by WES MOSS
Suze Orman is at it again!
In a 2023 interview for Moneywise, she took aim at the 4 Percent Rule. “I think it doesn’t work anymore,” she said. “I think it’s very dangerous.”
To say I take umbrage with her outlook is an understatement. Claiming that a time-tested retirement plan is irresponsible doesn’t sit well with me. Sure, every case is unique, but let’s not throw the retired baby out with the retirement bath water. Taking 4 percent, with a willingness to adjust up or down, has been a productive way to find happiness and security in retirement for many happiest retirees.
Suze worries about the rules and tax ramifications of Medicare B premiums and Social Security. She wants people to keep these in mind and possibly “. . . work until at least seventy, or longer so that your assets have more of a chance to build up . . .” I’m not saying there aren’t cases when this is necessary, but it’s unfair and untrue to deny that using the 4 Percent Rule of thumb as a guide can work for many retirees.
Suze does not budge. “I would not be using the 4 percent figure on any level,” she declared. Specifically, she wants retirees to withdraw 3 percent at most every year. On a million-dollar retirement portfolio, that 1 percent drop leads to a $10,000 annual difference. I just disagree. People work hard and save their entire lives, and I’m not interested in telling them to keep working forever. At some point, it’s okay to enjoy your life. Otherwise, what was the point?
Origin of the Story: The 4 Percent Rule
Let’s use some context and market history to defend the legitimacy of the 4 Percent Rule.
In 1994, William Bengen, an MIT aeronautics and astronautics graduate turned Certified Financial Planner™, made a historic discovery. He calculated actual stock returns and retirement scenarios over the last seventy-five years. He found that retirees who draw down 4 percent of their portfolio in their first year of retirement and adjust every year for inflation should likely see their money outlive them. (This scenario assumes a 50-75 percent allocation in stocks.) Based on his calculations, 80 percent of the time, nest eggs lasted fifty years. In the worst-case scenario, the money lasted thirty-five years.
In 2021, Bengen again broke news by revealing that “by adding a third asset class, small-cap stocks, investors could safely withdraw as much as 4.5% annually.” One-half of a percent may not seem like much, but that bump gives retirees a 12.5 percent increase in purchasing power, meaning they could possibly retire months or years ahead of their current schedule.
Is 4.5 percent the correct number? Everyone’s financial situation is unique, so there’s no exact answer. During my twenty years of helping people plan for retirement, I’ve found that starting around 4 percent and adjusting dynamically can be very effective. That might mean withdrawing less than 4 percent at times and possibly withdrawing up to 5 percent at other times. The more you roll with it, the less you depend on a roll of the dice.
I believe one of the scariest notions for retirees is the fear that their retirement savings won’t last. That’s why people like Suze Orman take such a harsh view of the 4 Percent Rule. To be fair, she’s not the only one. The Wall Street Journal cited a Morningstar study that “simulated future returns over a 30-year period and found that in a quarter of the simulations a half-stock, half-bond portfolio would run out of money if withdrawals stayed at 4%.” The article reported that the 4 percent strategy worked well from 1926 to 2020 but that beginning in 2021, that reality had changed because market forecasters predicted lower returns in future years.
Do I pay attention to studies like this? Of course. Do they change my view? Not so far. Indeed, it’s never a good idea to be close-minded and intransigent. But I also value what Warren Buffett said about people who try to make economic predictions. “Something different happens all the time. And that’s one reason economic predictions just don’t enter into our decisions. Charlie Munger – my partner – and I in 54 years now never made a decision based on an economic prediction.”
Warren Buffett’s mindset has worked well for him and his company, Berkshire Hathaway. I think it applies to retirement planning as well. None of us are fortune tellers. But we don’t need to be as long as we remain flexible and willing to adapt to a changing environment.
There have been other critics, too. In 2018, The Wall Street Journal published another article in which Wade Pfau, a professor at the American College of Financial Services in Bryn Mawr, Pennsylvania, argued that “3% is the new safe withdrawal rate.” Pfau doubled down in a 2020 Forbes article, arguing that the 4 Percent Rule should be replaced with a 2.4 Percent Rule. Note that Bengen’s 4.5 percent is almost double that of Pfau’s!
If widely respected financial gurus say 2.4 percent, what’s stopping someone down the line from calling for 1 percent withdrawal as the new normal? The retirement marathon is already hard enough. Would you even start the race if you could only withdraw 1 or 2 percent of your savings? Or would you just take on Suze Orman’s apprehensions and work until you die?
All of the doubters inspired my team and me to run our own numbers. We recreated and updated the 4 Percent Rule, replicating Bengen’s study, but with retirement withdrawals every year from 1929 to 2009, giving us eighty-two different retirement starting points. Using actual market data through 2022, we made multiple simulations with historically conservative average return estimates after that: 5 percent for stocks, 3 percent for bonds, and 3 percent for inflation.
We found that 59% percent of the time, the retirement funds lasted 50 years or more. In the worst-case scenario, the nest egg was depleted in 29 years. So, by my research, the 4 Percent Rule still can work, but you need to understand that it’s meant as a rule of thumb and needs to be adjusted over time to ensure its effectiveness.
Let’s walk through some examples:
Retirement begins on January 1st, 2000.
- The S&P 500 kicks off your retirement with a brutal run of returns: -9 percent, -12 percent, and -22 percent in the first three years.
- After using actual stock, bond, and CPI (inflation) numbers through 2022, we assume 5 percent stock returns, 3 percent bond, and 3 percent inflation.
- In this model, the money lasts 44 years.
Retirement begins on January 1st, 2008.
- Using actual returns through 2022, we assume 5 percent stock returns and 3 percent bond returns. In this model, we assume you don’t inflate your earnings every year.
- In this case, the money lasts 82 years!
- If inflation goes to 3 percent, spending goes from $40,000 to $133,000 in the last tested year. Even then, the money lasts 44 years!
Finally, let’s try January 1st, 2000, again, but this time with a 5 percent withdrawal.
- With actual returns and inflation, then 5 percent, 3 percent, and 3 percent for stocks, bonds, and inflation, respectively, the money still lasts 31 years!
Despite all of the media skepticism, we believe the 4 Percent Rule still works. And I believe the 4.5 Percent Rule passes the same muster as long as you remember that retirement planning is not a straight line. There isn’t, and never will be, an exact percentage that retirees need nor want to stick to each year, come hell or high water. Remember that these “rules” are guidelines, not laws etched in stone. Flexibility is the key.
In my twenty years of helping people plan for retirement, I’ve seen that using a dynamic approach to your nest egg is the key. Anywhere from 4 to 5 percent should be sustainable if you are willing to make adjustments. And there’s always the three-step dance between math (objective), common sense (subjective), and emotions (very subjective) like greed or fear.
My focus is on happy retirees. They’ve worked hard to save for an enjoyable life after their primary working years have passed. I want to help them max it out without running out. And as much as Suze Orman might hate to hear it, the 4 Percent Rule is a helpful tool for making that possible.
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