped up for inflation.
Even in the worst markets we’ve ever seen, the money would last.
This became known as the “4 percent rule” – a retirement planning north star.
The concept is simple: Pull 4 percent from your savings that first year. In later years, withdraw the same amount, adjusted for rising prices.
- If you have a $2 million portfolio, you could withdraw $80,000 in Year One, and $80,000 adjusted for inflation every following year.
- If you have a $3 million portfolio, you could withdraw $120,000 in Year One, and $120,000 adjusted for inflation every following year.
Your portfolio should weather any storm, if you follow this formula.
There’s also a quick math trick that pairs with the 4 percent rule.
Want to know your retirement number? Take the amount you need/want to spend each year and multiply by 25.
Let’s assume that your goal is to retire on $100,000 per year (excluding Social Security, pensions, or any other income). How big should your portfolio be?
Assuming you don’t own rental properties, or have any other residual income streams, the “multiply by 25” rule says that you’d need an investment balance of $100,000 x 25 = $2.5 million.
Simple enough.
But it might be flawed.
In the Dallas — Ft. Worth area lives a man named Dr. Wade Pfau.
He holds a Ph.D in economics from Princeton, a Chartered Financial Analyst designation, and a Retirement Income Certified Professional® designation.
He’s a former coeditor of the Journal of Personal Finance, twice received an editor’s award from the Journal of Financial Planning, and Investment News named him top “40 under 40” in 2014. He’s won awards from industry groups such as the Retirement Income Industry Association and the Academy of Financial Services.
Dude knows his stuff.
He’s critical of the 4 percent rule. He calls it a “research simplification” that ignores market performance.
In doing so, the 4 percent rule “creates the MOST sequence of returns risk,” Pfau says.
Here’s his full quote:
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…. ” uhhhh …. Sequence of who? what?” ….
Sequence-of-returns.
That’s financial jargon for a retiree’s worst nightmare: having to sell your stocks when they’re down in the dumps.
Picture this: It’s 2008. The market’s getting pummeled. But you need to sell stocks just to put food on the table.
Anyone who started retirement that year — forced to cash out when prices were in the gutter — never really recovered.
That’s the brutal reality of sequence risk.
And here’s the kicker: According to Dr. Pfau, the 4 percent rule – where you withdraw the same amount no matter what the market’s doing – actually makes this risk worse.
Not exactly a ringing endorsement.
I caught up with Bill Bengen at the Bogleheads conference in Minneapolis to ask about Dr. Pfau’s take.
His response? He nodded in agreement.
But then he dropped a bomb: For many folks, he said, 5 percent might be a perfectly fine withdrawal rate.
Five. Percent.
Wait … what?!
Let me get this straight: Higher market risk means we can take OUT more money?!
Here’s the twist: Bengen explained that 4 percent is the nuclear winter scenario. It’s what you’d need if you retired in 1966 — right before the markets got hit with a brutal combo of two recessions and skyrocketing 1970’s inflation.
But if you’re not retiring into financial armageddon? You’ve got more wiggle room.
And that scary sequence-of-returns risk? There’s a hack for that. Drop your stock exposure when you first retire, then dial it back up a few years later.
…. “um, do what?” ….
Okay, let’s back up.
Traditionally, we’re taught that you should lower your stock exposure as you age.
There’s even a (hyper-conservative) rule-of-thumb about asset allocation: invest “your age in bonds,” with the rest in stocks.
That traditional model looks like this:
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The older you get, the fewer stocks you hold. Simple.
But the U-shaped model, which both Bengen and Pfau support, looks like this:
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(Okay, it’s not really a “U,” because the left and right side aren’t equal. It’s more of like a …. a scoop?)
In this model, you reduce sequence-of-returns risk at the start of retirement by rebalancing away from stocks.
But after a few years, when you have the safety of knowing that your portfolio won’t get hammered at the beginning of retirement, you increase your stock exposure.
This is a jargon-y way of saying: shift gears.
Drop your stocks from 5th gear down to 3rd gear, ride that out, and then rev back up to 4th gear.
This advice flies in the face of the traditional model, which says your stock exposure should always decrease with age.
In that regard —
It’s counterintuitive AF.
But Bengen likes it so much, he refers to it as one of the “four free lunches” in financial planning.
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“Mmmm. Lunch sounds delicious. But what do you mean by ‘free lunch’?”
Bengen named four ways to boost returns — without taking on extra risk.
- Shift gears: Start with a higher stock allocation, dial it down when you first retire, then gradually increase it again as you age
- Don’t put all eggs in one basket: Spread money across different types of investments – stocks, bonds, real estate, and other assets
- Regular tune-ups: Periodically adjust your portfolio back to its target mix, selling the winners and buying the losers
- Small but mighty: Slightly overweight towards small company stocks (small cap), which tend to deliver bigger gains over time
This is the “getting something for nothing” — better rewards without higher risk — in the financial world.
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Bengen’s view? Don’t obsess over doomsday scenarios. No need to pinch pennies with a lower withdrawal rate.
Focus instead on grabbing those four risk-free rewards.
Additionally, he said, don’t panic about a recession. Those are temporary. Historically, recessions are short-lived and markets bounce back.
But DO panic about inflation. Once prices rise, they tend to remain higher forever.
Watch our full interview on Youtube.
Speaking of shifting gears —
“The announcements section of the newsletter has entered the chat!”
# 1: NYC Money Nerds – Let’s Meet IRL! 🗽
Your five fave finance podcasters are taking over Pianos Bar in NYC on Dec 12th.
The crews from Stacking Benjamins (Joe & OG), Earn & Invest (Doc G), and Retire Often (Jillian Johnsrud) — plus me — are gathering for a night of great conversation, cold drinks, and zero scripted content.
Tickets are $17.85 (oddly specific; blame our spreadsheet obsession), and they’re going fast.
# 2: This post is sponsored by Facet.
Facet: A Game-Changer in Financial Planning
Imagine if your gym membership fee increased every time you got stronger or lost weight. Sounds ridiculous, right?
Yet that’s essentially how many financial planners operate – the more your money grows, the more you pay in fees.
This business model is called “assets under management,” or AUM. You get charged based on a percentage of your portfolio. The larger your portfolio grows, the bigger of a bite your advisor takes.
It’s like being penalized for your success. Like a gym getting more expensive as you get closer to achieving your fitness goals.
You might be thinking: “Okay, well the AUM model sounds like it’s good for beginners.”
Nope.
Thanks to the nature of the AUM business model, many financial planners don’t even bother working with clients who don’t have a specific minimum portfolio size.
It’s not uncommon to find a financial planner who requires, say, a minimum of $500,000 or $1 million before they’ll entertain the idea of working with you.
So the AUM model — in my view — stinks for everyone. It deprives beginners of access to valuable personalized financial advice. And it’s a drag on the performance of larger portfolios.
Well, what if I told you there’s a way to get top-notch financial advice without feeling like you’re being penalized for growing your money?
Enter Facet – the financial planning membership that’s shaking things up with their flat-fee membership model.
Here’s the deal: Instead of watching your fees climb as your portfolio grows, Facet charges a transparent flat membership fee.
It’s like joining a gym for your finances – you know exactly what you’re paying, no matter how buff your portfolio gets. 💪
Think about it. With traditional planners, the more successful you are at growing your money, the more you pay in fees.
It’s like being charged extra for getting stronger at the gym. Doesn’t make sense, right?
But with Facet, you’re in control. You get the expert advice, without the anxiety of unpredictable costs. It’s designed for the modern investor – transparent, fair, and aligned with your success.
Their membership includes comprehensive and dynamic financial planning that evolves with you through every stage of your life – from tax strategy, to retirement planning, Facet has you covered. And with monthly check-ins to keep you accountable, you’ll never have to make a big financial decision alone.
I want you to know that I’m enormously picky about which financial services companies I partner with. Facet impressed me for two crucial reasons:
First, they’re eschewing the AUM model, which aligns perfectly with my philosophy on healthy financial planning.
Second, all Facet planners are Certified Financial Planner™ (CFP®) Professionals, always fiduciaries, and backed by a team of specialists.
Ready to take control of your financial future without the drag of percentage-based fees?
With Facet’s limited time kickstart offer* you’ll get $300 into your brokerage account if you invest & maintain $5k within your first 90 days, plus the $250 enrollment fee will be waived for new annual members.
This offer expires November 30, 2024. Head to facet.com/paula to book your free introductory call today.
*Offer applies to Core, Plus and Complete memberships and is not applicable to Foundations members. Terms and conditions apply.
Disclosure: Paula is not a member of Facet. She has an incentive to endorse Facet, as she receives cash compensation for introducing you to Facet. All opinions are her own and not a guarantee of a similar outcome.
Talk to you soon!
— Paula
P.S. Leave a comment on the Bengen interview — let us know your thoughts, questions, dreams and worries about investing and retirement!
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